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DATE

• Wednesday, July 30, 2025, at 11 a.m. EDT

CALL PARTICIPANTS

• Chairman, President, and Chief Executive Officer — Katherine Gates
• Senior Vice President and Chief Financial Officer — Mark Marinko
• Chief Strategy Officer — Shantanu Agrawal

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RISKS

• Net income attributable to SunCoke Energy (GAAP) fell to $0.02 per share in 2025, driven by the timing and mix of lower contract coke sales, reduced earnings from the Granite City contract extension, declining CMT volumes, and $5.2 million in acquisition-related transaction costs in Q2 2025.
• Spot coke sales margins are "significantly lower than the contract sold coke sales margins due to the current challenging market conditions," according to Marinko.
• CMT terminal handled lower volumes in the logistics segment owing to "tepid market conditions," contributing to a decline in adjusted EBITDA for Q2 2025.

TAKEAWAYS

• Consolidated Adjusted EBITDA: $43.6 million, down from $63.5 million in the prior year period, primarily due to lower contract coke sales, less favorable Granite City economics, and reduced logistics volumes, partially offset by lower legacy black lung expenses.
• Phoenix Global Acquisition: $325 million purchase expected to close August 1, 2025, on a cash-free, debt-free basis, funded by cash and revolver borrowings, representing roughly 5.4x LTM adjusted EBITDA; projected annual synergies of $5 million-$10 million.
• Domestic Coke Segment EBITDA: $40.5 million, with adjusted EBITDA impacted by adverse contract/spot mix at Haverhill and weaker Granite City performance.
• Logistics Segment EBITDA: $7.7 million on 4.8 million tons throughput. Barge unloading expansion at KRT completed and new take-or-pay coal handling agreement to drive second-half results.
• Liquidity Position: $186.2 million in cash and $350 million undrawn revolver, yielding total liquidity of $536.2 million.
• Dividend Declared: $0.12 per share dividend payable Sept. 2, 2025; $10.2 million paid in the quarter.
• Revolving Credit Facility Extended: Now matures July 2030, down to $325 million from $350 million, with similar covenants.
• Free Cash Flow Guidance: Free cash flow guidance is now expected to be between $103 million and $118 million in 2025, lowered to reflect the Phoenix transaction, debt costs, and a new tax bill in full-year 2025 free cash flow guidance; guidance for operating cash flow unchanged.
• Full-Year Guidance Reaffirmed: Consolidated adjusted EBITDA (non-GAAP) expected to be between $210 million and $225 million for full-year 2025; Domestic coke adjusted EBITDA guidance range of $185 million to $192 million in 2025; Full-year logistics adjusted EBITDA guidance range of $45 million to $50 million.
• CapEx Guidance: CapEx guidance has been lowered to approximately $1 million in 2025 after spending $12.6 million in the quarter.
• Phoenix Integration: Will combine operations with the logistics segment to form a new industrial services segment, bringing new international reach and customer diversification, including electric arc furnace operators.
• Coke Sales Volume Outlook: 2.0-2.1 million tons projected for the second half of 2025 for an annual total of approximately 4 million tons of coke sales in 2025, with per-ton adjusted EBITDA expected to normalize to $46–$48 in the second half of 2025, based on mix.
• New KRT Throughput: The logistics volume increase in the second half of 2025 is anticipated to stem mainly from the KRT terminal's expansion project.
• Phoenix Revenue Profile: Contracts are long-term, carry fixed and pass-through revenue, and limit commodity price risk by avoiding consumables ownership.

SUMMARY

SunCoke Energy (NYSE:SXC) announced it will close its $325 million acquisition of Phoenix Global on Aug. 1, supported by a newly extended $325 million revolving credit facility now maturing in July 2030. Adjusted EBITDA of $43.6 million in Q2 2025 reflected reduced contract coke volume and logistics softness, confirming management's position that this quarter represents the earnings low point for the year. The company reaffirmed full-year consolidated adjusted EBITDA guidance of $210 million to $225 million for 2025 and updated full-year 2025 free cash flow guidance to $103 million to $118 million, citing transaction costs and tax law changes. A quarterly dividend of $0.12 per share was declared, and total liquidity stood at $536.2 million. SunCoke leadership signaled that Phoenix will be integrated as a new industrial services segment, diversifying its customer base and operational footprint.

• Chief Financial Officer Marinko stated, "We believe Q2 2025 to be the trough of the year, and with higher contract coke sales expected in the second half, we are reaffirming our domestic coke adjusted EBITDA guidance range" of $185 million to $192 million.
• Chief Strategy Officer Agrawal explained that reduced revolver capacity will not restrict Phoenix funding, as "$200 to $210 million" is expected to be drawn; the GPI project would require separate financing.
• Management is in "active discussions" regarding contract renewals with the largest customer, despite external commentary on potential reductions in third-party coke demand.
• Lower CMT volumes in May and June shifted into July, supporting management's unchanged logistics segment guidance despite market volatility.
• Phoenix's "last twelve months trailing adjusted EBITDA of about $61 million (non-GAAP, for the twelve months ended March 31, 2025)" remains a baseline as SunCoke completes integration and explores organic growth from new customer exposure.

INDUSTRY GLOSSARY

• CMT: Convent Marine Terminal, a bulk export terminal operated by SunCoke handling coal and other materials.
• KRT: Kanawha River Terminals, a logistics asset for coal and other dry bulk material handling within SunCoke's portfolio.
• Blast Coke: Metallurgical coke used in blast furnace steelmaking, distinct from foundry coke or spot coke sales.
• Foundry Coke: A high-quality coke sold to foundries for metal casting, generally with higher margins than blast coke.
• Take-or-pay Agreement: A long-term logistics contract obligating a customer to pay for a minimum volume, securing revenue for the operator.
• Electric Arc Furnace (EAF): A steel production process that uses electricity to melt scrap and reduce iron, with different coke requirements than blast furnace operations.
• Spot Coke: Coke sold on the open market at prevailing prices rather than through fixed, long-term contracts; typically carries lower, more volatile margins.

Full Conference Call Transcript

Katherine Gates: Thanks, Shantanu. Good morning, and thank you for joining us on today's call. This morning, we announced SunCoke Energy, Inc.'s second-quarter results. I want to share a few highlights before turning it over to Mark to discuss the results in detail. We delivered Q2 2025 consolidated adjusted EBITDA of $43.6 million, driven by the timing and mix of contract and spot coke sales, as well as lower volumes at CMT. During the quarter, we announced the acquisition of Phoenix Global for $325 million. We are happy to share that we received the necessary regulatory approvals faster than anticipated and now expect to close on August 1.

Additionally, we amended and extended our revolving credit facility originally due June 2026 during the month of July. Covenants are similar to the previous agreement, and it is now maturing in July 2030. Earlier today, we also announced a $0.12 per share dividend payable to shareholders on September 2, 2025. From a balance sheet perspective, we ended the second quarter with a strong liquidity position of $536.2 million. I would like to take this opportunity to review the fundamentals of the Phoenix acquisition. Let's turn to Slide four. Phoenix Global is a leading provider of mission-critical services to major steel-producing companies.

SunCoke Energy, Inc. will purchase 100% of the common units of Phoenix for $325 million on a cash-free, debt-free basis, representing an acquisition multiple of approximately 5.4 times on a March 31, 2025, last twelve months adjusted EBITDA of $61 million. This transaction is expected to be immediately accretive for SunCoke Energy, Inc. We will fund the purchase through a combination of cash on hand and borrowing on our amended and extended revolver, which is fully undrawn with $325 million of borrowing capacity. We expect to recognize between approximately $5 million and $10 million in annual synergies from this transaction.

After closing, we will plan to host investor conferences where we will share updated guidance for SunCoke Energy, Inc., including Phoenix. Turning to Slide five to revisit the transaction benefits to SunCoke Energy, Inc. Phoenix is an excellent strategic fit with the core elements of our business, namely customers, capabilities, and contracts. With the addition of these operations, SunCoke Energy, Inc.'s reach will now extend to new industrial customers, including electric arc furnace operators that produce carbon steel and stainless steel. Phoenix's global footprint will add to our existing Brazil footprint, as well as select international markets. Phoenix's operations provide high-value, site-based services that are mission-critical to operational efficiency and reliability for steel mills.

SunCoke Energy, Inc. has a reputation as a critical partner in the steel value chain and as a reliable provider of high-quality industrial services through our logistics business. Similar to SunCoke Energy, Inc., Phoenix's contracts are long-term in nature, with contractually guaranteed fixed revenue and pass-through components. Additionally, under its current contracts, Phoenix does not take ownership of major consumables, reducing exposure to commodity price volatility. Phoenix offers a well-capitalized asset portfolio, having invested approximately $75 million since June 2023 on new equipment or the refurbishment of existing equipment. New customers and new markets provide multiple paths for future organic growth.

By leveraging SunCoke Energy, Inc.'s strong financial position and operational excellence, we will build upon Phoenix's success to better serve our existing and new customers. Following the closing of the transaction, we expect Phoenix's operations will be combined with our logistics segment to form a new industrial services segment. We are pleased to have a strong operator within SunCoke Energy, Inc. to lead the new operations. He will be joined by certain Phoenix employees whose knowledge and experience will be beneficial to the successful integration. We are excited to welcome Phoenix's team members to the SunCoke Energy, Inc. family as we build on the strong foundation set by the business in recent years.

With that, I will turn it over to Mark to review our second-quarter earnings in detail.

Mark Marinko: Thanks, Katherine. Turning to Slide six. Net income attributable to SunCoke Energy, Inc. was $0.02 per share in 2025, down $0.23 versus the prior year period. The decrease was primarily driven by the timing and mix of lower contract coke sales coupled with lower economics from the Granite City contract extension in the domestic coke segment. Additionally, CMT volumes in the logistics segment were lower due to market conditions. Finally, transaction costs of $5.2 million related to the acquisition of Phoenix Global also impacted earnings per share. Consolidated adjusted EBITDA for 2025 was $43.6 million compared to $63.5 million in the prior year period.

The decrease in adjusted EBITDA was primarily driven by the timing and mix of lower contract coke sales and unfavorable economics on the Granite City contract extension in the coke segment, and lower transloading volumes at CMT in the logistics segment, partially offset by lower legacy black lung expenses in corporate and other. Moving to Slide seven to discuss our domestic coke business performance in detail. Second quarter domestic coke adjusted EBITDA was $40.5 million, and coke sales volumes were 943,000 tons. The decrease in adjusted EBITDA as compared to the prior year period was primarily driven by the change in mix of contract and spot coke sales at Haverhill.

Additionally, spot coke sales margins are significantly lower than the contract sold coke sales margins due to the current challenging market conditions. Lower economics and volumes at Granite City from the contract extension also impacted domestic coke results. We believe the second quarter to be the trough of 2025, and with higher contract coke sales expected in the second half of the year, we are reaffirming our domestic coke adjusted EBITDA guidance range of $185 million to $192 million. Now moving on to Slide eight to discuss our logistics business. Our logistics business generated $7.7 million of EBITDA in 2025, and our terminals handled combined throughput volumes of 4.8 million tons.

The decrease in adjusted EBITDA was primarily driven by lower transloading volumes at CMT due to tepid market conditions. Our previously announced barge unloading capital expansion project at KRT has been completed and is operating. We expect to see benefits from the new take-or-pay coal handling agreement starting in the third quarter and reaffirm our full-year logistics adjusted EBITDA guidance range of $45 million to $50 million. Now turning to Slide nine to discuss our liquidity position for Q2. SunCoke Energy, Inc. ended the second quarter with a cash balance of $186.2 million and a fully undrawn revolver of $350 million.

Net cash provided by operating activities was $17.5 million and was impacted by income tax and interest payments as well as $5.2 million in transaction costs. We spent $12.6 million on CapEx and paid $10.2 million in dividends at the rate of $0.12 per share this quarter. In total, we ended the quarter with a strong liquidity position of $536.2 million. Our free cash flow guidance has changed as a result of the transaction costs related to the Phoenix acquisition, extension of the revolving credit facility, and the new tax bill that was recently passed.

We did not previously include transaction or debt issuance costs in our free cash flow guidance, but we now expect to incur between $12 million and $14 million related to these transactions during the year. We are now expecting our cash taxes to be between $5 million and $9 million and have also lowered our CapEx guidance to approximately $1 million during the year. We now expect our free cash flow guidance to be between $103 million and $118 million. Our operating cash flow guidance is unchanged. With that, I will turn it back over to Katherine.

Katherine Gates: Thanks, Mark. Wrapping up on Slide 10. The acquisition of Phoenix is a result of SunCoke Energy, Inc.'s disciplined pursuit of profitable growth to reward long-term shareholders. SunCoke Energy, Inc. is well known for our best-in-class safety, advanced technology, operational discipline, and strong financial position. We remain focused on safely executing against our operating and capital plan and maintaining the strength of our core businesses while working to integrate Phoenix's operations. Phoenix is a service provider of choice for steelmakers, and we look forward to continuously engaging with their customers to find new opportunities to expand the scope of services provided as well as enter into new contracts at other sites.

As always, we take a balanced yet opportunistic approach to capital allocation. We continuously evaluate the capital needs of the business, our capital structure, and the need to reward our shareholders, and we will make capital allocation decisions accordingly. Finally, we see improvement in both logistics and domestic coke in the second half of the year, and we are reaffirming our full-year consolidated adjusted EBITDA guidance range of $210 million to $225 million. With that, let's go ahead and open up the call for Q&A. We will now begin the Q&A session. If at any time your question has been addressed and you would like to withdraw, please let us know. The first question comes from Nick Giles with B.

Riley Securities. Please go ahead.

Nick Giles: Thank you, operator, and good morning, everyone. This is Henry Hurl on for Nick Giles. So to start off, you reaffirmed your annual guidance, and my math implies roughly a 22% increase in quarterly EBITDA for the remainder of the year to reach the low end of your guidance at $210 million. So my question is, can you walk us through the drivers of the improvement from here? And what are your assumptions around last coke sales volumes?

Mark Marinko: Sure, Henry. Thanks for the question. So as we talked about, if you look at our Q1 domestic coke adjusted EBITDA per ton, it was $55, and our Q2 is around $42 a ton. Right? And if you take the average of those two, we are right in the range of $46 to $48. That is kind of our annual guidance. So in Q3 and Q4 or the second half of the year, we expect to kind of get back to our average full-year EBITDA per ton range where the mix, you know, it was all about the mix. That's why we are talking about a mix between contract and spot sales. Right?

In Q1, we were very heavy on the contract side. In Q2, we were very heavy on the spot side. So in Q3 and Q4, this will kind of become normalized, and we will have roughly 2 to 2.1 million tons of coke sales in the second half, getting us closer to the 4 million tons guidance of the total coke sales. With the average domestic coke distributor margin of $46 to $48 a ton. So that's kind of on the coke side. On the logistics side, you know, we saw surprisingly lower volumes in May and June at CMT, and we are already seeing those volumes get picked up in July.

There were a couple of shipments in June that did not, you know, the timing of the ship kind of shifted to July. So we are going to pick that up in Q3. So we will go back to our normal run rate EBITDA for logistics as a whole in the second half. And that's how we are getting to our full-year adjusted EBITDA guidance range of $210 million to $225 million.

Henry Hurl: Understood. Thanks for that.

Nick Giles: And then could you also talk about the macro drivers of Phoenix Global? So I understand you have a large share of fixed and contracted revenues in place. Hoping to get more color on what moves the needle in the long term? Thanks.

Katherine Gates: Sure. So I think the short answer to your question is that we will have a lot more to say on Phoenix when we go out and do our investor days and roadshow following the close. As I said, you know, we are going to be closing on August 1, and then we will be working through, you know, opening balance sheet, taxes, some other valuation work. So we are going through, you know, that process now. I think what I can say in terms of drivers going forward is that we are very excited about having the EAF exposure, which really diversifies our customer base.

And, you know, as I said on our call when we signed, I think it is very, very critical to us that we use this as a platform for organic growth. So when we think about drivers, we see opportunities with our technical and our engineering teams to look to the customers and expand the suite of services that we are providing at sites where we are already operating, as well as looking to new sites to bring on new business. You know, what we said when we signed is that Phoenix had, you know, a last twelve months trailing adjusted EBITDA of about $61 million.

And what I can say today is that, you know, that business, despite some of the cyclicality and some of the challenges in the steel sector right now, that, you know, that is still not an unreasonable number to put out there as you think ahead to Phoenix. So we feel good about the business today in the foundation, and then our opportunity to expand it, bringing our operational excellence and our engineering and technical expertise.

Henry Hurl: Thanks. I appreciate the color there. And then one more for me. Could you also talk about the recent conversations with your largest customer and if there is any potential for renewal of the Haverhill contract? Or any other color on how to think about your contracts that are rolling off this year and the split between contracted versus blast coke?

Katherine Gates: Yeah. Absolutely. You know, frankly, we were extremely surprised by the comments on the Cliff's earnings call, given that we are in active discussions with Cliff on contract renewal. As we said back in January, we knew that Cliff did not need more coke in 2025. And that's why we announced in January that we were sold out even though, you know, the pricing in the spot market is not what we wanted it to be, but we sold out and we sold into the spot market knowing that Cliffs would not need more coke from us in 2025. So that is unchanged.

But at the same time, we were continuing contract discussions with Cliff, and we are continuing those discussions with them today. In terms of specific detail on volumes, etcetera, as you know, we do not talk about the specifics of our contract negotiations with our customers. So I cannot really say more than that, other than that we are in active discussions with them.

Henry Hurl: Okay. Thanks for that. To you and your team, continue best of luck.

Katherine Gates: Thank you. The next question comes from Nathan Martin with Benchmark Company. Please go ahead.

Nathan Martin: Thanks, operator. Good morning, everyone. And maybe just following up on that last line of questioning. Like you said, surprised maybe by some of the comments Cliff made. You know, they indicated they have got plenty of internal coke production post the Stelco acquisition. They do not need any third-party coke, you know, kind of going forward. You know, how if that's the case, like, how do you guys go about finding another long-term contract for that production in Haverhill? Is it a case where whoever Stelco was selling to previously could be a potential option?

Or, you know, could the shift to Cliffs using more internal coke lead to a balance disruption in the market that needs to be addressed with, you know, supply curtailments?

Katherine Gates: Sure. I mean, I think, you know, just the starting point is we continue to be in active discussions with Cliff, but we have also, and you have seen this over time, we have looked for ways to profitably sell our coke when we are not selling on a long-term contract basis. So whether that is selling foundry and selling more foundry going forward, that's certainly a very profitable avenue for us, and we have continued to grow our market share in the foundry market. We would also look to profitably sell our blast coke to other customers.

So while we obviously, you know, cannot get into any sort of discussions on that front, we have been able to profitably sell our blast coke even at these depressed prices. Selling into North America. We would continue to look to sell into the seaborne market if that was profitable. So that will continue to be our focus just as it has been in the past years.

Nathan Martin: I appreciate that, Katherine. Any thoughts, like, does this potentially upset the supply-demand balance here in North America or not necessarily if they continue or start using more internal coke?

Katherine Gates: Well, I think, you know, as we have said before, you know, there is a volume of coke that is needed for the volume of steel that is being produced. So, you know, if, for example, Cliffs is now using more of the Stelco coke, Stelco coke that was being used by another customer, as you pointed out before, would be a customer that we would pursue going forward. So from an overall kind of supply-demand balance, you know, we would understand that as being there today, and we would try to take advantage of that if things were moving.

Shantanu Agrawal: Nate, I would want to add a little bit. This is Shantanu. You know, like, if they are running at full capacity, I think the question is more on the Cliffs side. You know, if there is a capacity rationalization, permanently on their side, on one of the blast furnaces, that definitely disrupts the supply-demand balance of coke. Right? Then the structure looks very different. In the long run, if one of the blast furnaces, which had been running for a longer time, goes down, then, yes, it definitely disturbs the supply-demand balance of coke within Canada and the US, and that makes it a little bit challenging for us, you know, from that perspective. Right?

But if the assumption is that they continue running the blast furnaces, which they have been running and their demand stays the same, as Katherine mentioned, there is demand for that coke to go there.

Nathan Martin: Gotcha. Shantanu, I appreciate that. Maybe shifting to the logistics business. Again, you called out the weakness at CMT. Was that mainly coal, or was that any other product there first? And then how do you view kind of export coal demand over the next few quarters? Are you guys assuming any benefit at all from price adjustment given where the indices are today?

Katherine Gates: Well, in terms of products, you know, we move products other than coal through CMT, including iron ore, including pet coke. So there is a mix of products there, but the vast majority of the volumes there are, you know, are coal for export. We have seen higher domestic pricing and higher demand, you know, as we kind of look at the market today. And so that higher demand domestically can impact volumes being shipped internationally just based on that pricing.

But at the same time, as Shantanu mentioned earlier, we look at, you know, the volumes that we are shipping in July, and we look at what we have in our plan for the balance of the year, and, you know, we are reaffirming our logistics guidance based on what we see going forward. We are comfortable with that. In terms of any sort of, you know, price adjustment mechanism, we have not had a price adjustment thus far under the new contract, and we did not contemplate that in our guidance for 2025.

Nathan Martin: Got it. That's helpful, Katherine. And then just back to the guidance for a second. I know you reiterated your full-year adjusted EBITDA guidance for the segment. But I do not think I saw any update to the volume guidance. So should we assume you still feel good about handling, I think it was around 22.9 million tons for the full year? And if so, is that, you know, increase in tonnage here in the second half versus the first half mainly expected to come from the KRT expansion?

Shantanu Agrawal: That's right.

Nathan Martin: Okay. Perfect. Maybe just one final one. Again, congratulations on successfully amending and extending your revolver. Obviously, capacity did come down a little bit to $325 million from $350 million. You previously said, I think you expected to borrow about $230 million on the revolver for Phoenix. That lower capacity, does that impact your plans at all there for financing? And then does it still leave, you know, enough room to continue pursuing the GPI project?

Shantanu Agrawal: Yeah. So, Nate, I mean, actually, our borrowing amount for the acquisition is lower. It's closer to $200 to $210 million on the revolver, being more having more cash available on the balance sheet. So we are using that. And then, you know, that leaves us more than enough to do kind of, you know, work through the working capital changes. You know, we have been undrawn on the revolver for, like, at least a couple of years. So that leaves us enough capacity for our working capital day-to-day work.

On the GPI side, now that we have done the Phoenix acquisition, if we do the GPI project, that will lead us into a separate borrowing, and it will all be, you know, some sort of term loan or a note or something like that. So that will be a separate financing deal when we get into the GPI project.

Nathan Martin: Makes sense, Shantanu. And I guess I should just go ahead and ask, you know, are there any updates on that GPI project, any additional thoughts on the discussions you guys are having with Nippon at this point?

Katherine Gates: So we are in active discussions with US Steel. I guess, at this point, we would say US Steel because it is truly, you know, US Steel with Nippon, but we are in active discussions, but I do not have anything to share at this point.

Nathan Martin: Got it. I'll leave it there. I appreciate the time, Katherine and Shantanu, and best of luck in the second half.

Katherine Gates: Thank you.

Shantanu Agrawal: Thank you.

Operator: This concludes our question and answer session. I would like to turn the conference back over to Katherine Gates for any closing remarks. Please go ahead.

Katherine Gates: Thank you all again for joining us this morning and for your continued interest in SunCoke Energy, Inc. We look forward to announcing the completion of the Phoenix Global acquisition. Let's continue to work safely today and every day. Thank you for attending today's presentation. You may now disconnect.

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DATE

Wednesday, July 30, 2025 at 12:00 a.m. ET

CALL PARTICIPANTS

President & Chief Executive Officer — James Nesci

Chief Financial Officer — Kelly Pecoraro

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TAKEAWAYS

Net Loss—$2 million, or 10¢ per diluted share, representing a $735,000 improvement from the prior quarter.

Net Interest Income—Increased by $896,000, or 8.3%, driven by a 12 basis point expansion in net interest margin.

Loan Growth—Gross loans rose by $47.4 million, with approximately 3% growth, including a $22 million increase in commercial and industrial loans and a $12 million increase in construction loans year to date.

Core Deposit Growth—Core deposits expanded by nearly 4%, or $25.2 million, contributing to total deposit growth of $29.1 million; time deposits increased $3.9 million, offset by a $20 million increase in brokered deposits at lower rates.

Yield on Loans—Increased by eight basis points to 4.8%; yield on total interest-earning assets improved by seven basis points to 4.58%.

Cost of Deposits—Decreased by 13 basis points to 2.62%; cost of funds also fell 13 basis points to 2.72%.

Noninterest Expense—Declined by $90,000 from the prior quarter, primarily due to seasonal occupancy factors.

Provision for Credit Losses—$463,000 provision recorded, mainly for reserves on unfunded commitments scheduled to close.

Purchased Loan Activity—$45 million in credit-enhanced consumer loans and $19 million in residential loans were added to the balance sheet; consumer loans up by $76 million year to date through June 30, 2025.

Net Interest Margin Expansion—Net interest margin increased by 12 basis points, marking the third consecutive quarterly improvement.

Tangible Book Value Per Share—Rose by 6¢ to $14.87, up from the prior quarter.

Share Repurchases—406,000 shares repurchased at a weighted average price of $9.42, below tangible book value.

Capital Ratios—Tangible equity to tangible common assets at 15.1%, among the highest in the industry, according to management.

Asset Quality—Nonperforming assets and loans both increased by three basis points, reaching 30 basis points and 38 basis points of total assets and loans, respectively.

Allowance Coverage—Allowance for credit losses to total loans dropped one basis point; allowance to nonperforming loans fell to 211% from 230% sequentially.

Loan Pipeline—Letters of intent exceeded $40 million at quarter-end, mainly for commercial lending with anticipated yields above 7%.

Consumer Loan Strategy—CFO Pecoraro said, "We are comfortable going to about 7% to 8% of the loan portfolio over the next couple of quarters" for credit-enhanced consumer loans.

Expense Outlook—Noninterest expenses are expected to remain in the "mid to high $13 million range" over the next several quarters, with potential modest increases for variable compensation in the second half of the year.

Margin Guidance—CFO Pecoraro said, "We are only looking at a couple of basis point expansion probably in the third quarter," suggesting limited net interest margin expansion in the second half of 2025.

SUMMARY

Blue Foundry Bancorp(NASDAQ:BLFY) reported a sequential improvement in net loss and continued progress on strategic objectives, including portfolio diversification and disciplined capital management. Management emphasized the focus on higher-yielding asset classes, such as owner-occupied commercial real estate and credit-enhanced consumer loans, to drive returns and manage risk. Deposit growth was attributed to deepening commercial banking relationships and new product strategies in a competitive rate environment. Adjustments in deposit pricing, including the introduction of short-duration and eight-month CDs, were aimed at balancing funding cost and customer retention. Share repurchases were executed below tangible book value, and capital ratios remain among the highest in the industry. Asset quality metrics remain stable, with only modest increases in nonperforming assets and loans on a low base.

CFO Pecoraro detailed the future repricing schedule, noting approximately $75 million of loans set to reprice in 2026 at a current rate of 3.75% and $23 million scheduled to reprice in the remainder of 2025.

Purchased credit-enhanced consumer loans carry a 3% reserve, affecting allowance methodology.

CEO Nesci affirmed continued focus on operating efficiency, stating, "We are looking at everything. Constantly, especially expenses," and highlighted ongoing efforts to leverage technology and optimize staffing to control expenses.

Management highlighted strategic efforts to grow core deposits through comprehensive client relationship management, particularly within commercial banking.

INDUSTRY GLOSSARY

Core Deposits: Stable, non-brokered, typically lower-cost customer deposits considered more reliable during market disruptions.

Credit-Enhanced Consumer Loans: Consumer loans structured or purchased with additional protective features, such as third-party guarantees or reserves, to reduce loss risk.

Tangible Book Value: Book value of equity excluding intangible assets, frequently used to assess a financial institution's shareholder value and capital strength.

Full Conference Call Transcript

James Nesci: Thank you, Operator. And good morning, everyone. We appreciate you joining us for our second quarter earnings call. As always, I am joined by our Chief Financial Officer, Kelly Pecoraro, who will review our financial performance in detail following my update. Earlier today, we reported a net loss of $2 million or 10¢ per diluted share. We are pleased with the progress made toward our strategic objectives in the second quarter, and thus far in 2025. Despite the competitive environment, we are able to grow core deposits and the net interest margin for the third consecutive quarter.

This, coupled with our expense discipline of approximately $1 million versus last quarter, our strong capital liquidity position continues to support our transformation into a more commercially focused institution. This quarter's increase in core deposits reflects the deepening of our relationships with the businesses and communities we serve and marks continued progress. We achieved approximately 3% loan growth during the quarter while improving the yield on our loan portfolio by eight basis points. This was supported by $29 million in deposit growth, including an almost 4% increase in core deposits and a 13 basis point reduction in our cost of deposits. Together, these results contributed to a meaningful 12 basis point expansion in our net interest margin.

Loan production year to date totaled $180 million with $90 million produced during the second quarter at a weighted average yield of approximately 7%. Year to date, our diversification efforts have led to a $22 million increase in commercial and industrial loans, including owner-occupied commercial real estate. Additionally, construction loans increased $12 million while we thoughtfully decreased our multifamily portfolio by $37 million. We also saw a $76 million increase in consumer loans through June 30, primarily driven by purchases of credit-enhanced consumer loans at attractive yields. As we continue to execute our strategy of portfolio diversification, we remain focused on prioritizing asset classes that deliver higher yields and better risk-adjusted returns.

Growth in our owner-occupied commercial real estate and construction lending reflects our disciplined approach to supporting local businesses while managing credit exposure. Additionally, our investment in credit-enhanced consumer loans further enhances returns while maintaining a strong risk management framework. These portfolio shifts are aligned with our goal of driving earnings and long-term value creation. Our loan pipeline remains healthy, with executed letters of intent totaling more than $40 million at quarter-end, primarily in commercial lending with anticipated yields above 7%. We expect this momentum to continue in the coming quarters. Tangible book value per share increased to $14.87, up 6¢ from the prior quarter. We remain committed to enhancing shareholder value through disciplined capital management.

During the quarter, we repurchased 406,000 shares at a weighted average price of $9.42, a significant discount to our tangible book value and adjusted tangible book value. Both the bank and holding company remain well-capitalized, with tangible equity to tangible common assets among the highest in the industry at 15.1%. Our capital position and credit quality remain strong, and we are encouraged by the sustained momentum across both lending and deposit fronts. We believe these efforts will continue to support balance sheet and income growth in the coming quarters. With that, I will turn the call over to Kelly for a deeper look at our financials. After her remarks, we will be happy to answer your questions. Kelly?

Kelly Pecoraro: Thank you, James. And good morning, everyone. Net loss for the second quarter was $2 million. This is a $735,000 improvement to the prior quarter. We are encouraged by the positive momentum in net interest income, driven by unfunded loan commitments. Net interest income increased by $896,000 or 8.3%, driven by a 12 basis point expansion in our net interest margin. Interest income expanded $725,000, primarily due to loan growth. Interest expense declined by $101,000, reflecting lower deposit costs. The yield on loans increased by eight basis points to 4.8%, and the yield on total interest-earning assets improved by seven basis points to 4.58%. Our cost of funds declined by 13 basis points to 2.72%.

The cost of interest-bearing deposits decreased 13 basis points to 2.62%, and the cost of borrowings decreased nine basis points to 3.3%. Noninterest expense decreased by $90,000 compared to the prior quarter, driven primarily by seasonal occupancy expense. We are pleased that expenses have remained relatively stable over the past several quarters and continue to expect them to stay within the mid to high $13 million range. As we progress toward our growth targets and achieve corporate goals, we anticipate a modest increase in compensation expense in the second half of the year due to higher variable compensation costs.

For the quarter, we recorded a provision for credit losses of $463,000, primarily attributed to reserves required on unfunded commitments that are scheduled to close. As a reminder, in Q3, the majority of our allowance is derived from quantitative models, and our methodology continues to assign greater weight to the baseline and adverse economic scenario. From a balance sheet perspective, gross loans increased $47.4 million during the quarter. Organic growth was primarily in owner-occupied commercial real estate and construction. We also purchased $45 million in credit-enhanced consumer loans and $19 million in residential loans to support our residential portfolio. Our available-for-sale securities portfolio, with a duration of 4.1 years, declined by $2.4 million due to maturities, calls, and paydowns.

This was partially offset by purchases and a $1.7 million improvement in unrealized loss. Deposits increased $29.1 million or 2%. We experienced $25.2 million or approximately 4% growth in core deposit accounts. Importantly, growth in core deposits was fueled by full banking relationships with commercial customers, emphasizing our strategic focus on deepening client engagement in a competitive market. Time deposits increased $3.9 million as we strategically repriced promotional thinking and backfilled runoff with $20 million in broker deposits at lower rates. Borrowings increased slightly to help fund loan growth. Lastly, asset quality remains strong. Nonperforming assets increased due to a slight rise in nonaccrual loans.

Nonperforming assets to total assets picked up by three basis points, and nonperforming loans to total loans also ticked up by three basis points. Both remain low, at 30 basis points and 38 basis points, respectively. Allowance coverage decreased slightly, with the allowance for credit losses to total loans declining by one basis point, and the ratio of allowance for credit losses to nonperforming loans decreased from 230% to 211%. With that, James and I are happy to answer your questions.

Operator: Thank you very much. To ask a question, please ensure your device is unmuted locally. Our first question comes from Justin Crowley from Piper Sandler. Your line is open. Please go ahead.

Justin Crowley: Hey, good morning. Just wanted to start off on the margin and some of the drivers as you look ahead here. Can you quantify for us what loan repricing looks like through the back half of this year and then as you get into 2026? Just any detail on volume and then what the rate pickup looks like. I think you have mentioned previously that it is really next year when you see a lot of that multi-portfolio start to turn, but just wondering if you could put the numbers around that for us.

Kelly Pecoraro: Yeah. Sure. No problem, Justin. You are right. 2026 is really where we see a lot of the repricing taking place. In '26, we have about $75 million that is standing at a rate of about 3.75%. That is due to reprice not exactly equally during the year, but spread over the year in '26. For the remainder of '25, we have just about $23 million that is today at a rate of that is sitting at a rate of 75 that is going to reprice. Important to keep in mind throughout Q3 and Q4, we also have maturities that are coming in. Those maturities, the majority of them sit in the construction portfolio.

And there are current market rates while we have a nice pipeline of construction coming in, as you know, do not fund all upfront. So we will see a little lag in terms of the construction portfolio having maturities.

Justin Crowley: Okay. Got it. And then, I guess, on the CD side and maybe just assuming flat rates for a moment, through year-end. Who knows what we will get out of the Fed? But, you know, has the pricing opportunity there largely grown its course? And so would it really just take lower rates from here to see funding costs move appreciably lower? What is the thinking there?

Kelly Pecoraro: Well, from a CD perspective, we were keeping the book relatively short right around that three-month time frame. But we did introduce an eight-month CD that has extended that maturity. So we will not see that repricing of that book until January or February, as those CDs will mature.

James Nesci: Justin, I think there is also a market component to that question. It depends on what our competitors do in the marketplace. So we are obviously working through the market competition like everybody else, and we are keeping an eye on our deposit base and trying to make sure we produce products that our customers are interested in purchasing.

Justin Crowley: Okay. Helpful. And I guess just sort of putting it all together, obviously, a decent step up in the NIM through the first half of this year. Given kind of all the puts and takes, would you kind of expect expansion to be more limited through the back half of this year with 2026 really being when we start to see kind of more significant improvements in margin?

Kelly Pecoraro: Yeah. Justin, you have it absolutely right. We are only looking at a couple of basis point expansion probably in the third quarter. And then when we get to the fourth quarter, you know, that will depend upon pipeline and what is coming on and what happens in the market. But the expansion will be limited in the back half of the year.

Justin Crowley: Okay. I appreciate that. And then in terms of the consumer purchases, I know in the past, you said there is not necessarily a magic number in mind. But, you know, with the book at 5% of loans today, can you just give us a sense for thinking on adding to that portfolio from here, how that fits in?

Kelly Pecoraro: Yeah, Justin. So right. The it is right now, we are comfortable going to about 7% to 8% of the loan portfolio over the next couple of quarters.

Justin Crowley: Okay. And then can you just remind us that, you know, as far as the credit enhancements that come along with those, can you just boil down the exact structure of these credits and how much in the way of potential loss you are protected from?

Kelly Pecoraro: Right. So these come with a 3% reserve against these credits. So, you know, they do run through our normal allowance calculation. We look to see if there is any additional exposure there. But they are we have a 3% credit reserve against.

Justin Crowley: Okay. And then maybe just one last on a bigger picture question. You know, profitability is obviously still strained here, but at least moving closer to being in the black and, you know, it seems like, particularly next year, there are some margin tailwinds that will help over time. But, you know, is there anything else behind the scenes that you are looking into or weighing, whether that be from an expense standpoint? I know you gave guidance there. So either there or just wherever that could help accelerate that progress?

James Nesci: So what I would tell you is we are looking at everything. Constantly, especially expenses. And I noticed some of the early notes mentioned, you know, expense discipline. Kelly and I are very focused on looking for any dollars we can find. It is expensive to run a bank in today's age. It just takes people to run the bank. We have kept a close eye on our headcount. We have our people working as efficiently as we can. But with AI, we are always looking to gain new efficiencies. So those are the things that we are working through. What else can we do with fewer people and getting a greater output from our existing staff?

So those, I cannot give you a timing of when that happens, but I can tell you that is the type of stuff that we are constantly looking at.

Justin Crowley: Okay. Got it. Well, I appreciate everything. I will leave it there. Thanks so much.

James Nesci: Thanks, Justin.

Kelly Pecoraro: Thanks, Justin.

Operator: Our next question comes from David Conrad from KBW. Your line is open. Please go ahead.

David Conrad: Yes. Hey, good morning. Justin kind of went through the quarter pretty good there. So really just kind of have a very longer-term picture question. Kind of looking regarding, you know, the asset generation, but also kind of tied to the noninterest-bearing deposit levels. You know? I think it is kind of early days on C&I, but are you kind of thinking about, you know, how can we get that mix up and thinking about what type of assets you can generate maybe to grow the noninterest-bearing deposits?

James Nesci: Well, good morning, David. Thank you for joining our call today. Good morning. Yes. We are looking at it. The noninterest-bearing is obviously a key point for us to focus on. So we are not just looking at C&I. We are looking at our commercial real estate borrowers and we are trying to make sure that we get a full relationship from all borrowers, regardless of what asset class they may be borrowing in. And that has been working really well. We believe by providing good products to our customers, commercial or consumer, that we will get more of that core type deposit. And, again, it seems to be working. We are encouraged by that pathway.

And we will keep reaching out to our existing customers on the loan side to say, we really like your full banking relationship. So, yes, that is clearly part of the strategy, and we think it is working and will continue to work going forward.

David Conrad: Great. Perfect. Thank you.

Operator: We currently have no further questions. I would like to hand back to James Nesci for some closing remarks.

James Nesci: Thank you, Operator. I want to thank everybody who dialed in today to listen to the earnings call. Again, we are encouraged by the quarter and what we are starting to see, and it all stems from our dedicated employees out on the line working hard every single day. I want to acknowledge all of our customers and shareholders that have been with us. Some of you for a very long time have been shareholders that have stuck with us as we recreate our strategy and try to drive towards profitability. With that, I just want to say thanks again, and hope to speak with all of you again next quarter. Thank you.

Operator: This concludes today's call. We thank everyone for joining. You may now disconnect your lines.

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DATE

• Wednesday, July 30, 2025, at 10 a.m. EDT

CALL PARTICIPANTS

• Chairman and Chief Executive Officer — Albert Nahmad
• President — A.J. Nahmad
• Executive Vice President and Chief Financial Officer — Paul Johnston
• Executive Vice President — Barry Logan
• Executive Vice President and Chief Digital Officer — Rick Gomez

Need a quote from one of our analysts? Email [email protected]

RISKS

• Sales declined: Management stated, "Sales declined 4% as double-digit pricing gains for new equipment were offset by lower volumes."
• SG&A increased 6%: The company incurred extra costs from the A2L transition and the addition of new locations, with core SG&A growth higher than management's preference in a down quarter.
• Inventory peaked above expectations: CEO Albert Nahmad stated, "it's more than we had hoped for," with Inventory peaked at $2 billion before being reduced to $1.8 billion in Q3 2025.
• Residential new construction market down 15%-20%: Management cited, "RNC is probably down 15 to 20%."

TAKEAWAYS

• A2L Refrigerant Transition: Approximately 55% of historical product sales were affected by the 2025 transition to A2L refrigerants, impacting inventory, supply chain, and branch staffing.
• Sales Performance: Total sales declined 4% as double-digit equipment price gains were offset by lower volumes, with residential and international segments subdued.
• Gross Margin: management does not expect the 29% gross margin to be sustained in the back half of 2025 ("I don't want us to extrapolate that 29% into the back half").
• EBIT and EBIT Margin Growth: EBIT increased and EBIT margin expanded, driven by OEM pricing actions and digital pricing optimization, despite lower sales.
• SG&A Expense: SG&A rose 6% due to transition-related inefficiencies and acquisitions; approximately 25% of that SG&A growth was from recent acquisitions, with core SG&A trending about 4.5% higher.
• Inventory Levels: Inventory peaked at $2 billion and was reduced to $1.8 billion in Q3 2025, with less than 5% now comprised of legacy R410A and transition in progress to new A2L products.
• Digital and Technology Initiatives: E-commerce is now a $2.5 billion business, or 34% of our sales; Mobile apps now have 70,000 users and grew 17% versus last year; OnCallAir’s annual product volume increased 19% to $1.6 billion.
• Product Mix Shift: Parts and supplies, which carry higher margins, constituted about 30% of sales as of Q2 2025; management launched initiatives to expand this segment.
• AI Implementation: Two AI platforms -- internal and external -- deployed to leverage company and customer data for improved efficiency and growth strategies, with about 21 internal users weekly.
• National Customer Strategy: Watsco One sales platform targeting multi-location institutional customers is in development, planned for 2026 launch, designed to unify offerings and capture incremental opportunity outside core replacement business.
• Balance Sheet: Maintains a solid cash position and no debt, providing capacity for ongoing M&A and strategic investments.
• M&A Pipeline: Management is "having as many of those conversations as we can" regarding acquisitions, with one significant target under consideration.
• Market Mix Consistency: 85% of products sold remain at minimum efficiency levels in the first half of 2025; shift to lower-branded products has not occurred.
• Regional Weather & Demand: Weak volume performance in May was attributed mainly to adverse weather in the North; improvement was noted into July (Q3 2025).

SUMMARY

Watsco (NYSE:WSO) management directly addressed ongoing challenges related to the large-scale product and regulatory transition in 2025, highlighting operational complexity and near-term margin opportunities. Strategic technology investments are accelerating digital channel growth, data-driven pricing optimization, and sales to multiregional institutional customers. The company emphasized that recent peak inventory levels reflected temporary needs of the product transition, with systematic reductions underway. Watsco’s leadership detailed margin drivers and clarified that the extraordinary gross margin performance in Q2 2025 reflected both pricing and mix, not sustainable run rates. The management team remains focused on monetizing technology adoption and expansion of higher-margin parts, while actively positioning for consolidation opportunities in a fragmented HVAC distribution market.

• President A.J. Nahmad said, "We have accelerated adoption of our pricing platform PriceFX. Our goal is to reach a 30% gross profit margin."
• OEM pricing actions early in the quarter were cited as amplifying near-term margin, with Barry Logan stating, "there is obviously an algebraic benefit to margin when OEMs raise prices."
• Watsco’s e-commerce now constitutes 34% of sales; Mobile apps serve 70,000 users; OnCallAir drives higher attach rates for high-efficiency products when utilized by contractors.
• There was greater than 80% A2L sell-through by quarter end and less than 5% of inventory remaining as legacy
• Management’s "dream plan two" targets $10 billion revenue, 30% gross margin, and five times inventory turns, with the latter up from pre-COVID levels of 4.5x on investments in inventory systems.
• The chief digital officer stated, there has been about 200 basis points of gross margin expansion attributable to this price optimization and bringing more technology to how we price over the past two or three years.
• Tariffs and metals inflation are beginning to impact input costs for non-equipment segments, notably a 10% increase cited on copper-heavy products.
• Softness in residential new construction and international sales continues, but July showed sequential improvement over June, and management expects improved efficiency in SG&A as the transition winds down in the second half of 2025.

INDUSTRY GLOSSARY

A2L Refrigerants: New-generation, low-global-warming potential refrigerants with mild flammability used to comply with updated environmental regulations in HVAC equipment.

R410A: A widely used legacy HVAC refrigerant being phased out due to environmental regulation.

OEM: Original Equipment Manufacturer; refers to companies that produce HVAC units Watsco distributes.

OnCallAir: Watsco’s digital sales tool enabling contractors to recommend and sell HVAC products more effectively, with a proven impact on high-efficiency sales mix.

PriceFX: Watsco’s proprietary pricing technology platform used for dynamic price optimization.

Watsco One: Forthcoming unified digital sales and service platform tailored to large institutional, multi-location HVAC customers, scheduled for launch in 2026.

RNC: Residential New Construction; market segment focused on sales of HVAC products for newly built homes.

Full Conference Call Transcript

Albert Nahmad: Good morning, everyone. Welcome to our second quarter earnings call. This is Albert Nahmad, Chairman and CEO. And with me is A.J. Nahmad, President, Paul Johnston, Barry Logan, and Rick Gomez. Before we start, our normal cautionary statement: This conference call has forward-looking statements as defined by SEC laws and regulations and are made pursuant to the safe harbor provisions of these various laws. Ultimate results may differ materially from the forward-looking statements. Watsco delivered healthy second quarter results in soft market conditions. I should say 2025 marks a year of significant product transition to next-generation equipment containing A2L refrigerants. The transition affects roughly 55% of our historical product sales.

This transition affects our inventories, our supply chain, staffing levels in our branches, and other aspects of our business. Regulatory changes have historically been good for our business and good for our customers. We expect that transition to be no different than has happened in the past. The changes are substantial and complete, and we'll look forward to operations and simpler business in 2026. Let me turn to second quarter highlights. Sales declined 4% like the double-digit pricing gains for the new equipment, offset by lower volumes. We had a late start to the summer season. Sales for residential, new construction, and international markets remain subdued. On the plus side, Watsco achieved record gross profit margins.

Our performance yielded an increase in EBIT and expanded EBIT margins despite lower sales. Our results benefited from OEM pricing actions. Our pricing technology platform called PriceFX also contributed. Gross margins remain a focus. There is much potential to improve over time. SG&A increased 6% as we incurred extra costs during the transition. We also added 10 new locations from recent acquisitions. Our balance sheet remains solid. We have a strong cash position and no debt. We continue to invest in innovation and technology to separate us from our competitors. Watsco's technology journey began fifteen years ago, and we have made terrific progress.

For example, e-commerce continues to grow and is now a $2.5 billion business, or 34% of our sales. Mobile apps have now 70,000 users and grew 17% versus last year. The annual volume of products sold through OnCallAir, which is our digital selling platform for customer contractors, increased 19% to $1.6 billion. It's a great assist to our customers. But we're not standing still in terms of ideas and making further investments. We are building on or adding new initiatives to drive growth and to delight our customers. Examples include a new technology-driven sales platform being developed to capture larger national customers. We're talking about national customers here.

This would be incremental to Watsco's core replacement vehicles and is expected to be launched in 2026. We have accelerated adoption of our pricing platform PriceFX. Our goal is to reach a 30% gross profit margin. We have launched an initiative to grow the parts and supplies segment of our business, which today is roughly 30% of sales and can be much larger over time. And we launched two AI platforms, one internal and one external, to harness our data. Artificial intelligence offers the potential to further transform our customer experience, improve operating efficiency, and create new data-driven growth strategies. This is an exciting time, and these are just a few of the many initiatives underway.

Now we will expand on these themes at an investor event in Miami, which will occur after temperatures have dropped a bit. Stay tuned for additional details. Finally, we believe our culture of innovation, along with our scale, entrepreneurial culture, and capacity to invest, are unmatched in our industry. With that, let's turn to Q&A.

Operator: We will now begin the question and answer session. To ask a question, you may press star then 1 on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. And if at any time, your question has been addressed and you would like to withdraw it, please press star then 2. At this time, we will pause momentarily to assemble our roster. And our first question here will come from Ryan Merkel with William Blair. Please go ahead with your question.

Ryan Merkel: Good morning, Ryan. Hey. Good morning, everyone. Good morning. Alright. My first question is just, you know, on volumes in the quarter. Were a little bit worse than I was expecting. I know you mentioned weather, H2L, new. Would just love it to hear from you, you know, I'm gonna ask both Paul and Barry to respond to that. Not as strong as we anticipated going into Q2. You know, what we saw was a kind of a lumpy picture in the marketplace. Where April came in strong, May ended up being very weak, mainly because of the weather patterns in the North. And then in June, they came back again. And it was sure.

You know, RNC is probably the our new construction new construction is probably down 15 to 20%. Replacement is still holding fairly strong. We didn't really see a lot of repair at the beginning of the quarter, which we saw towards the end of the quarter and continues into July. But not enough to offset, you know, the unit sales that were certainly down I mean, on international sales. Yeah. I'll comment on that. Also, on one of the exposures we talked about in the first quarter that repeated itself in the second quarter, was our international, which is Mexico, Mexico is probably the most volatile market.

It's a small part of our business, but a big contributor from a margin point of view. Mexico was down well, let's put it this way. It cost us about 10¢ a share in the quarter. 20¢ a share year to date. In June, it grew. In July, it's grown since then. So I'll take kind of one market that's been irritating which seemed to be a lot better in the last couple of months. As far as July goes, Ryan, I would say it's better. August is bigger than July in our forward-looking commentary.

So if I say that July is better than what we saw in June, that's okay, but it needs to extend itself and extrapolate itself as the year goes on. The good news is that in general, you know, what we can control is margin, pricing, and the wherewithal of our business to support all these new products in the market with our customers. I'm glad we have our balance sheet to do that with. Because it's been a pretty extraordinary product change this year. You can see the building of inventories. That's a customer-focused effort to help our customers get going in this market.

The margin speaks to capturing new pricing on as we say, over half the products we sold we sell, we had to capture price inflation since that price and get off on the right track in margins and be able to say, that's been accomplished. So we like what we can control. We'll be patient about what we can't control. And I think also maybe this is more of a 2026 discussion. But, you know, the entire industry, every OEM we sell products for have been through an extreme product cycle probably for the last two or three years.

And at what point does that serenity, you know, play itself out in terms of growth and market share development and product expansion the blocking and tackling that I think, is particularly good for us and that we're good at. So maybe that's more of a next year event, but we're kinda looking forward to it quite honestly. Yeah. That's fair. Okay. Since you mentioned gross margin, that was the other, you know, metric that was really strong this quarter.

Albert Nahmad: My sense is it's both price cost and initiatives, but you know, my question is I don't I don't want us to extrapolate that 29% into the back half. So just how sustainable is that? Was 2Q kind of temporary due to price cost timing?

Barry Logan: Go ahead, Barry. Yeah. Yeah. I think there is obviously an algebraic benefit to margin when OEMs raise prices. In April and May, we talked last quarter that OEMs had faced some inflationary realities going on with tariffs and raw materials and so on. On top of the like-for-like price increase on the new product they introduced inflationary pricing, early in the quarter. That clearly, you know, helped build a bigger margin this quarter, and the benefit of that you know, kind of. But I'm the one that probably three years ago, talked about 27% as a floor, as a benchmark.

And I, you know, I stand by that, obviously, and if I say now 27% plus I would expect that for, you know, the last half of the year. But we won't have the benefit of those pricing actions that you see in the first half of this year. So somewhere in between would be my conjecture and the market will play out and determine what it is. But so I think I think we have a chance to beat our benchmark and but not have the benefit that we saw as extraordinarily this quarter. In terms of pricing.

Ryan Merkel: Well, that's great. We had very unexpected. Yeah. Thanks. Just wanna add. I mean, this is A.J. Nahmad. Just real quickly. I mean, there is the benefit on the OEM price increases, but also the efforts we're making on our price optimization and the leadership of those teams and the pricing teams. That's also working. So it's a combination of both, but we continue to put points on the board in terms of the pricing efforts that we're taking internally. Yeah. I'll add that. As we move our product mix, which I mentioned in the opening statements, towards parts and supplies, and that's what we're focused on with our technology.

That by its nature, carries a higher margin than equipment sales. So our product mix, hopefully, sometime later this year or into next year, we'll improve margins too because parts and supplies carry higher margins.

Ryan Merkel: Thank you very much. I'll pass it on.

Operator: And our next question will come from Brett Linzey with Mizuho. Please go ahead.

Brett Linzey: Good morning. Yeah. Maybe just a follow-up on that. Let the last point there. So if you could maybe just unpack the year-over-year gross margin contribution. Is there any way to delineate that between the pricing optimization tools versus the parts mix versus some of that raw pricing in just in the marketplace in the quarter? That's an interesting question. Who wants to deal with that?

Rick Gomez: Yeah, Brett. I'll take a stab at that. This is Rick Gomez. This is directional because there's, you know, a lot of art and a lot of science to this as well. And but it's not all science. So when we look at the quarter, there was and when we look at the year as well, pretty consistent. There's about 50 to 60 basis points of gross margin enhancement that we can attribute to the day-to-day job of a distributor in the market. And so gross margins would have been in the high 27s. Absent any of that inflation, and the inflation helps but it's not something that you can underwrite, you know, perpetually, obviously.

So that's what it's amounted to. The way, that's been pretty consistent. If I look back, maybe two or three years in the data, we've been at that you know, we can aggregate and say there's been about 200 basis points of gross margin expansion attributable to this price optimization and bringing more technology to how we price. Keep in mind that the complexity of price in the industry is something that generally benefits a distributor. What I mean by that is that virtually every SKU has a different price to every customer. And so to imagine that we are optimized, well, it's the opposite. We're far from optimized.

And that's why we think there's so much room still to go. And, oh, by the way, just to finish, the thought is that during that period of time, we've also gained market share over that three-year period, if I measure it. So that's mainly attributable to all the technology. And my point there is that has not borrowed from customer acquisition and market growth at the end.

Brett Linzey: No. That's very helpful. You know, appreciate that. And then just a follow-up on the cylinder shortage. Sounds like you guys think it abates by the second half. I know some of the peers think it does persist into the second half. So maybe what was the impact do you think in quarter from the shortage situation? And then are you assuming that some of that does carry into H2?

Paul Johnston: Yeah. I think, you know, what this is Paul Johnston. What we had was we had an allocation situation where we were being allocated refrigerant. What the OEMs did was they came through and did an overcharge in the unit so that they didn't require as much, you know, field installation type refrigerant. And so it's become less and less of a concern as time goes on, as our allocations continue to increase. We feel good that sometime in August, we should be off of allocation. And I think it was very irritating. It was very disturbing that we had to go through that.

But I don't think that really is the total cause of why the market was slower than what it was.

Brett Linzey: Thanks for the color. Yeah. Just editorial on that. I you know, the like-for-like SKUs that we're selling now, A2L versus the prior is a 10% difference in price. And a speed bump on the canisters or refrigerant is that. A speed bump? And the transition itself, if we look forward again to that word serenity I used earlier. We're looking forward to it.

Operator: And our next question will come from Tommy Moll with Stephens. Please go ahead with your question.

Tommy Moll: Morning, Tommy Moll. Morning, Albert Nahmad. Thanks for taking my questions.

Albert Nahmad: Of course.

Tommy Moll: Wanted to start on inventory. Maybe you could characterize for us the investment there versus what you would have expected to need for the transition. Just in dollar terms, is it about what you would have soft circled or maybe a little elevated anything you can do to frame that for us and then also how you think it might trend over the next couple quarters?

Albert Nahmad: Well, the honest answer is that it's more than we had hoped for. And some of that is because we expected not to have the unusual demand industry demand that we the lower industry demand. So we peaked at about $2 billion. But we are now very focused on what to do about it and we've lost in terms of inventory investment, $200 million so far in the third quarter, we're down to $1.8 billion. And plus this transition of product you have to have the old and you have to have the new on the equipment side. And we'll transition out of the old before the end of the year. And that will help reduce the inventory investment.

Paul Johnston: That's a very good question. I'm very dedicated to increasing our inventory turn. And it's been a rough time to do that, but I think that.

Albert Nahmad: Yeah. Pretty stoked.

Paul Johnston: Oh, go ahead.

Albert Nahmad: Yeah. On a raw number basis, you know, we had double inventory. We had about 5% of the total inventory was four ten, and then we had the more expensive A2L product in there. So we probably had a 15% rise just between what we had in four ten left over. And what we experienced when we had price increase. The balance of it is exactly what Albert Nahmad said. You know, the demand just wasn't there to be able to take the inventory back down. That you're going to see come down at the end of the third quarter.

Tommy Moll: Thank you both. As a follow-up, wanted to ask about the M&A environment and pipeline hasn't gotten a ton of airtime lately, but how can you characterize that for us?

Albert Nahmad: That's a very good question. We are eager to see what owners of distribution businesses and HVAC are going to do with this existing very soft market. They may do nothing. They may continue or they may say, well, now it's time to do something. In terms of an M&A. And, of course, we have a great reputation with distributors because the way we treat sellers, we're very careful about relationship build continuing post-acquisition with the pristine leadership of the business acquired. So I can't say it's gonna happen, but I'm sure hoping. We have a very, very strong balance sheet. We could take advantage of opportunities as they come.

That I cannot I can only tell you that well, I can't disclose it, but there is one that we think that without disclosing much more than that, that is of size. We'll see how that turns out. It's still under study.

A.J. Nahmad: Yeah. I would say rest assured we're having as many of those conversations as we can. We're super ambitious, and we have the balance sheet. To support anything we want if we can manage to muster up. So hopefully, it can be an exciting period in M&A.

Tommy Moll: Thank you both. I'll turn it back.

Operator: And our next question will come from David Manthey with Baird. Please go ahead.

David Manthey: Morning, David Manthey. Hey. Good morning. Was wondering if you had any thoughts on consumer preference during this product transition, like are you continuing to see a premium on the R410 systems? And then as people are buying the A2L, are they gravitating to one end or the other?

Albert Nahmad: I wonder who in our Oregon who in our team can respond to that.

Paul Johnston: Well, Paul Johnston, are you the one, Paul Johnston? You always are. Yeah. The industry really hasn't popped as far as high-efficiency product. You know, it's still at the entry level. I mean, we're at you know, basically using the old SEER rating. We're at we're at above 15 SEER for minimum efficiency. So it's high-efficiency product. So we really haven't seen a change in the direction of the industry. It's still very much sliding along the idea that it's going to be whatever the minimum efficiency is. And that represents probably 85% of the market. That has not changed. And then when you get into the brands that we're selling, the brands have been consistent throughout the year.

And they continue to hold steady. You know, we're seeing the Carrier brand and the Rheem brand you know, and the Goodman brands all doing their job and holding up their share of the business. We're not seeing a migration to a lower branded product. No.

David Manthey: David Manthey, I was just to just to just to add to that for the fun of it. If I look at brands, products, markets, customers, geographies, north and south, east and west, and we're selling, you know, close to 20 brands. The first half of the year is very consistent amongst you know, that collection of data points. So nothing stands out, Dave, and I don't think this has been disruptive to what kind of the baseline products being sold is going on.

A.J. Nahmad: Yeah. The exciting anomaly, though, and I think it's in our press release, is OnCallAir. When our customers are using the tool that we've created for them, which we call a sales engine, they are selling high-efficiency systems at a much higher rate, like the inverse amount. Meaning, I think it's, like, 70 or 75% of the time, a contractor is selling using OnCallAir. They're selling high-efficiency systems. When we can help influence that through that tool, that's powerful because the consumer gets a better product, the contractor makes a bigger ticket. As do we. It's a win-win-win.

David Manthey: It sounds good. Thanks for all the color there. My follow-up it's the first time we've seen other do better than the equipment in a long time. And as Paul Johnston said, the residential new construction is not helping. I assume all the ductwork and thermostats and things in the other category. So should we not read into this that there's a stronger fix versus replace trend this quarter? Or is it I don't know, commodities, or I'm just making this up. But any thoughts on that?

Paul Johnston: That's pretty small. You know? When you take a look at the entire marketplace, you know, you just take compressors. You know? The normal demand for compressors in The US was about a million two to a million three. And the balance of them go warranty. Because you have a five and a ten-year warranty on most of the equipment. You take a look at the equipment side, it's seven to 8 million units. So for the offset of a down market, on the unit side, through additional parts, yes, it's gonna help our gross margin. But, no, it's not gonna help the top line. It's not gonna help your revenue line.

The ratio is just too great between what parts represent versus equipment. Are we seeing an uptick? Yes. We started seeing an uptick in June. Which historically is the month in which you're going to see that up. It's continued into July, but we really haven't seen a radical increase in units. We've seen an increase in dollars more than we have units.

Albert Nahmad: Now let's not mislead either. Our sales in the new quarter are not they're pretty flattish. Small incremental. Low digit increase. They're not it's nothing that does not signify a major double-digit increase yet.

David Manthey: No.

Albert Nahmad: Thanks very much, about you yeah. When we talked about unit growth of compressors and coils, things like that, year to date is single digit. It's not, you know, it was not an avalanche of transition to that. It could be us just selling more compressors in the market. And I think you heard Carrier talk yesterday very directly about that, and they're talking to you know, 150 independent distributors when they're answering your question to that. So it's obviously an opportunity to sell more parts, but the wholesale trend is not something that I think is quite in the numbers yet.

David Manthey: Yeah. Thanks, Barry. Well, and somebody mentioned earlier, the M&A. We're very eager to do more M&A. Sometimes opportunities arise when you have these kind of markets. I'm sure hoping for it. Are we shut down again?

Operator: Oh, our next question will come from Jeff Hammond with KeyBanc Capital Markets. Please go ahead.

Jeff Hammond: Morning, Jeff Hammond. Good morning, everyone. Is this Real Al or AI Al?

Albert Nahmad: It's a combination.

Jeff Hammond: You have to figure it out. You see? I know it's the real Al. Yeah. That's a good one. Yeah. To clarify on the flattish sales comment, was that parts for July, or is that overall?

Albert Nahmad: Overall.

Jeff Hammond: Okay. Overall. And then just on invent back to inventories, can you just you know, maybe talk about you know, where you wanna ultimately get your turns to? I know you were kinda running four and a half. Turns a year, you know, pre-COVID and pre all these regulatory changes, and now you're kinda three to three and a half. And know, kinda where you see that happening over and over what time frame?

Albert Nahmad: Well, first of all, let me compliment you on the day. You're right about those turns. I'd like I'm not I'm not gonna put a time limit on this, but I'd like to get to five. At some point in time, giving all the technology we're investing in it, I'd like to get to five.

Paul Johnston: I mean, you could think about it. Pre yeah. Pre-COVID, we were at four and a half. We didn't have the technology investment in inventory systems and the management systems that we currently have. So as we come out of it, I think Albert Nahmad's goal of five is very attainable.

Albert Nahmad: We have what we call the dream plan. We may have mentioned it before. Actually, dream plan two because the dream plan one was achieved after three years of effort, and dream plan two is a new. I mean, may take three years to do that. Dream plan two is $10 billion in revenue, 30% in gross profit margin, and five times on the inventory turn. And that's the those are the targets that we're focused on.

Jeff Hammond: I remember when it was 10% growth and 10% margins for a $100. You guys blew through that one.

Albert Nahmad: Believe it or not, though. Believe it or not, that was twenty years ago.

Jeff Hammond: Yeah. Boy, that's this is a hell of a history lesson here today.

Albert Nahmad: Yeah. Yeah. That's pretty impressive. Yeah. I'm so impressed. For the and for those 20-year-old listening to us, Jeff Hammond is right. We're call Pan and Chemicals a 100. It was called ten and ten equals a 100. We got our management team together and rallied around that. Many of them thought Albert Nahmad was out of his mind. And, obviously, we've blown past that, you know, some time ago.

So we reinstituted that cultural you know, kinda concept about six months ago, actually, a year ago, and got everyone together and some of the initiatives that you're not asking about today that you will ask about as we develop them is built on that dream plan two concept and if we got had 75 other Watsco core managers on this call, you would you'd be able to ask them about it, not just ask us just know that culturally, those kind of things go on, and we have fun with it.

A.J. Nahmad: Yeah. And culturally, I mean, really, the takeaway is that we're super ambitious. And that's why we're investing in these big goals that we expect to hit. In time.

Albert Nahmad: And truth is that we also have an equity culture. That really inspires people to achieve and to meet the goals set by senior management. Which means what is the equity culture? Many, many, employees hold the Watsco shares. Either through a 401k or through the different stock plans. And we like that. We like the ownership culture to be spread out. Throughout the organization. It's very unique. And it's very extensive. And so that ownership culture drives their desire to meet goals, I think. And I've always used it, and it's been working. And I expect it to continue working.

Jeff Hammond: Great. Thanks for the time, guys.

Operator: And our next question will come from Patrick Baumann with JPMorgan. Please go ahead.

Patrick Baumann: Good morning. Morning. Thanks for taking my questions. Maybe I was just curious if you could provide some examples of the large enterprise institutional customers that you cite as offering emerging opportunities for growth? Like, and what and what exactly are you doing to go after them?

Paul Johnston: Sure. Sorry? Paul Johnston? Go ahead, A.J. Nahmad. I would I would have A.J. Nahmad into that. Yeah. A.J. Nahmad? Yeah. So I'll jump in first.

A.J. Nahmad: And know, we teased some of this in our press release and also teased that we want you guys to come down to Miami and spend time with us. And see it and hear it and feel it more succinctly. But it's a there are macro trends going on in our industry including private equity, trying to buy up and consolidate contractors. And between that and home warranty companies and other institutional type customers, they're emerging and have emerged would call it, multi-location contractors who may have some business in Florida, some in Texas, some in Tennessee, you name it. And with our size and scale, we should be able to we should be their preferred vendor.

We should be the most exciting place for them to buy product. But don't necessarily have a unified experience for them to take advantage of our whole offering and our whole scale. That's what we're building. We call it Watsco One. And it will be a it'll be exactly that. It'll be one interface for these large institutional type contractors to buy and secure the products that they need from any of our locations whenever they need it.

Patrick Baumann: Interesting. Is it doesn't. Right. It huge undertaking. It doesn't sound that way just using words. But we are a very, very decentralized system. And to aggregate to meet to aggregate ours. Our inventories, and our pricing systems, and all our support systems to meet the needs of a large national customer. That is it takes a lot of lot of initiative. And we're investing to compare all those tools to do that. But it should have a very significant impact once we've accomplished it. Because no one else has these capabilities.

Patrick Baumann: A follow-up to that. Would you see selling to, like, a larger national account contractor any different than I guess, you said it is, but, like, in terms of, like, they're buying capacity, is that something that you would see as a headwind for your gross margin over time?

Albert Nahmad: Of course. That's one of the Yes. One of the elements.

A.J. Nahmad: Would say yes. But we can also we also have the opportunity to sell them a lot more parts and supplies. But which has been discussed earlier. Have a higher gross margin profile. Right. That's why I think it's not so the answer is not so linear, Pat. It's because today, when we look at those big institutional type accounts we're largely selling them equipment, and we're selling them equipment in bulk. And so to broaden that offering means we're taking all else equal we're taking a customer, and broadening the mix of products we sell them, and that's generally accretive to margin at the end of the day.

Patrick Baumann: That makes sense. Okay. Yeah. I just Pat, I'm just gonna say this again for the more for the fun of it. I mean, a great home service is business you could invest in the last fifty years as Rollins. If you don't know the company, look it up. Mean, technology you know, deployed at Rollins you know, yielded 10% higher EBIT margins for their business over time. Right? So the question is, in our partnership with any customer of any size, do we have a business model, an that can help them grow, help them price products, help them you know, operate their business twenty-four seven. You know?

So part of the visibility of what we've done for most smaller contractors, the question is, is that a pliable technology for larger accounts and larger contractors? And it's not about just selling more stuff. It's about helping any kind of size customer operate their business more profitably through us. And our products just happen to be the one they'll scale with to do that with. So this is as much of a technology play as it is a product or any other, you know, any other kind of label you might put on it?

Patrick Baumann: Thanks. Thanks for the color. Sounds interesting and exciting. Maybe just switching gears on my next question on the operating cost side. I think you cite something in the release about targeting cost efficiencies for the rest of the year. Could you provide any color on, I guess, one, the 6% growth rate in the second quarter of SG&A expense? You mentioned cost of the A2L transition. I don't don't know how that kinda made it made it to SG&A, but if you give color on that. And then can you bend that growth rate in the second half with some of the cost efficiencies you're targeting?

A.J. Nahmad: Sure, Pat. I can I'll take a stab at the so first, let's take let's start with the 6%, and we said in the release that we made some acquisitions. We've opened some new locations. So about 25% of that 6%, is attributable to that. So you can think of you know, core SG&A growth, if we call it that, more in the four and a half percent range. Which is still, you know, higher than it should be in a down quarter. But that's kind of our starting point as we think about it.

Then when you think about just the day-to-day life in a branch, during a transition, if we have more inventory, it means that we've received more inventory. It means you need more people receiving that inventory. It means that you have more trucks coming to your locations. It means that you know, you're not optimizing, you know, what you have. It's not business as usual in the day-to-day of a in the day-to-day life of a branch. During such a large-scale transition and to underscore something we said earlier and mentioned in the release, this impacted every domestic location we have in The US, about 650 of them.

So that's where there was some inefficiency, as I would say, in the you know, the labor and the logistics side. And do we think we can bring that down and bring it more into balance in the end of the year? The answer is yes. Our leaders are working on that right now. One of the things that should naturally help that is that when we look at our inventory today, about five to 7% of that inventory is four ten a product. Which means we've largely received all the new product we're gonna get, and we've largely worked out of all the old stuff.

And that means that the branch can't get back to kind of its routine and should be a little bit more efficient in the back half of the year.

Paul Johnston: Yeah. Just to say it a little. My way. You know, as we sell through four ten a product, we need to make sure that we have system matchups that are selling in location. So there's a lot of transferring product within our network to make sure that we have the right systems in place that are sellable in a market where they are selling. If that makes sense. So there's some extra cost that's gone into that as well.

Patrick Baumann: That makes a lot of sense. Thanks a lot. I really appreciate the color.

Operator: And our next question will come from Damian Karas with UBS. Please go ahead.

Damian Karas: Hi. Good morning, gentlemen.

Albert Nahmad: Good morning.

Damian Karas: I'm curious how you're thinking about pricing through the rest of the year. On the equipment side, know, our price is pretty much set. For the rest of the year, and you're just gonna continue to get that benefit of the higher value mix flowing through. Top line. And do you foresee any changes on your parts and commodity supplies that respect to price? And just thinking about you know, further metals inflation and tariffs?

Paul Johnston: Yeah. I don't think on the equipment side, we're gonna see a lot of price increases going forward. On the non-equipment side, you know, Friday is copper day. 50% tariff start on copper. We've already seen about a 10% increase on some of those products that are heavily endowed with copper. So, you know, it's just it's just a matter of wait and see on some of the non-equipment type product. I think the equipment is pretty much in place, though.

A.J. Nahmad: Understood. Yeah. I would just say, let's just make sure, you know, when we I think what we're talking about is cost. Costing you know, the cost of our products and our equipment products I don't think we're expecting much change from our OEM partners. But on price, meaning our price to our customers, that's a con that's what the tooling and the technology enables. It's because every different customer has a different price on every product we sell and every region and every market. That complexity is opportunity. Trends and patterns and anomalies and outliers and segments that should be priced appropriately.

And so we run different I call them plays where we can measure and track when we make a change and that customer's price or a customer segmentation price or a cohort of customers pricing on different products. We can take that to market. We can measure and track, and we can see the impacts. And either double down or go on to the next play. So pricing will always be opportunity just to clarify that costing versus pricing.

Damian Karas: Got it. Got it. That's helpful. And I know this is never an easy task, but if you had to guesstimate, if you will, how much of a headwind to volumes in the second quarter do you think are attributed to are attributable to weather and the canister shortage you know, versus weaker housing and underlying, market demand? You know, I'm just trying to get a sense for what underlying demand might look like as you move past these more transient issues.

Paul Johnston: Yeah. I don't I know if we can I don't think the canister is a business. Yeah? Have anything to do with, with sales the second half of the year. You know, as far as the refrigerant we receive. I think it's gonna be what the consumer feels like, what the weather patterns are gonna be like, how we're able to react and meet inventory demands that the consumer need or that the contractor needs to handle the consumer. I think it's just gonna be blocking and tackling in the second half.

A.J. Nahmad: Yeah. I mean, I think real it's all been said, but has gotta be the noisiest year in HVAC ever be between the tariffs and the weather and consumer confidence and the canister shortages and the home building changes and interest rates and trading homes isn't happening as frequently. I mean, there's just so many things going on at macro levels, most of which are out of our control.

So it's a lot of noise in the industry, and our job is to win in any environment and emerge bigger and stronger and more profitable and take more share from our competitors, and that's I like where we sit in that equation because of our scale, because of our balance sheet, because of our willingness and ability to invest in technology. You know, I'm very, very pleased to be Watsco given all this noise.

Damian Karas: Really appreciate your thoughts. Good luck out there. Thank you.

Operator: And our next question will come from Nigel Coe with Wolfe Research. Please go ahead.

Nigel Coe: Good morning, guys. Appreciate all the color. Hi, Albert Nahmad. So just I think you mentioned four ten a well, 60% or thereabouts. For the quarter. I'm just curious how that trended or maybe where that's trending you know, right time you know, right now real time. And any concerns that you're holding too much for any inventory just given the demand weakness? And, you know or do are you are you confident you'll be done with that transition, you know, this quarter?

Albert Nahmad: I'm chuckling because that's very much on my mind. And, yes, we're doing something about it. So that we don't have that risk. And, Paul Johnston, you can answer in some detail if you'd like.

Paul Johnston: Yeah. It's less than 5% of our inventory at the pleasant time. You know, where we're really, you know, working our butts off is be able to get the right combinations that A.J. Nahmad mentioned before. Gotta have an indoor unit to go with the outdoor unit. And as you sell the inventory down, the pond gets lower, you end up with an indoor unit sitting in one city, and you end up with the outdoor unit in another. So we're putting those pieces together, which is gonna be a drag on SG&A know, with freight. Know, for a period of time here. But I think each one of our companies hear about it continuously that we need to reduce.

We need to keep the focus on four ten, get rid of it, and focus then on being able to sell the A2L product that we've got.

Nigel Coe: Does that mean that you give.

Paul Johnston: Yep. Yep. Yep. Sorry. Does that mean you're incentivizing, you know, that sell through of that? Sorry. Sorry.

Albert Nahmad: For cutting off that, but any does that mean you're incentivizing that process to make that happen?

Albert Nahmad: That's not how we work. We deal with the markets on a decentralized basis. Those are local decisions made by the local entities that we have.

Nigel Coe: Okay. And, Nigel Coe, I would just add to that. Just to add very quickly in terms of the progression of A2L. It's progressing very, very well. I mean, we ended the we exited the quarter in June with more than 80% sell through of the A2L product. And so that's a function of, obviously, diminishing inventory of four ten a, It's also a function of contractors transitioning and adapting well to the product. So, at this point, it's greater than 80% of our sell through as you'd expect.

Nigel Coe: Okay. That's great color. And then my follow-up is you know, what we've seen from you and from your suppliers is tremendously strong price prices holding, which is good news, but, obviously, volumes are incredibly weak. What are you hearing from your contractors? So are they are they asking for you know, some incentives here to try and stimulate some movements? Or are they content to just wait for rates to turn and perhaps demand picks up? Are you starting to get more inbounds on price reductions or discounts or incentives?

Paul Johnston: I don't think we're really getting a lot of feedback on getting lower prices in the market. There's not elasticity to market. If we drop the price two or 3%, it's gonna it's gonna stimulate a 10 or 12% increase in volume. Ain't gonna happen. So, you know, I think the contractor always wants the lowest price, the best price in the marketplace. So that they can compete fairly. But I don't think we're getting a lot of a lot of pushback right now from most of the contractors on the price.

Nigel Coe: Okay. Makes sense. Thanks, guys. Appreciate it.

Operator: And our next question will come from Sam Schneider with Northcoast Research. Please go ahead.

Sam Schneider: Hey. Hi. Looking forward to morning. How are you? Good. Looking Thank you. Looking forward for an excuse to come down to Miami pay for by my employer. So thank Well, you heard it. You did hear loud and clear. Right? Yeah.

Albert Nahmad: Oh, yeah. Let's wait till it goes out. That was great.

Sam Schneider: We'll welcome you when you're coming.

Albert Nahmad: Oh, yeah. No. Thank you.

Sam Schneider: So, look, just focusing on the mix shift which seemed to benefit margin. On parts. I was wondering if the shift was you know, in part at all due to the canister shortage where have people do more repairs. For the time being?

Paul Johnston: You know, most of the most of the canister shortage occurred in the first and the first in the second quarter. And it was something that we worked our way through. We made it through it. Now, as I said, we're seeing a lot more inventory coming in. It's going out as quickly as it comes in. I see it stopping sometime in early August. Early August is, what, two weeks away. So I don't think it's really playing on demand right now as heavily as it was before. I don't see any bubble capening on repair versus replace because of canisters.

Sam Schneider: Got it. Okay. And then just a real quick follow-up. Sort of on the same topic. But any sort of sizable shift to R32 based systems and if so, is that a temporary thing or more permanent in your view?

Paul Johnston: Well, it's only one manufacturer. Daikin, which we represent very proudly, with our Goodman and Amano lines, is R32. Rest of the industry is four fifty-four. So what we've seen is we've seen you know, excellent response from Daikin. To be able to help us with the 32. There hasn't been a shortage of 32. You know, when you get into the four fifty-four, it's been Carrier, Rheem, American Standard, All of them sell four fifty-four units. Roughly 70% R32. It's a blend. Of 32 plus twelve thirty-four y f.

Sam Schneider: A big one. Are you seeing?

Albert Nahmad: That's happened three times, Harry. Yeah.

Operator: It paused the Operator, are you there? Yeah.

Albert Nahmad: I'm here.

Operator: Yes. I'm here.

Albert Nahmad: Is it Why are we tuning out?

Operator: We can go to the next to the next question? Okay.

Operator: Our next question will come from Chris Dankert with Loop Capital Markets. Please go ahead.

Chris Dankert: Good morning, guys. Thanks for taking the question. I guess circling back to WatscoOne, you guys sound excited and sound this is a pretty big opportunity. Is there any way to get a bigger than a breadbox sense here? I mean, we are we talking about serving 500 customer locations, 5,000, or is it too early to kinda get into that type of scaling?

Albert Nahmad: Well, maybe a better way to approach is what is our existing sales of parts and supplies? And what do we think we could provide? I don't wanna speculate too much. What kind of margin improvement do we think we can get from that? It's a very big chunk of our business, 30%. 30% of $7.5 billion. How much of that could we improve our margins on? I'm not gonna speculate, but there will be an improvement.

A.J. Nahmad: Right. You take any percent of that number and it's meaningful.

Chris Dankert: Makes sense. Makes sense. Well, thanks for that. And I guess maybe just to touch on the AI a little bit here. Can you give us maybe some examples for what the use cases are for App Watsco internally? I mean, how is this kinda helping your associates? Is this inventory positioning? Is it warranty data? What's the real use case here?

A.J. Nahmad: My gosh. There's so many. I'm at How much time do we have? Yeah. It is it's helping marketing folks design content and publish content. It's helping our software engineers write code and publish and push more technology faster. It's helping our their teams sort through data and understand trends and patterns and anomalies. It's helping our customer service folks get to more get through more cases more quickly with more accurate answers. And therefore helping our customers at a greater scale or greater rate. Increasing customer satisfaction I can go on and on and on.

And, like, it could be said in the press release, there's about 21 people a week internally who are using these tools or the tool and the ways that they're using it are more and more creative and fast.

Chris Dankert: So, I mean, it really is holistic then. It. Well, thank you so much for that, A.J. Nahmad, and thank you all for the time.

Operator: Absolutely. Chris Snyder with Morgan Stanley. Please go ahead.

Chris Snyder: K. Thank you. I wanted to on the four ten a inventory. I think you guys have less than 5% of your inventory. Do you have any sense, you know, for what that number could look like across your distributor competitors?

Albert Nahmad: No.

Chris Snyder: I don't think we really have any good intelligence on that. And we try not to figure that. That's irrelevant. But we Yeah. It's being phased out. We don't really care.

A.J. Nahmad: Fair enough. Don't care.

Chris Snyder: Chris Snyder, there's a couple data points. I mean, I think, you know, one peer of ours that also distributes their product gave a data point on that, in terms of what their sell through is, and it was pretty high. The other data point these are all anecdotal. This is not science. It's aggregating anecdotes. Is, you know, when we are talking to M&A targets, what do they tell us about their philosophy and their positioning and as a reminder, most of this stuff was built prior to December 31 and shipped in the first quarter.

So someone would have to make a pretty big bet on inventory and would have to really leverage their balance sheet to do that. And so our sense, just by having these conversations in the channel with the M&A targets, is that they're largely phasing out of four ten a at about the same pace we are.

Chris Snyder: Thank you. I appreciate that. And if I could, you know, maybe follow-up on a different sort of inventory question. I guess it's kind of surprising that volumes remain down materially, it seems like, July. You know, with the weather picking up. Does that change the way you guys think about how much inventory is downstream at your customers? You know, could they have been holding extra stock? And perhaps that's why, you know, the sell through has been softer. Thank you.

Paul Johnston: I would say some of the bigger contractors may have some inventory. Inventory at the contractor level is not really material to our industry. It's being held at the distribution point. Not at the contractor point. So I don't think it's a big deal, you know, with the contractor. I would always also remember that you know, in Florida, it's either hot or hotter. It's not it's not just hot, you know, all the time. It's hot. So we've not had a cold summer down here. We've not had a cold summer in Texas.

Where the weather really impacts us is up north where we've got know, where it's you've got a chance out of every third year that you're gonna have a hotter normal summer. Or a normal summer or a lower than normal summer. And so we are definitely seeing a lot of regional differences in the volume. Based on weather. But in the South, we're not really seeing much movement because it's hot in Florida or hot in Texas. It's always hot.

Chris Snyder: Thanks. I appreciate that, Chris Snyder.

Operator: And this concludes the question and answer session. I'd like to turn the call back over to Albert Nahmad for any closing remarks.

Albert Nahmad: Well, thank you for your interest. I love the questions, and that shows a lot of interest. And I hope we've answered your questions fully. And if not, please contact us on your own. And we'll respond to whatever questions you may still have. And other than that, look forward to having you visit us in the cold months that are coming. We'll give you more detail. Thank you. Bye-bye.

Operator: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.

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DATE

Tuesday, July 29, 2025 at 8 p.m. ET

CALL PARTICIPANTS

Chief Executive Officer — Jonathan Stein

President and Chief Operating Officer — John Gatling

Chief Financial Officer — Mike Chadwick

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RISKS

Mike Chadwick cited an incremental $15 million in expected interest expense for full year 2025, mainly due to a higher debt balance following the repurchase transactions, as a negative driver in net income guidance.

Guidance for full year 2025 includes an incremental $15 million in expected income tax expense resulting from ownership changes, as reported by Mike Chadwick.

TAKEAWAYS

Throughput Volumes: Gas processing averaged 449 million cubic feet per day, crude terminaling reached 137,000 barrels per day, and water gathering averaged 138,000 barrels per day.

Growth vs. Prior Quarter: Gas processing and oil terminaling volumes increased by approximately 6% and 10%, respectively, from the previous quarter, reflecting strong upstream production and system availability.

Adjusted EBITDA: $316 million in adjusted EBITDA for the second quarter, up from $292 million in the first quarter, driven by a $30 million increase in total revenues, excluding pass-through revenues, primarily from volume growth in the second quarter.

Segment Revenue Drivers: Gathering revenue increased by $16 million, processing by $9 million, terminaling by $4 million, and third-party services by $1 million compared to the previous quarter.

Costs and Expenses: Excluding depreciation, pass-through costs, and LM4 earnings net, costs rose by $6 million from the first to the second quarter, mainly due to seasonal maintenance and higher third-party processing fees in the second quarter.

Adjusted EBITDA Margin: Maintained at approximately 80% in the second quarter, which is above the company's 75% target.

Capital Expenditures: $70 million in capital expenditures for the second quarter; Full-year 2025 capital expenditures guidance remains unchanged at $300 million.

Net Income: $180 million in net income for the second quarter, up from $161 million in the first quarter; Full-year 2025 expected net income range raised to $685–$735 million following updated interest and tax costs.

Adjusted Free Cash Flow: $194 million in adjusted free cash flow for the second quarter; Updated full-year 2025 adjusted free cash flow guidance is between $725–$775 million.

Distributions: Annual distribution per Class A share is targeted to grow at least 5% per year through 2027. The latest quarterly distribution in the second quarter included growth beyond the annual target after repurchase transactions.

Share Repurchases: The $200 million repurchase in May 2025 included public shareholders for the first time. The company is maintaining an approximate cadence of $100 million in share repurchases per quarter, but actual amounts may vary.

Leverage and Credit Rating: Senior unsecured debt upgraded by S&P to BBB- investment grade.

Liquidity: $273 million drawn balance on the revolving credit facility at the end of the second quarter, with management citing sufficient trading liquidity for ongoing buybacks.

Financial Flexibility: More than $1.25 billion available through 2027 for further unit and share repurchases and incremental shareholder returns.

Governance Changes: New board structure now requires approval from at least one independent director on major decisions, following GIP's full exit and Chevron’s governance participation.

SUMMARY

Hess Midstream LP (NYSE:HESM) reported record operating metrics for the second quarter of 2025, including sequential increases in both throughput and adjusted EBITDA (non-GAAP), supported by strong upstream performance and system availability. Management reaffirmed full-year 2025 guidance for volumes, capital expenditures, and adjusted EBITDA, while incorporating higher interest and income tax expenses into updated net income and cash flow projections. The company maintained its shareholder return strategy, including a targeted 5% annual distribution growth per Class A share through 2027 and a consistent share repurchase cadence, all underpinned by an upgraded investment-grade credit rating and revised board governance requirements to ensure balanced oversight after GIP's exit.

Jonathan Stein stated, Senior unsecured debt was upgraded by S&P to an investment grade rating of BBB- following the close of the Chevron Hess merger, highlighting enhanced credit quality.

Mike Chadwick confirmed, We are maintaining our adjusted EBITDA guidance range of $1,235 to $1,285 million for 2025, directly addressing second-half expectations.

Shareholder return flexibility extends to over $1.25 billion in potential excess capital available for distributions and buybacks through 2027, as stated by management.

Jonathan Stein emphasized, "key decisions require the approval of one independent director" with this mechanism designed to preserve a balanced governance model post-GIP exit.

INDUSTRY GLOSSARY

MVC: Minimum Volume Commitment—a contractual obligation between a producer and the midstream provider, ensuring baseline throughput for a set period, directly impacting revenue predictability.

GOR: Gas-to-Oil Ratio—the volume of produced gas relative to produced oil, an important factor in assessing basin maturity and infrastructure planning in oil and gas development.

ASR: Accelerated Share Repurchase—a mechanism allowing a company to buy back its own shares quickly, often from the open market and/or large shareholders, typically as part of capital return programs.

Full Conference Call Transcript

Jonathan Stein: Thanks, Jennifer. Welcome, everyone, to our second quarter 2025 earnings call. I have a few opening comments, and I will hand the call over to John Gatling to review our operations and Mike Chadwick to review our financials. I wanted to first say that we are all excited and eager to work together with our new Chevron colleagues to continue to drive value for our shareholders. Our new board members, including our new chair, Andy Walls, Chevron's President of Downstream, Midstream, and Chemicals, have significant experience across the upstream, midstream, and downstream businesses and complement the operational and financial expertise of our current board members.

I am also excited to welcome Mike Chadwick to his new role as Chief Financial Officer of Hess Midstream. I've worked alongside Mike for the past twenty years as he's progressed through various financial roles at Hess Corporation. And we are fortunate to have his experience and leadership capabilities working with the midstream. I am also excited to step into my new role as CEO of Hess Midstream. Since our IPO, we have created value for shareholders through operational excellence and execution that drives a visible trajectory of growth and supported by a financial strategy that includes a differentiated combination of balance sheet strength and a priority on shareholder return.

With the continuity of the midstream team in place, we are excited to take this strategy forward as we continue to build Hess Midstream with a unique combination of sector-leading growth and shareholder returns. Today, I want to focus briefly on three themes. First, we continue to deliver outstanding operational performance, which you can see reflected in the quarter that we reported today and also in our fourth annual sustainability report, which we issued a few weeks ago and which highlights our commitment and track record of safe and reliable execution.

In the second quarter, throughput increased across all segments, and we are in line with our annual guidance for volumes to grow by approximately 10% across all oil and gas systems in 2025, compared with 2024. Second, we continue to deliver outstanding financial performance. We are estimating an approximate 11% increase in adjusted EBITDA growth in 2025, with approximately 7% growth at the midpoint in the second half of the year. With total expected capital expenditures of approximately $300 million, we expect to generate adjusted free cash flow of approximately $725 to $775 million, which more than covers our targeted 5% annual distribution growth and generates excess free cash flow.

And third, we are committed to our ongoing financial strategy, which prioritizes return of capital to our shareholders and has made Hess Midstream total shareholder return yield one of the highest of our midstream peers, while also maintaining one of the lowest leverage ratios. Highlighting our balance sheet strength, last week Hess Midstream senior unsecured debt was upgraded by S&P to an investment grade rating of BBB- following the close of the Chevron Hess merger. Since 2021, we have returned greater than $2 billion to shareholders through accretive repurchases and have increased our distribution per Class A share by more than 60%. To 5% targeted annual distribution growth and distribution level increases following each share repurchase transaction.

We expect to generate greater than $1.25 billion of financial flexibility through 2027 for incremental shareholder returns, including the potential for further unit and share repurchases over this period. With a consistent strategy at Hess Midstream, we are excited for the future. We have a visible trajectory of growth that underpins our unique and ongoing return of capital, then Mike will review our financial results and guidance. In the second quarter, Hess Midstream delivered record operating performance. Throughput volumes averaged 449 million cubic feet per day for gas processing, 137,000 barrels of oil per day for crude terminaling, and 138,000 barrels of water per day for water gathering.

Throughputs increased across all segments of our business, with gas processing and oil terminaling volumes increasing by approximately 610%, respectively, from the first quarter, primarily driven by outstanding upstream production performance and high midstream system availability. Turning to Hess Midstream guidance, we're again reaffirming our previously announced full-year 2025 oil and gas throughput guidance. In the third quarter, we expect volume growth from the second quarter across our oil and gas systems, partially offset by higher seasonal maintenance activity. Turning to Hess Midstream's capital program.

John Gatling: Our multiyear projects continue as planned. In 2025, we remain focused on the completion of two new compressor stations and associated gathering systems as well as continuing to progress the Kappa gas plant. Full-year 2025 capital expenditures remain unchanged and are expected to total approximately $300 million. In summary, we remain focused on executing our strategy of disciplined, low-risk investments to meet basin demand while maintaining reliable operations and strong financial performance. We expect our growth strategy to generate sustainable cash flow and create opportunities to return capital to our shareholders. I'll now turn the call over to Mike to review our financial results and guidance.

Mike Chadwick: Thanks, John, and good afternoon, everyone. I wanted to say first that I'm really excited to join the Hess Midstream team and look forward to meeting you in the future. Today, I'm going to review our results for the second quarter and our financial guidance, and then we will open the call for questions. For 2025, net income was $180 million compared to $161 million for the first quarter. Adjusted EBITDA for 2025 was $316 million compared to $292 million for the first quarter.

The increase in adjusted EBITDA relative to the first quarter was primarily attributable to the following: total revenues, excluding pass-through revenues, increased by approximately $30 million, primarily driven by higher throughput volumes resulting in segment revenue changes as follows. Gathering revenues increased by approximately $16 million, processing revenues increased by approximately $9 million, terminaling revenues increased by approximately $4 million, and third-party services and other income increased by approximately $1 million. Total costs and expenses, excluding depreciation and amortization, pass-through costs, and net of our proportional share of LM4 earnings, increased by approximately $6 million, primarily from higher seasonal maintenance activity and third-party processing fees. Resulted in adjusted EBITDA for 2025 of $316 million.

Our gross adjusted EBITDA margin for the second quarter was maintained at approximately 80%, above our 75% target, highlighting our continued strong operating leverage. Second-quarter capital expenditures were approximately $70 million and net interest excluding amortization of deferred finance costs, approximately $52 million, resulting in adjusted free cash flow of approximately $194 million. We had a drawn balance of $273 million on our revolving credit facility at quarter-end. In January, we announced that we are targeting annual distribution per Class A share growth of at least 5% through 2027, which is supported by our existing MVCs.

This week, we announced our second-quarter distribution that included our targeted 5% annual growth per Class A share and an additional increase utilizing the excess adjusted free cash flow available for distributions following the repurchase. Turning to guidance. For 2025, we expect net income to be approximately $175 million to $185 million and adjusted EBITDA to be approximately $315 to $325 million, reflecting higher volumes and revenues partially offset by seasonally higher maintenance costs. We also expect CapEx to increase in the third quarter consistent with seasonally higher activity levels.

For the full year 2025, we are updating net income and adjusted free cash flow guidance to include the impact of an incremental $15 million in expected interest expense mainly on higher debt balance following the repurchase transactions completed so far this year. The updated net income guidance also includes the impact of an incremental $15 million in expected income tax expense resulting from ownership changes following the previously completed secondary equity offerings and repurchase transactions. As a result, we now expect net income of $685 to $735 million. We are maintaining our adjusted EBITDA guidance range of $1,235 to $1,285 million, implying growth of approximately 707% in adjusted EBITDA at the midpoint in the second half of the year.

With total expected capital expenditures of approximately $300 million, we now expect to generate adjusted free cash flow of approximately $725 to $775 million. With distributions per Class A share targeted to grow at least 5% annually from the new higher distribution level, we expect excess adjusted free cash flow of approximately $125 million after fully funding our targeted growing distributions. We continue to have more than $1.25 billion financial flexibility through 2027 that can be used for continued execution of our return of capital framework, including potential ongoing unit and share repurchases. This concludes my remarks. We will be happy to answer any questions. And I will now turn the call over to the operator.

Operator: Thank you. Please press 11 on your telephone. And wait for your name to be announced. To withdraw your question, please press 11 again. Our first question comes from the line of Jeremy Tonet from JPMorgan Securities LLC.

Praneeth Satish: Hey. Good morning. This is, Roth and Reddy on for Jeremy. I wanted to start off with the Hess deal now closed. If you guys have any insight into Chevron's view in the '26 and '27?

John Gatling: Yeah. Maybe I'll touch on it, and then Jonathan and Mike can hit it as well. But just from our perspective, we're currently running four rigs. We've seen very strong upstream performance, well delivery with our increased laterals. The midstream availability has just been phenomenal. You know, we'll continue to execute strongly and stay focused on that. And as we do every year, we'll update our development plan as we get an update with Chevron coming in as our sponsor. So that'll happen towards the end of the year, and then we'll be issuing guidance in January.

Praneeth Satish: Got it. Thank you. And then turning to capital allocation, wondering if you could talk a little bit specifically about your appetite for buybacks at current prices and with GIP sell down now complete, if we should think about any change in the magnitude of repurchases going forward?

Mike Chadwick: Yeah. So with buybacks, as we announced in January, we have about $1.25 billion financial flexibility through 2027, and we expect to do multiple repurchases a year as we've done in the past. So there's no change to that guidance. As we previously mentioned, our January repurchase that was in lieu of not having completed a repurchase in Q4 of last year. Our May repurchase of $200 million which included the public for the first time, that got us back into our cadence of about a hundred million every quarter. However, the size of that is not set in stone. But, generally, a $100 million a quarter is what we will be completing.

We have done over the last couple of years.

Jonathan Stein: And this is Jonathan. You know, as we said at the beginning, as I said in my comments, you know, overall, there's no change to our strategy in terms of our business strategy and to our financial strategy. And you saw that just this week, we issued, as Mike said, our quarterly dividend announcement on Monday night that included our distribution level increase as well as the $200 million increase following the $200 million share buyback that we did earlier. So, you know, really no change in return on capital program going forward. You mentioned GIP. Obviously, GIP out in terms of secondaries. You know, that's not something that we expect.

But in terms of return on capital, which is really always focused on that framework that continues as is.

Praneeth Satish: Makes sense. Thank you, guys.

Jonathan Stein: Thank you.

Operator: One moment for our next question. Our next question comes from the line of Samuya Jain from UBS.

Samuya Jain: Hi, good afternoon. Congrats on the quarter. I was wondering how are you guys seeing GORs trending in the near term? And along with that, what's your outlook on the Bakken heading into 3Q?

John Gatling: Yeah. So the GORs really haven't changed you know, as the basin matures over the longer term. GORs are expected to increase, which they're acting as exactly as we would expect them to. Looking at the North Dakota pipeline authority, Justin Crinstead and the team there, kinda looking at longer term basin growth in the in the gas space And it is anticipated that Bakken Gas Is Gonna Grow Over The Long Term, And We Would Expect The Pest And Chevron Bakken volumes to basically do the same trend the same way. So we're expecting oil to remain in the in the pipeline authorities forecast. They're expecting oil to remain flattish. With gas growing over the longer term.

Samuya Jain: Got it. Thank you. And then could you detail where gas processing volumes are at now over the past month? Any changes to note? We're just trying to understand the cadence, and same with oil terminaling.

John Gatling: Yeah. I think, generally speaking, we've seen an it expect to continue to see the growth through the end of the year, as our guidance has supported that. So, again, we had a very, very strong second quarter. We do continue to expect to see growth into the third and fourth quarters and finish the year at guidance. So I would say you would continue to see that growth through 2627 as the as the MVCs have kind of outlined. And, again, if there's any if there's any changes to the development plan, that'll happen, as part of our normal annual development plan process and that'll be updated in, in January.

Samuya Jain: Got it. Thank you.

John Gatling: Yeah. Thank you.

Operator: Thank you. One moment for our next question. Our next question comes from the line of Doug Irwin from Citi.

Doug Irwin: Thanks for the question. Congrats Jonathan and Mike, on the new roles as well. I just want to start with the guidance range here. If I just take the first half of guidance, first half 25 guidance just in the aggregate, I think you're turning about $15 million above the guided midpoint here year to date. And now third quarter is pointing to a bit more growth from here. I guess is it fair to say you're turning above the annual midpoint at this point, or there may be some variances versus your initial outlook that is kind of shifted around the timing throughout the year here versus your initial second half exit patients.

John Gatling: No. Maybe I'll touch on the operational side, and I can hand it over to Mike and Jonathan. But, overall, we again, we had an extremely strong second quarter. You know, very little weather impact. Essentially, maintenance activity. You know, coming out of the first quarter, which was a bit more challenging, you know, we were really just trying to stabilize operations, and I think we were very pleased with how both the upstream performed, but also how the midstream performed.

We're gonna continue to see that growth going into the third and fourth quarters, but you know, as we transition in, we are expecting to see a little bit more maintenance in the in the second half of the year. And that'll probably be kind of in the in the later part of the year. We're still kind planning all of the all of the activity, but there's there's still there's still some room there. And we're again, I think we're we're still very comfortable with the guidance that we've got currently. Yes. Thanks, John. And I'll just tag on the back of that as we

Mike Chadwick: have seen, we're keeping our adjusted EBITDA guidance for the year, which already includes quite a lot of growth baked into the second half. You know, as Jonathan said and I said in my notes, taking the midpoint of our full year guidance, we expect about 7% higher EBITDA in the second half of the year compared to the first half. And so while revenues are expected to grow on higher volumes, as John described, you know, phasing of maintenance costs means expenses are expected to be higher in Q3, and we also retained some winter weather contingency in Q4. And while winter weather can also lower maintenance costs, Q4 also typically see some variability in our allocation costs.

So we're keeping guidance there. For the second quarter.

Doug Irwin: Okay. That's helpful. Thank you. And then maybe another on buybacks, just asking a slightly different way. It's it's obviously early on in the relationship with Chevron here. I'm just curious if he you expect them to participate in buybacks kind of similar to how Hess did Or will buybacks moving forward pretty much be entirely dependent on buying back shares from public owners? And to the extent that you are buying back more public shares, does just general liquidity of those public shares impact kind of your ability to maintain the run rate? Kind of in as smooth of a cadence as you have in the past?

Jonathan Stein: Sure. This is Jonathan. Yeah. Look. I there's no change as we had said in the past, you know, when we had secondaries and buybacks happening, simultaneously, they're really two separate objectives, while the secondaries were changing ownership levels, the buyback program is really just to return a capital program, and so you would expect over time that we'll have the same you know, participation more closer to the relative proportional levels of the public and Chevron going forward. So really no change to our approach there.

We did include, as you know, now we have the we have kind of road tested, I'll call it, or use, the ASR process last time to include the public in our buyback program. And you know, have that mechanism available for us to be able to do that going forward as well. So really no change there. And in terms of our liquidity, I think you've seen that our liquidity has, you know, continued to increase as we did all the secondary transactions and the public ownership went up.

Our, you know, our liquidity at this point and average trading volume is, you know, more than sufficient to handle our buyback program at the level we've done in the past and expect to do going forward. Great. That's all for me. Thanks, Sean.

Mike Chadwick: Thank you.

Operator: One moment for our next question. Our next question comes from the line of Praneeth Satish from Wells Fargo.

Praneeth Satish: Thanks. Good afternoon. Also, congrats Jonathan and Michael, on the new roles. Maybe can you just provide any more context around GIP's decision to exit its investment in Hess Midstream back in May? I mean, I know they were selling down their stakes, so it wasn't really a surprise. But I guess why do it in May versus maybe after the merger with Chevron?

Jonathan Stein: Sure. So, you know, as you know, we've over the past you know, three years plus, we've been executing secondaries in a very disciplined fashion, each one increasing in size generally over time, and increasingly tighter discounts. So very disciplined approach. GIP saw an opportunity, as we'd always said, The second is based on demand from investors, and then GIP would have assess that relative to their value proposition expectations, and that existed in May. And so they continued taking that opportunity. They, of course, have their own investors and timeline and really, you know, really executing relative Timing. So, really, just continuing the disciplined execution that we had in the past and the opportunity presented itself.

Praneeth Satish: some investors have viewed GIP as providing an independent, voice that kind of helped balance, the sponsor interests with those of the public. So I guess with GIP now out, how do how do you think about the new governance structure versus having that third party institutional investor at the table?

Jonathan Stein: Sure. Yeah. No. We agree that, you know, one of our differentiating strengths relative to other sponsored midstream companies has been our balanced governance. And certainly with GIP, historically, part of the board that provided some, you know, level of that. So consistent with that approach, as you saw, we updated our governance in June following the GIP's exit. And that included that certain key decisions require the approval of one independent director That includes things like leverage above a certain level, issuing equity, or major capital decision among other key strategic decisions. That mechanism is now in place.

As you know, we're adding also a fourth independent board member, but this mechanism is in place independent of the number of board members at the time or the timing of the fourth independent member joining the board. So I think it really highlights our continued belief in the value of a balanced government model that we've had historically. And then with this new mechanism in place that we will continue to have going forward.

Praneeth Satish: Got it. Thank you.

Operator: Thank you. One moment for our next question. Our next question comes from the line of John McKay from Goldman Sachs.

John McKay: Hey, everyone. Thanks for the time. I wanted to pick up a little bit more on the Chevron side. I totally understand it's early and you're you'll have your annual review of activity levels later in the year. But Hess has been talking about this kind of 200 kboe a day target for a long time. Think we've kinda thought about that as the reasonable run rate for the footprint.

Could you maybe just acknowledging that can, I guess, change, but can you maybe just remind us of how that 200 a day level was set kind of what the thought process behind it was, and then, you know, maybe from that, any read on why that might be the right level going forward?

John Gatling: Again, I think, as we think about the 200,000 barrels a day, it was really kind of hitting the over a 100,000 barrels a day of gross oil. Or of net oil and then the gas growth over time. And as we've been doing just from a overall field development pamper plan perspective is we've really been trying to optimize the upstream drilling activity with the midstream infrastructure plan. And so it's it's really about having the infrastructure in place and then keeping that infrastructure as utilized as it possibly can be.

And so where when we looked at the build over time and looked at the infrastructure development and kinda where we felt like the development the field development from a drilling perspective was happening. We felt like that 200,000 barrels a day is about the right level. So, you know, outside of the two compressor stations that we're building this year, we're you know, in the process of progressing the Capa gas plant. You know, as far as material long term infrastructure, activity, we're we're kind of at that at that level where the infrastructure is stable.

And so from our perspective, you know, we're kind of looking at this as how does the drilling activity the infrastructure system really complement each other so that you get very, very high utilization of that equipment and really optimize the system itself. So that's that's really kinda where we are and how we've we've continued to look at it. And as we continue to look longer term, we'll we'll you know, look at our development plan again, which, again, it's a it's a very integrated,

John McKay: activity between the upstream and the midstream.

John Gatling: Know, that'll happen in the fall, and then we'll be updating our longer term guidance in, January.

Jonathan Stein: This is Jonathan. You know, one thing just to highlight, John really picked it up on the end, and I think it's important to highlight this stage, which is one of the historic strengths of Hess Midstream has been the partnership that we've had between the upstream and the midstream between Hess Midstream and the upstream and Hess to be able to develop the block in the most optimal way And you know, now as we go forward with Chevron, there's no change to that partnership. There's no change to the focus on both of us. Working together to optimize the Bakken and develop it, as John described.

And as he said, you know, that the normal process will continue where we get a updated development plan, We'll figure out what's the right infrastructure required to meet that development plan going forward. And then we'll update our guidance based on that going forward. So really continuing in that strong partnership that has really been a hallmark of our relationship historically.

John McKay: That's helpful, and that's all clear. Maybe just one related one. You've seen kind of increased efficiencies on the upstream side there, just what's been the latest commentary around related inventory life?

John Gatling: Yeah. I mean, I think, you know, we're still everybody gets still hung up on rig count and well counts and all of that. And, you know, really, as we move into an extended lateral program, it really is the lateral footage drilled. And so from our perspective, the overall lateral footage that's been drilled as far as what's available to develop really remains unchanged.

And in fact, we're actually seeing a little bit of growth in that space just from the standpoint of as those extended laterals become a bigger part of the portfolio, that creates opportunities for improved economics on those wells where they may be in more challenged areas But if you're drilling a three, four mile lateral, your the economics get much better, and that unlocks some of the of the rock that may have been challenged before. So I think we're we continue to be extremely optimistic in that space, and that's something that continues to be a tailwind for us as we as we look forward, for the basin development.

John McKay: Alright. That's clear. Appreciate the time. Thank you.

Mike Chadwick: Thank you.

Operator: This concludes today's conference call. Thank you for participating. You may now disconnect.

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This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. Parts of this article were created using Large Language Models (LLMs) based on The Motley Fool's insights and investing approach. It has been reviewed by our AI quality control systems. Since LLMs cannot (currently) own stocks, it has no positions in any of the stocks mentioned. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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DATE

• Wednesday, July 30, 2025, at 10 a.m. EDT

CALL PARTICIPANTS

• Chairman and Chief Executive Officer — Bill Lynn
• Chief Financial Officer — Mike Dippold

Need a quote from one of our analysts? Email [email protected]

RISKS

• Management cited, "germanium availability and pricing remain a thorny issue," with export restrictions constraining supply and increasing costs, and noted that reliance on safety stock is required to sustain product deliveries for most of the year.
• Adjusted EBITDA margin expansion guidance for FY2025 was reduced due to R&D investment running well above plan, as well as "increased raw material input costs related to germanium."
• "Quarterly cash usage was higher than this time last year," attributed to increased working capital investment, although expected by management.
• The company is "actively mitigating the germanium availability challenge" but expects "more meaningful relief in 2026," signaling continued near-term operational risk.

TAKEAWAYS

• Bookings: $853 million of bookings, reflecting a book-to-bill ratio of 1.0 with notable strength in electric power and propulsion, naval network computing, advanced infrared sensing, and ground systems.
• Total Backlog: $8.6 billion total backlog, up 9% year over year, with funded backlog experienced double-digit growth.
• Revenue: $829 million in revenue, representing 10% year-over-year growth and balanced contributions from both business segments.
• Adjusted EBITDA: Adjusted EBITDA was $96 million, a 17% increase in adjusted EBITDA, yielding a margin of 11.6%—70 basis points higher versus the prior year.
• ASC Segment Performance: ASC adjusted EBITDA increased by 5%, though ASC adjusted EBITDA margin declined by 50 basis points due to higher internal R&D and unfavorable program mix arising from germanium cost pressures.
• IMS Segment Performance: IMS adjusted EBITDA was up 41% and margin expanded by 290 basis points, predominantly driven by the Columbia Class program and broader electric power and propulsion activities.
• Net Earnings: Net earnings (GAAP) were $54 million, with diluted EPS (GAAP) of $0.20, up 42% and 43%, respectively, compared to Q2 FY2024.
• Adjusted Net Earnings: Adjusted net earnings were $62 million, with adjusted diluted EPS of $0.23, increasing 32% and 28%, respectively (non-GAAP).
• FY2025 Guidance (Revised): Revenue raised to $3.525-$3.6 billion for FY2025 (9%-11% growth), adjusted EBITDA narrowed to $437-$453 million, and adjusted diluted EPS set between $1.06-$1.11, assuming a 19% tax rate, and 269 million fully diluted shares (guidance for FY2025).
• Free Cash Flow: The company expects approximately 80% conversion from adjusted net earnings for the full year 2025.
• Q3 Outlook: Revenue is forecasted to be near $925 million for Q3 FY2025, with adjusted EBITDA margin (non-GAAP) targeted in the mid-12% range, with and free cash flow generation comparable to 2024.
• Macro Tailwinds: Management directly referenced $150 billion in new U.S. defense funding via the One Big Beautiful Bill Act, enacted earlier in 2025, with $113 billion front-loaded into FY2026, allocated to FY2026 defense funding, and a FY2026 U.S. defense budget request totaling $962 billion, up 12% year over year for FY2026 compared to FY2025, including reconciliation funding.
• International Demand: NATO members are now targeting 5% of GDP for national security with 3.5% dedicated to defense, higher than the previous 2% benchmark, supporting further international growth for Leonardo DRS, Inc.
• Golden Dome: Management said initial order activity is expected in 2026 due to the early-stage program architecture and procurement planning.
• Internal R&D Investment: Increased IRAD reached the mid-threes percent of revenue at the half-year mark in 2025, up from 2.8% in 2024, focusing on counter-UAS, space, and missile seeker capabilities.

SUMMARY

Leonardo DRS (NASDAQ:DRS) management reported revenue and profitability growth across both business segments in Q2 2025, driven by ongoing program execution and strong U.S. and international demand. Operating performance prompted an upward revision to full-year 2025 revenue and adjusted earnings guidance, despite near-term cost headwinds from materials and elevated R&D investment. Macro environment developments, including major increases in U.S. defense spending and rapidly rising NATO commitments, underpin long-term demand visibility across core program areas without material changes to contract structure or company positioning.

• The company expects to be largely insulated from direct impacts of expiring tariff reprieves, although management acknowledged potential second-order risks, including new critical minerals trade restrictions.
• Bill Lynn noted upward pricing pressure in the M&A market due to heightened sector interest, and stated, We are seeing properties that would be interesting there. The prices are relatively high.
• Management clarified that the Columbia Class program’s contract structure provides stability against budget changes and reported delays, as contracts for ship sets are secured into the mid-2030s.
• Mike Dippold stated that R&D investment, directed at expanding ReadyNow solutions, has been intentionally increased to accelerate competitive positioning in counter-drone and space-focused markets, with internal R&D spend rising from about 2.8% in 2024 to the mid-3% range at the half-year point.

INDUSTRY GLOSSARY

• Book-to-bill ratio: A measure comparing new bookings (orders received) to revenue billed during the period; a ratio above 1.0 indicates backlog growth.
• ASC: Advanced Sensing and Computing segment, focused on infrared sensors, electronic warfare, and computing systems.
• IMS: Integrated Mission Systems segment, comprising electric power, propulsion, force protection, and mission system solutions.
• IRAD: Internal Research and Development; company-funded R&D for product and technology development outside customer contracts.
• Golden Dome initiative: U.S. strategic layered air and missile defense funding priority named in recent federal defense legislation.
• Columbia Class program: U.S. Navy nuclear ballistic missile submarine program central to company’s naval power content and growth outlook.
• ReadyNow: Proprietary term management uses to reference rapidly deployable, mature, production-ready technologies.
• Counter UAS: Solutions and technologies targeting the detection, tracking, and neutralization of unmanned aerial systems (drones).

Full Conference Call Transcript

Bill Lynn, our Chairman and CEO, and Mike Dippold, our CFO. They will discuss our strategy, operational highlights, financial results, and forward outlook. Today's call is being webcast on the Investor Relations portion of the website, where you'll also find the earnings release and supplemental presentation. Management may also make forward-looking statements during the call regarding future events, anticipated future trends, and the anticipated future performance of the company. We caution you that such statements are not guarantees of future performance and involve risks that are difficult to predict. Actual results may differ materially from those projected in the forward-looking statements due to a variety of factors.

For a full discussion of these risk factors, please refer to our latest Form 10-Ks and our other SEC filings. We undertake no obligation to update any of the forward-looking statements made on this call. During this call, management will also discuss non-GAAP financial measures, which we believe provide useful information for investors. These non-GAAP measures should not be evaluated in isolation or as a substitute for GAAP performance measures. You can find a reconciliation of the non-GAAP measures discussed on this call in our earnings release. At this time, I'll turn the call over to Bill. Bill?

Bill Lynn: Thanks, Steve. Good morning, and welcome, everyone, to the Leonardo DRS, Inc. Q2 earnings call. Our second quarter results reflect sustained momentum and capturing customer demand, driving revenue growth, expanding both profitability and margin. In the quarter, we secured $853 million of bookings, which is a 1.0 book-to-bill ratio for the quarter. We saw particular strength for electric power and propulsion, naval network computing, advanced infrared sensing, and ground systems technologies, all of which contributed meaningfully to Q2 bookings. Our total backlog stood at $8.6 billion, rising 9% year over year. Also noteworthy was that our funded backlog maintained a healthy double-digit growth rate in the quarter.

We continue to expect a book-to-bill ratio greater than 1.0 for the full year, thanks to strong performance in the first half and consistent customer demand across the portfolio. Diving deeper into our quarterly financial performance, we delivered double-digit organic revenue growth squarely in line with the framework shared on the last call. Furthermore, the foundation built in the year to date is leading us to increase our full-year revenue growth expectations to 9% to 11%. Our profit metrics also showed strong performance. Adjusted EBITDA was up 17%, corresponding margin increased by 70 basis points, and adjusted diluted EPS was up 28%. In aggregate, our strong Q2 results position us well to meet our full-year outlook.

That said, the team and I remain focused on disciplined program execution, investing for future growth, and navigating a complex operational environment. We continue to operate in a dynamic macro backdrop, one that remains largely favorable to Leonardo DRS, Inc., though not without its complexities. Let me begin with the positives. Earlier this month, the One Big Beautiful Bill Act was enacted, a sweeping tax reconciliation package that includes $150 billion in defense funding, with $113 billion front-loaded into FY '26. This legislation represents significant opportunities and tailwinds for Leonardo DRS, Inc.

The funding emphasizes the following: shipbuilding and enhancing industrial base resiliency, layered strategic air and missile defense, including initial funding for the Golden Dome initiative, counter UAS and unmanned systems, electronic warfare, missiles and munitions, and more broadly, investment in innovation to enhance asymmetric capabilities. Our portfolio is well aligned with these national priorities, and we expect to benefit across the company as this funding is obligated over the coming years. Additionally, the administration's FY '26 defense budget request calls for $962 billion in total defense spending, including the reconciliation funding, which in total represents a 12% increase year over year. Beyond the US, global defense spending continues to rise amid ongoing geopolitical tension.

Notably, NATO members are now targeting 5% of GDP for national security, with 3.5% dedicated to defense, a sharp increase from the long-standing 2% benchmark. This trend is expected to support incremental international demand, particularly for our ReadyNow differentiated capabilities. The intensifying global threat landscape is especially acute for our operations and employees in Israel. We are grateful to report that all employees in the region are currently safe. We are closely monitoring the situation and are taking proactive steps to enhance employee safety and operational continuity. Shifting to supply chain, while our overall supply chain remains relatively healthy, germanium availability and pricing remain a thorny issue. Export restrictions have constrained the available global supply of this raw material.

Unfortunately, new mining and refining capacity has also been slower to ramp. We are currently relying on our safety stock, which provides sufficient runway for most of the year. However, in order to sustain timely product deliveries, material flow must improve in the second half. We are actively mitigating the germanium availability challenge through a multipronged approach. We expect these mitigation efforts to offer more meaningful relief in 2026. Onto tariffs. The temporary reprieve granted by the administration is set to expire later this week. As previously discussed, we expect to be largely insulated from direct impacts, particularly for inputs where cost increases can be clearly tied to tariffs.

However, second-order risks persist, including the potential for retaliatory trade restrictions on items such as critical minerals. Despite the complexities of the macro environment, Leonardo DRS, Inc. continues to innovate and deliver cutting-edge technologies to meet the evolving needs of our customers. This quarter, we delivered advanced infrared sensing content for the next-generation short-range interceptor or stinger replacement, as well as other future missile systems. These sensors provide a distinct operational advantage, offering higher resolution, improved countermeasure resilience, lower cost, and enhanced overall performance. We are also seeing growing opportunities to integrate our mobile power generation solutions into new missile systems.

Overall, I am pleased with our ability to broaden the applicability of our infrared sensing expertise into this logical adjacency. Amid rising strategic and tactical threats, Golden Dome is a critical part of this effort. Our portfolio, including our over-the-horizon radar, tactical radar technologies, as well as counter UAS capabilities, is highly relevant and well-positioned to support this demand. Additionally, some of our increased internal research and development investment is being directed toward further demonstrating and maturing our space sensing capabilities. We believe we have a highly differentiated offering that can provide customers added capability in space-based missile tracking and intercept. We are committed to securing competitive successes in this domain.

The persistent threat environment is driving escalation of customer interest and an expansion of existing contracts across each of the capability areas I noted earlier. Our tactical radar offering has maintained strong international demand, as allied nations look to reinforce their short-range air defense posture. At the same time, we are seeing rapid expansion in counter UAS opportunities across the company, but also a comprehensive technology suite including infrared sensors, laser and RF systems, along with platform integration expertise to deliver best-of-breed solutions. Customer focus on counter UAS is here to stay, and its importance is only growing, as evidenced by the recent launch of a joint interagency task force to tackle this ongoing threat.

Beyond sensing and force protection, our network computing business plays a critical role in enabling next-generation shipboard computing, supporting both US and allied naval modernization initiatives. Our proprietary ice piercer cooling technology is starting to gain traction, especially as customers seek to increase computing density and system performance in constrained platforms. Lastly, to round up my operational updates, I want to briefly touch on our electric power and propulsion business. This part of Leonardo DRS, Inc. continues to perform exceptionally well, serving as a consistent financial tailwind propelling both top-line growth and margin expansion.

We are well-positioned to capitalize on medium and long-term opportunities tied to next-generation platforms and to expand platform content in support of the priority to improve shipbuilding throughput. Our Q2 financial results reflect the strength of our portfolio and growing demand for differentiated capabilities in a rapidly evolving threat environment. We have solid momentum in bookings and a remarkable backlog that provides ample runway visibility into enhanced revenue growth. That said, we remain rigorously focused on continuing to deliver for our customers. Our success to date is a testament to the hard work of our team, and we are committed to building on this foundation in the second half of the year.

Let me now turn the call over to Mike, who will review the second quarter and our revised 2025 guidance in greater detail.

Mike Dippold: Thanks, Bill. I am pleased with our year-to-date performance. We had a solid quarter, but we are keeping focus on consistent execution to deliver against our full-year financial objectives. Let me begin by reviewing Q2 performance. Revenue for the quarter was $829 million, 10% higher year over year. The strong continued organic growth is fueling our ability to raise our guidance for the full year, which I will discuss shortly. Both segments had relatively balanced contributions to our increased quarterly revenue. The IMS segment and the company in total benefited from greater revenues from electric power and propulsion programs. Advanced infrared sensing and ground network computing programs bolstered growth at ASC as well as at Leonardo DRS, Inc. at large.

Moving now to adjusted EBITDA. Adjusted EBITDA in the quarter was $96 million, up 17% from last year. Adjusted EBITDA margin in Q2 was 11.6%, representing a 70 basis points of margin expansion compared to last year, and improved profitability at our electric power and propulsion business, most notably on our Columbia Class program. Shifting to the segment view, ASC adjusted EBITDA increased by 5%, but margin contracted by 50 basis points due to greater internal research and development investment along with less favorable program mix and less efficient program execution caused by rising raw material costs, namely germanium.

IMS adjusted EBITDA was up 41%, and margin expanded by 290 basis points, thanks to improved profitability on our Columbia Class program and across the rest of the electric power and propulsion business. Onto the bottom line metrics, second-quarter net earnings were $54 million, and diluted EPS was $0.20 a share, up 42% and 43%, respectively. Our adjusted net earnings of $62 million and adjusted diluted EPS of $0.23 a share were up 32% and 28%, respectively. Solid core operating performance coupled with reduced interest expense led to favorable year-over-year comparisons. Moving to free cash flow.

Although our quarterly cash usage was higher than this time last year, it was in line with our expectations as we anticipated increased working capital levels to fuel growth. Despite higher capital expenditure investments in 2025, halfway through the year, we are revising our full-year 2025 guidance across our key metrics. We are increasing the range of revenue to $3.525 to $3.6 billion, implying a 9% to 11% year-over-year growth. We have solid backlog visibility for the balance of the year, with a modest portion of our revenue coming from book-to-bill programs. Approximately 90% of our full-year revenue has been realized or is in backlog.

Given the healthy visibility, the timing of material receipts will be the most important factor in determining the level of our revenue output. We are also narrowing the range of adjusted EBITDA. The revised range is expected to be between $437 and $453 million. At this time, we expect IMS to offer more growth and margin improvement opportunity relative to ASC. The guidance adjustments to revenue and adjusted EBITDA result in a reduced implied margin expansion for the year. This is due to two factors. One, our increasing R&D investment well above plan, and two, we are seeing increased raw material input costs related to germanium.

Our revised adjusted diluted EPS range incorporates the tailwinds from increased core profitability, lower net interest expense, and a reduced diluted share count. We now expect adjusted diluted EPS between $1.06 and $1.11 a share. Assumed in these figures is a tax rate of 19%, which is unchanged from our prior guide, and a $269 million fully diluted share count, lower than our prior guide as we factor in the impact of stock repurchases. With respect to free cash flow conversion, we still anticipate approximately 80% conversion of our adjusted net earnings for the full year.

The recently enacted tax legislation is expected to have limited benefit to our 2025 free cash flow, but it will be a modest tailwind in 2026 and beyond. That said, we are still working to quantify the specific impact. Now let me offer up our framework for the third quarter. We expect revenue in the neighborhood of approximately $925 million, adjusted EBITDA margin in the mid-12% range, and free cash flow generation comparable to 2024. Please note the timing of material receipts will weigh heavily on how the second half is allocated on a quarterly basis. Let me offer some closing thoughts before we take questions. I want to extend my gratitude to the broader Leonardo DRS, Inc. team.

Our financial success is a direct result of their incredible efforts and unwavering commitment. As we navigate an increasingly complex global environment, we remain consistently focused on delivering exceptional technology to our customers, executing with excellence, and driving sustainable long-term growth. With that, we are ready to take your questions.

Operator: Thank you. Due to time restraints, we ask that you please limit yourself to one question and one follow-up question. Our first question will come from the line of Peter Arment with Baird. Your line is open.

Peter Arment: Yes. Hey, good morning, Bill, Mike, Steve. Nice results. Thanks for the color on kind of Golden Dome and how you're positioned. Maybe if I could just ask, when do you expect, you know, I know the architecture hasn't been fully laid out with General Goodline just getting the assignment. But how do you expect it to kind of roll out in terms of impact, you know, your backlog? When should we start to see kind of some of the programs that you might be well-positioned on?

Bill Lynn: Thanks, Peter. I mean, as you said, they're just organizing themselves on the architecture. There are industry meetings starting, and the department has an internal effort to lay out an architecture. So I think that means you won't see much in the way of bookings or orders this year in calendar '25. But I think given that they're trying to really focus on doing things in this presidential term, you'll start to see orders roll out in the '26 time frame.

Peter Arment: Okay. Appreciate that. And just as my follow-up, just could you talk maybe a little bit about the M&A environment? I know you've had interest there in the past, and just, you know, are you seeing more deals just given, you know, where funding is and any update there? Thanks.

Bill Lynn: Yeah. I mean, we're, as you know, we're in the market. We're looking. We're doing diligence. We're seeing a continual flow of things in those four core markets where we're focused. We have been active. I'd say the only change we're seeing is given the interest in the sector, I think prices are pushing up. So I think that's been a factor here. We're having to assess our financial criteria, which are relatively strict, although we're open to things the closer they are strategically to our main areas of focus, the more we're willing to extend on financial criteria. And that's what's going on right now is that strategic focus. We are seeing properties that would be interesting there.

The prices are relatively high.

Peter Arment: Got it. I'll jump back in the queue. Thanks, Bill.

Operator: And one moment for our next question. And that will come from the line of Robert Stallard with Vertical. Your line is open.

Robert Stallard: Thanks so much. Good morning.

Bill Lynn: Morning. Good morning.

Robert Stallard: Couple for you. First of all, I was wondering if we could dig into this whole germanium thing. And what's going on there. You know, how much of a headwind has it been so this year? What are you expecting in the second half? And what is this metal used for in terms of your products? And then secondly, maybe following up on Peter's question, was wondering if you could elaborate on this flexibility on looking at M&A. Does this mean you might be open to using equity, for example? Are you looking at a different return metric in terms of when the deal might pay off? That would be helpful. Thank you.

Bill Lynn: Yeah, Peter, let me—I'm sorry, Rob, let me start on germanium and then let Mike expand on it. On germanium, you know, what's happened is given the tension with China, the source of most of the germanium in the world is the supply has reduced to a trickle. We anticipated this in the sense that we built up a safety stock. And we're now having to utilize that safety stock. That has been effective for us, but it has caused prices to increase. And it's also caused us to seek other sources of germanium outside China. So we're looking at other countries and sources of germanium. We're looking at other customers.

There is an ability to recycle out of existing products. And then there are opportunities on some products we could use something other than germanium, although that requires at least a couple of months' work in terms of redesign, qualifying. It's not overly taxing, but there is a time lag. We're pursuing all of those with a target of 2026 to bring some or all of those online. Let me let Mike address your question on the fiscal impacts.

Mike Dippold: Yes. So Rob, first, you had a question in terms of what product are they used for? This is going through our infrared product line. So in our advanced sensing, computing business, but more focused on our infrared sensing capabilities, that's where you see this metal being used. For the impact, we spoke a little bit about last quarter in terms of the price shock that we saw because of the supply-demand elements that were in play. And we made the comment that absent the germanium impact, the margins of ASC would have been in line in Q1 with expectations. Looked into Q2 here, and the prices remained fairly stable.

What we're seeing is as that availability becomes a concern later in the year, we've had some absorption issues and some overhead rates that have impacted a little bit more than we had anticipated in Q1. So that's what we're looking at from an impact perspective. All of that's now incorporated into the revised guide that we put forward.

Bill Lynn: Rob, I'd come back on your M&A question, the financial. We have three financial metrics: EPS, ROIC, and then our overall margin and growth. On EPS, we expect it to be accretive in the first year. There's a little flex there, but probably not. With that, we will look at ROIC, we're looking at a multiyear return. I think there we would have flex. I think things that would take maybe a little bit longer to bring a positive contribution to ROIC, we're willing to kind of go along beyond our notional three-year window looking four years, five years. I think that would be well within something we'd find acceptable. And the other is more general.

We have, I think, a very strong, you know, right now, double-digit growth story. We have a margin enhancement story. I don't think we are now changing our approach there. We don't want to undercut that story with a significant acquisition. And that really hasn't changed. So the change is I think we'll be more flexible on ROIC.

Robert Stallard: Okay. That's great. Thank you very much.

Operator: And one moment for our next question. And that will come from the line of Michael Ciarmoli with Truist Securities. Your line is open.

Michael Ciarmoli: Hey, good morning, guys. Thanks for taking the question. Bill, maybe just a little bit more clarification on what Keith was asking about Golden Dome. I mean, you know, thinking about timing of order flow, does that kind of stand for already deployed existing systems, or is this kind of—are you talking architecture for some of the newer kind of systems and capabilities that might be deployed?

Bill Lynn: Right. It's a little hard to be specific because they don't even have a program yet. But I think, you know, directionally, I think the first orders would have to be on existing systems, just given the timing. And you're going to have to develop—it will take longer time to develop first the requirements and then the RFP and then the competition for kind of future-oriented. So I think what's behind your question is right. The early orders are likely to come from something that has some maturity, something that's already something that can be produced.

Michael Ciarmoli: Got it. Okay. And then just if I may, just because you used to be in the building, you know, this is obviously a unique and dynamic budget environment. We're getting a big bump up in front-end load here with reconciliation, but we don't have a FYDP yet. How are you guys thinking about, you know, just budget and trajectory longer term and maybe, you know, kind of, like I said, just drawing on your experience from being in the building?

Bill Lynn: Yeah. It's actually not unusual at this point not to have a FYDP. Usually, a new administration just puts out a first-year budget and is in the middle, as they are, of their kind of their strategic plan. Obviously, what they have done so far, they really inherited from Biden. It takes some months to develop that strategic plan, which they're doing. So I wouldn't expect to see a FYDP until the next budget, which is February. But that's not unusual. In terms of what to expect, I mean, there's lots of puts and takes in the reconciliation bill.

I think, you know, if you look at just general historical trends and tendencies, when you move from a Democratic to a Republican administration, normally, what you see is a modest at least bump up in the overall defense spending. Generally, politically, a Republican administration sees itself as stronger on defense, wants to show that in the budget. And then second, they have more initiative. You know, multiple questioners have mentioned Golden Dome. But there's force protection, there's shipbuilding, there are programmatic reasons to increase the budget. So I think at the end of the day, when the smoke clears, you'll see a Trump budget that, over time, is moderately higher than its Biden predecessor.

Michael Ciarmoli: Got it. Okay. Good color, Bill. I'll jump back in the queue here.

Operator: And one moment for our next question. And that will come from the line of Seth Seifman with JPMorgan. Your line is open.

Seth Seifman: Thanks very much, and good morning. Wanted to ask, you know, you talked about performance, good performance in electric power and propulsion, and about the opportunities there that may be to capitalize on what's coming into the resources coming into the industrial base. I wonder if you could be more specific around kind of where you see opportunities, you know, do those opportunities come out of the new facility in Charleston primarily? And you know, what the timeline for capitalizing on some of those opportunities might be?

Bill Lynn: Sure, Seth. And I'll start and then let Mike add some more color. I mean, first of all, the core program, of course, in our naval powers is Columbia, which is secured through the middle of the next decade and is on a steady increase. And we are using that South Carolina facility to execute that program with greater and greater efficiency, which should be a tailwind on margins. Beyond that, which is really what I think you're asking, is we see that facility and our overall capabilities generally as well-positioned to help the Navy surge content into the industrial base with the goal of particularly increasing the throughput of submarines where we have important content beyond just Columbia.

In particular, I would say the first of those opportunities is in the area of steam turbine generators. The Navy has now given us $50 million of that industrial base money to build a test capacity in South Carolina for that. What should follow on is another contract to design a new steam turbine generator with production to follow. The problem that's addressing is that there's only one producer of steam turbine generators, which makes it something of a choke point in submarine production. And the Navy is interested in the second source to address that choke point. So I think we're a principal part of the avenue to address that challenge.

And beyond that, I think there's a more general view, and we're talking to the Navy in the future about can we use our capacity to take on more work and allow the yards to dedicate their resources to producing submarines faster. That's still a sort of an early-stage discussion, but I think there's real potential for additional content to move to suppliers such as Leonardo DRS, Inc. with, again, the goal of increasing that submarine throughput.

Mike Dippold: Yeah. The only thing I'll add, Seth, is from a timing perspective, we do expect the Columbia portion of the building to begin to come on in 2026, in late 2026, and actually begin to pull the work in. That Columbia piece of the investment not only covers Columbia but also if we have some successes in new platforms that'll help from a capacity perspective and ability to execute. What Bill was mentioning in terms of the steam turbine efforts, that funding is now flowing, and we're starting those exercises.

That will come on from a timing perspective a little later, you know, outside of 2026 as we create that test capability and start to move forward on the steam initiative. From there, you can start to see that extra tool that we're putting in a toolbox from a steam turbine generator perspective start to be an impact of revenue outside of that 2027 time frame as we begin to execute development work with the anticipation of hopefully having production thereafter.

Seth Seifman: Great. Thank you. And maybe just as a quick follow-up, do you expect—how do you look at the bookings environment for the second half? Do you expect to exit the year with the backlog higher than it was at June 30?

Bill Lynn: Yes. We do. But let me let Mike address it.

Mike Dippold: Yeah. I would—I think the bookings for the quarter of the kind of one-to-one ratio, I wouldn't put too much stock into that. We're continuing to see strong demand across all elements of the business. For the six-month period, we're still sitting above the one-to-one ratio, and we expect that to continue throughout the second half of the year. So still a lot of confidence. The macro tailwinds in the threat environment are still there. The budget alignment is there. And we feel good about our ability to continue to see strong bookings throughout the remainder of the year.

Seth Seifman: Great. Thank you very much.

Operator: One moment for our next question. And that will come from the line of Andre Madrid with BTIG. Your line is open.

Andre Madrid: Good morning, everyone. Thanks for taking my question. Thanks, Andre. You previously disclosed international sales would outpace the broader sales growth for this year. With the new NATO commitments, again, that's not instantaneous. It's over a decade. But could we see upside to, you know, what you initially thought international would be through the out years?

Bill Lynn: Yeah. I think a couple of things are happening in the international space right now. First off, you know, what will drive a little bit of the international is what happens with Ukraine. So I think first and foremost, that's going to be an indicator of where our international sales go. So far, that demand has continued. From a NATO perspective, we are seeing consistent demand signals across some of the, you know, East European members of NATO and are focused on being able to execute there. The question in the long term will be, what does that mean from a European industrial base investment buying American?

We continue to see the elements moving towards the ReadyNow capabilities are still important. So we see that as a tailwind to, you know, kind of the US domestic opportunities to sell abroad. I expect to see that trend continue. Again, we still view the international market as a growth engine because of NATO, but also just because of the other macro trends and the hot global conflicts that are emerging.

Andre Madrid: Got it. Got it. Maybe a follow-up to that. I mean, so long as they, you know, fit into the criteria that you've outlined already, would you be especially interested in acquiring anything over in Europe? I guess, following on to that, given that, you know, valuations have been a little high right now, a little rich, what's your attitude towards forging partnerships with defense tech names? I mean, this just seems to be becoming more prevalent in the current threat and demand environment, so curious to hear your thoughts there.

Bill Lynn: On the—we have a global focus on our M&A. Obviously, we demonstrated that when we acquired RADA and the triangular merger that brought us public, RADA being an Israeli company. And we have looked in Europe and Asia as well. So we have an international focus. We're not limited just to the US. In terms of partnerships, that too is on the table. We have had discussions with different companies about arrangements we might make that will increase our mutual competitiveness. And so that would be on the table as well.

Andre Madrid: Got it. Got it. I'll jump back in the queue.

Operator: One moment for our next question. And that will come from the line of Christine Lewag with Morgan Stanley. Your line is open.

Christine Lewag: Hey, good morning, everyone. Bill, you've kind of talked a lot about the germanium risks here. I was wondering, are there other rare earth metals that you're watching? And it sounds like 2026, you'll see some improvement. But if you have, you know, I guess, what we're seeing in the industry is everybody else is also trying to figure out their supply. If things don't necessarily pan out as you expect for 2026, how could this shortage of germanium or higher cost affect operating performance?

Bill Lynn: Thanks, Christine. We do look at other—the biggest other material we think about is permanent magnets because that's a part of the electric drive system in Columbia and any other programs. We are pretty well protected right now in that we have the supply for all of our existing programs. So as we look at it, it's more protecting against future programs, and we're looking at what steps we would need to do to do that. But in terms of germanium on 2026, as I said, we have multiple paths in terms of recycling, other sources, other materials.

We think that through the course of 2025, those are going to come online and allow us to start to begin back up the ramp again in terms of germanium and protect the 2026 program.

Christine Lewag: I see. Thank you. That's really helpful. And following up on the opportunity in European NATO, even though NATO in Europe wants to spend more money on defense, there's also a concerted effort to focus more on indigenous capabilities. So, I mean, you guys are, you know, largely an American company. But your ownership is also with a European parent. So do you have any indication in terms of how these governments view you? Do they view you as an American company, or do they view you as hybrid because of your European parent ownership? How does that work? And does that change the opportunity for Europe for you regarding their higher spend?

Bill Lynn: I think we're in a proxy. We're most definitely a US company. I think that's how we're viewed both in the US and in Europe. I think though the angle towards which you're headed is right, is where we have opportunity, which is maybe unique given our ownership structure. We have the opportunity to team with and collaborate with Leonardo because of our closeness, and that allows us then to go into Europe as a home team and to use the good offices and the teaming arrangements with Leonardo. And we're seeing opportunities in the UK and elsewhere where we can execute on that partnership.

It's that partnership rather than just being seen as a—it's not how we're seen as our country of origin. It's how we partner with our 70% shareholder.

Christine Lewag: Great. Thank you.

Operator: One moment for our next question. And that will come from the line of Moeller with Canaccord Genuity. Your line is open.

Moeller: Hi. Good morning. Just my first question here. If we look at the House Appropriation Committee's draft of the defense bill, there's a 57% plus-up to about $5.27 billion for the Columbia Class program. I was wondering if you could just comment on that and the reported 12 to 16-month delay in boat construction for Columbia Class and how that affects the one versus two production rate for Columbia and Virginia Class and how we should think about that.

Bill Lynn: Yeah. On Columbia, the Navy, working with the yards, has intentionally put us in a relatively segregated position so that we have, as I said, the contracts on Columbia for the ship sets all the way through shipset 12, which takes you into the mid-2030s. The purpose of that was to insulate this critical component from the ups and downs of the program itself. The reason to do that is you don't want to lose—this is a complex program. You don't want to lose the learning. You don't want to lose the workforce by having gaps and, you know, having down cycles and then being forced to retrain.

That will cause schedule and budget issues in the Navy, and nor are we looking for that. So, you know, we're not really affected by that budget increase that you talked about. We have, you know, our budget set by contract all the way through the 2030s. And the intent of setting that contract out was not to change the motor schedule, the drive schedule, based on relatively modest changes in the ship delivery schedule, the submarine delivery schedule.

Moeller: Okay. And if we think about the force protection counter UAS side of the equation, if we do see the Ukraine war continue, I think you talked about this a little bit already, but presumably, that's incrementally positive for sales into US NATO allies, etc.

Bill Lynn: I think more generally, the threat that Putin posed through by attacking Ukraine is what's, you know, driving Europe to higher defense budgets, and they're seeing that concrete threat that Putin is prepared to cross borders in a way that we haven't seen in 80 or 90 years. That is then driving, you know, programmatic implications, prominent among them is force protection. The advent of drones, the importance of having not just kind of perimeter protection around your formations, but really organic protection inside those formations. So programs like RM Lids, that counter UAS system, become critical.

And what we're seeing is a growing international demand for that kind of system, partly driven by Ukraine, but more generally driven by the trends in warfare that we're seeing in Ukraine, you're seeing in Israel, and how do you bring on systems that counter that. And with some urgency given what Putin's doing in Ukraine and the future implications of that.

Moeller: Great. Thanks for all the details there.

Operator: One moment for our next question. And that will come from the line of Jon Tanwanteng with CJS Securities. Your line is open.

Jon Tanwanteng: Hi. Good morning, and thank you for taking my questions. Was wondering if you could break down the new guidance range and just the components of it. Especially the revenue line. What's driving that? Is it stronger demand or contract modifications? Maybe just more confidence in the ability to work down the backlog, you know, with improved supplier execution? Is there something else that's going on? Just a little help there would be helpful. Thank you.

Mike Dippold: Yeah. I'll—I'll from the guidance on the revenue side, here, the uplift is certainly driven just by the continued demand that we're seeing. We got out of the gate really hot from a bookings perspective in Q1. And that confidence coupled with the consistency of the supply base and the material receipts 13% year over year. So, you know, the bookings demand, where we are with the backlog year over year, what we've executed to date through the six months, and the stability of the supply base gave us the confidence to increase the revenue guide, Jon.

Jon Tanwanteng: Okay. Great. And how should we think about the R&D intensity going forward over the next three to five years and how that affects operating leverage, especially if you chase these new programs in the new DOD budgets and increase NATO spending.

Mike Dippold: I'm sorry, Jon. I didn't catch the end of that. I lost you. Can you repeat that question again?

Jon Tanwanteng: Yeah. How should we think about R&D intensity and the operating leverage that you have, especially with, you know, the new DOD budgets and with the higher NATO commitments?

Mike Dippold: Yes. So from an R&D budget perspective, I'm assuming you're talking about the internal R&D spend. Correct. Yeah. But ultimately, what we wanted to do and what we've made a priority of is there's certainly an emphasis within the administration to get products to the warfighter quicker. And therefore, they're trying to accelerate procurements, and we wanted to ensure that we have ReadyNow solutions and ReadyNow capabilities and are investing increased IRAD in order to make that a reality. So we've taken up our IRAD, you know, from about 2.8% in 2024 to an area where we're sitting at the mid-threes here at the half-year point. So that's a sizable headwind from a margin perspective.

But we do believe we're investing in areas that are getting a lot of enthusiasm surrounding. And when you talk about the counter-drone capabilities, when you talk about space, missile seekers, as Bill mentioned in the prepared remarks, these are the areas we're investing in. The markets are growing. And we thought it would be prudent to continue to invest heavily in there to facilitate our continued growth.

Jon Tanwanteng: Okay, great. If I could sneak one more in there, just when do you think you can get margins on products containing germanium or alternatives back to the normalized range, whether that's through pricing or through supply, or going to some of these alternative technologies to do so.

Mike Dippold: Yeah. I think the first challenge we have is to execute against the backlog. Right now, we're in a position where we're a predominantly fixed-price shop. So the pricing fluctuations are being realized in our results, and that's what's realized in our guide. Prospectively, we are looking at contract modifications that allow some flexibility. In terms of the recovery when you have the volatility in germanium like we've seen, which is largely due to some of the trade wars and other elements that are going on that are, you know, kind of outside of our control. We've seen mixed results from a customer receptive perspective on that.

And we're continuing to push hard on that to make sure that we're derisked from the price volatility.

Jon Tanwanteng: Okay. Any sense of timing of when that normalizes overall?

Mike Dippold: It's going to be a program-by-program negotiation, to be fair. So it'll be on a contract-by-contract basis.

Jon Tanwanteng: Okay. Great. Thank you.

Operator: Thank you. And as a reminder, if you would like to ask a question, please press 11. Our next question will come from the line of Ronald Epstein with Bank of America. Your line is open.

Ronald Epstein: Hey, good morning. So germanium has been a bit of an issue for you guys. It really doesn't seem like it's been for anybody else. I'm curious why that may be the case. And then two, are there any other rare earths that we should start worrying about for you or others given what's going on broadly with trade, particularly with China?

Bill Lynn: Ron, I think obviously, we're a sensor house since an important piece of our product base. So germanium, I think, stands out for us. I don't know what's going on with others. But I'm sure they're not getting germanium. The other one, and I mentioned it on an earlier question, I'd say the principal other one we focus on is in the electric power area is permanent magnets. And there, I think currently, we're in a strong position with holding what we need to execute our current programs. But we are trying to anticipate future disruptions and trying to think about how do we—how do we—of course, we're winning future electric drive programs.

So we need to think about how we protect future sources of supply. It's a high-class problem, but we're anticipating winning other programs, and we're taking steps now to protect against that future potential.

Ronald Epstein: And then if you could peel back, Daniel, a little bit on, you know, with the big investments that are being made into the naval industrial base, shipbuilding industrial base. What other opportunities are out there for you all? I mean, I would imagine there's got to be a whole bunch of them if you could maybe mention a few.

Bill Lynn: Are you talking shipbuilding, or are you looking beyond shipbuilding?

Ronald Epstein: Shipbuilding.

Bill Lynn: Shipbuilding, I think as we said, we have the current Columbia program. The biggest near-term opportunity is the steam turbine generator that I talked about. Coming after that, I think, is just the general enhancement industrial base programs and the realignment of the workload between yards and suppliers. And then the one I didn't mention, but I—well, two I didn't mention, future ship classes as the propulsion system because of the operational advantages in terms of cost, in terms of quietness, and in terms of the mechanical systems just cannot meet the needs. And even as you increase sensor demand, which is inevitable, mechanical systems won't meet the need. So we think the next-generation destroyer DDGX is a good candidate.

The next-generation submarine, the SSNX, probably an even better candidate. And then, of course, internationally, international navies are looking at electric drive as well. So we think, you know, over the next five to ten years, there's going to be a shift into electric drive, and we think we stand to benefit from that.

Ronald Epstein: Got it. Got it. And then if I can ask you just one more. Sort of more macro question. You know, again, given your experience, you know, kind of on the hill and in the building, how would you expect fiscal '27 to play out? Right? I mean, in terms of the budget process this year was sort of bizarre. Right? Do we get another reconciliation? I mean, how is it all going to go? I mean, it seems kind of likely that there's going to be another continuing resolution. I mean, I don't know. I mean, if you were to look in your crystal ball, take a swipe at it, how would you guess fiscal '27 plays out?

Bill Lynn: I think, as I said, at the end of the day, it's hard. As you said, this has been a very unusual year, particularly with the very large increase in the reconciliation bill. And there's still—they allocated a lot of that to '26, but not all of it. So there's still some reconciliation money out there that needs to be allocated. They have to make a decision on what is the '27 base bill. As I said in the answer to an earlier question, so I mean, I think what you want to see is, you know, maybe a sustained and predictable increase in the defense budget that will let us meet the growing threats from China and Russia.

That's, I think, the policy goal. I do think it's going to be the policy goal of this administration. So I think, you know, they're going to have to find a way through reconciliation, maybe a second reconciliation bill. I don't know. And the core base budget bills to execute on that sustained predictable growth. That should be their goal, and I think it is their goal.

Ronald Epstein: Got it. Alright. Thank you very much.

Operator: Thank you. I'm showing no further questions in the queue at this time. I would now like to turn the call back over to Steve Vather for any closing remarks.

Steve Vather: Thanks for your time this morning and for your interest in Leonardo DRS, Inc. As usual, if you have any follow-up questions, please call or email. We look forward to speaking with all of you again soon. Enjoy the rest of your day.

Operator: This concludes today's program. Thank you for participating. You may now disconnect.

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DATE

• Wednesday, July 30, 2025, at 10 a.m. ET

CALL PARTICIPANTS

• Chairman, President, and Chief Executive Officer — Aaron P. Jagdfeld
• Chief Financial Officer — York A. Ragen
• Vice President of Investor Relations and Financial Planning — Kris Rosemann

Need a quote from one of our analysts? Email [email protected]

RISKS

• Management stated, "the residential solar market in particular will contract in the years ahead," and noted a need to "recalibrate our level of investment in these technologies" due to expected reduced or eliminated incentive structures and policy changes, including the One Big Beautiful Bill Act.
• Guidance reflects no assumption for major power outage events in the remainder of 2025, potentially limiting upside for segments that historically benefit from outage-driven demand.
• Shipments to national and independent rental equipment customers "remained soft during the quarter," with expected continued weakness through the second half of the year.
• Chief Financial Officer Ragen said, "Operating expenses increased by $33 million, or 12%, in Q2 2025 compared to Q2 2024, primarily due to higher variable costs and ongoing expenses from recent acquisitions."

TAKEAWAYS

• Net Sales: $1.06 billion, up 6%, driven by 7% growth in residential product sales and a 5% increase in commercial and industrial (C&I) product sales.
• Gross Profit Margin: Gross profit margin was 39.3%, up from 37.6% in the prior year second quarter, attributable to favorable pricing and lower input costs, partially offset by unfavorable mix.
• Adjusted EBITDA: Adjusted EBITDA was $188 million, or 17.7% of net sales, up from $165 million, or 16.5%, in Q2 2024.
• GAAP Net Income: GAAP net income was $74 million for the second quarter of 2025, compared to $59 million in the prior year, with diluted EPS of $1.25 versus $0.97.
• Adjusted Net Income: Adjusted net income was $97 million ($1.65 per diluted share) for the second quarter of 2025, versus $82 million ($1.35 per share) in the prior year.
• Free Cash Flow: Free cash flow was $14 million for the second quarter of 2025, down from $15 million in the same quarter last year, primarily due to higher working capital and capital expenditures.
• Residential Product Sales: $574 million, up 7%, driven by energy storage systems and Ecobee, while home standby sales were flat.
• Commercial & Industrial Product Sales: $362 million, up 5%, reflecting growth in domestic industrial distributor and telecom channels, partly offset by weaker rental and international markets.
• International Segment: Sales rose 7% to $197 million in Q2 2025, with adjusted EBITDA of $30 million (15% margin), up from $25 million (13.6%) in the prior year.
• Dealer Network: The number of industrial dealers increased by approximately 400 to roughly 9,300 as of Q2 2025, strengthening the company's competitive position.
• Data Center Backlog: Backlog is above $150 million, with initial revenue recognition beginning in the second half of 2025 and the majority realized in 2026.
• Tariff Impact: Guidance for FY2025 assumes continued 30% tariffs on China and 10% on other countries, with pricing strategies intended to offset tariff-related costs.
• Full-Year Outlook – Net Sales: Full-year 2025 net sales growth guidance has been narrowed to 2%-5%, including an approximate 1% benefit from foreign currency and acquisitions.
• Full-Year Outlook – Adjusted EBITDA Margin: Increased to 18%-19%, higher than the prior range of 17%-19%.
• Full-Year Outlook – Free Cash Flow Conversion: The forecast for FY2025 has been raised to 90%-100% of adjusted net income, implying more than $400 million in free cash flow.
• EBITDA Guidance Factors: Higher C&I sales and lower expected tariffs are supporting margin expansion for FY2025, while residential product sales projections have been reduced based on updated tariff assumptions.
• Capital Allocation: $50 million in share repurchases were executed in Q2 2025, with $200 million remaining under the current authorization.
• Term Loan Update: Term Loan A principal updated to $700 million, revolving facility set to $1 billion, with maturity extended through July 2030.

SUMMARY

Generac Holdings (NYSE:GNRC) reported an accelerating global backlog for large megawatt generators in Q2 2025, with management identifying data center power infrastructure as an unprecedented market opportunity. Executives highlighted strong operational execution as key to outperformance in adjusted EBITDA and margin improvement, driven by pricing and volume leverage. Strategic priorities include accelerating data center market participation through capacity expansion, managing margin resilience by offsetting tariff headwinds, and optimizing capital deployment for next-generation residential and energy management products.

• Chief Executive Officer Jagdfeld said, "the size of the pipeline that we are cultivating in [the data center] market ... can move the needle like this. I think if we do things the right way ... C&I products are larger than the rest of the company."
• Share count is expected to decrease for the full year due to ongoing share repurchases, providing incremental EPS support.
• Executives emphasized recalibrating investment in the clean energy segment to restore profitability, as Ecobee delivered positive EBITDA, and overall drag from other "clean energy products" is targeted for reduction into 2026-2027.
• Incremental tariffs on steel and copper were factored into guidance for the second half of 2025; gross margin improvement benefited from a lower-than-expected tariff impact.
• Management expects home standby generator demand to remain stable at elevated levels, contingent on normal outage activity, acknowledging "a free option" for incremental upside if major storms occur.
• Recent investment in the Beaver Dam, Wisconsin plant enhances C&I production capacity, supporting both ongoing and future data center opportunities.
• Rising operating expenses are attributed to shipment volume, higher employee costs, and spending on recently acquired businesses.

INDUSTRY GLOSSARY

• Ecobee: Generac's smart thermostat and energy management platform, contributing premium recurring revenue from connected home devices.
• PowerCell 2: Generac's next-generation residential energy storage system, with shipments initiated in July 2025.
• PowerMicro: Newly developed microinverter product, anticipated to launch in the second half of 2025.
• Beaver Dam Plant: Generac's newest U.S. manufacturing facility dedicated to mid-range generator sets, enabling capacity expansion for large megawatt C&I products.
• One Big Beautiful Bill Act: Recent U.S. policy legislation impacting federal incentives in the residential solar and storage market; mentioned as a significant driver of market contraction for the company's clean energy segment.
• Gross Debt Leverage Ratio: Ratio of total outstanding debt to trailing adjusted EBITDA, reported at 1.7x for the quarter.
• USMCA: United States-Mexico-Canada Agreement, referenced for its continued impact on tariff qualification per management's guidance assumptions.

Full Conference Call Transcript

Aaron Jagdfeld: Thanks, Kris. Good morning, everyone, and thank you for joining us today. Our second quarter results exceeded our expectations, driven primarily by C&I product sales to our industrial distributors as well as increased shipments of residential energy storage systems. Additionally, adjusted EBITDA margins came in well ahead of our prior forecast for the quarter, as a result of continued strong gross margin performance and better than expected operating leverage on the higher shipment volumes. On a year-over-year basis, overall net sales increased 6% to $1.06 billion for the quarter. Residential product sales increased 7% from the prior year, driven by significant growth in shipments of residential energy technology solutions as well as higher portable generator sales.

C&I product sales increased 5% year-over-year with increases in shipments to our domestic industrial distributor and telecom channels. Favorable price realization helped gross margins expand by 170 basis points in the quarter, resulting in adjusted EBITDA margins increasing to nearly 18%. We also continue to execute on numerous new product development initiatives during the quarter, most notably the formal introduction of our large megawatt generators. We have experienced very strong receptivity to our initial entry into the data center market, with our global backlog for products serving this important end market growing quickly, now standing at more than $150 million today.

Given increased visibility into our full year 2025 financial results, including our second quarter outperformance and lower than previously anticipated tariff-related price increases in the second half, we are narrowing our full year net sales growth assumption and increasing the low end of our adjusted EBITDA margin guidance range, resulting in an increase to our full year adjusted EBITDA outlook at the midpoint of these ranges. This guidance assumes that currently implemented tariff levels are maintained for the remainder of the year. We will continue to optimize our pricing strategy within the evolving tariff landscape while aiming to fully offset the cost of tariffs in dollar terms.

Additionally, we are executing on a number of supply chain and cost reduction initiatives that will help to further offset the impact of tariffs and other cost increases over the next several quarters.

Discussing our second quarter results in more detail, home standby sales were flat from the prior year as the category held a new and higher baseline level of demand despite power outage hours being down significantly as compared to a strong prior year period. As expected, with lower outages, home consultations decreased on a year-over-year basis given the strong comparable period included the benefit of severe storms in the South Central Region last year. However, home consultations outside of this region were up nicely from the prior year, highlighted by continued strength in the Southeast resulting from last year's high-profile outage events.

Close rates improved sequentially in the second quarter, and we continue to expect further improvement as we move through the remainder of the year, with strong signs of recovery here in the month of July. Importantly, activations or installations of home standby generators increased modestly from the prior year, also driven by the strength in the Southeast region. We ended the second quarter with roughly 9,300 industrial dealers in our network, an increase of approximately 400 over the prior year. Our growing dealer network is an important competitive advantage and continues to support a new and higher baseline of consumer awareness for the home standby category. We remain committed to investing heavily in growing and developing our dealer base.

Additionally, we have had continued success in expanding our aligned contractor program, which targets electrical contractors that purchase our products through wholesale distribution and drives incremental engagement and training within this important distribution channel. Collectively, these efforts represent a critical element of unlocking the growth potential for the home standby category by expanding our sales, installation, and service bandwidth. Additionally, we continue to work towards the upcoming launch of our next-generation home standby generator line, representing the most comprehensive platform update for the product category in more than a decade.

In addition to the introduction of the market's first 28-kilowatt air-cooled generator, the new home standby generator line lowers installation and maintenance costs, as well as quieter operation and improved fuel efficiency. The new platform also offers a number of benefits for our channel partners, including lower commissioning times and improved remote diagnostics, enabling operational efficiencies for their businesses and greater uptime and cost savings for their customers.

Portable generator sales increased at a robust rate from the prior year despite the year-over-year decline in outage activity. This growth was primarily due to market share gains. While we expect these recent wins to support greater baseline demand for these products going forward, as our guidance does not assume any major outage events in 2025. Moving to residential energy technology solutions, our team continued to execute extremely well on our Department of Energy project in Puerto Rico for our energy storage solutions, and combined with a record quarter for Ecobee sales, resulted in strong outperformance for this part of our business in the second quarter.

Our Ecobee team continued to add to their recent strong sales momentum and drove significant margin improvement compared to the prior year, resulting in positive EBITDA contribution through 2025. Additionally, the connected homes count for Ecobee devices increased to more than 4.5 million residences during the quarter, with energy services and subscription attach rates also continuing to grow, contributing to a rapidly expanding high-margin recurring revenue stream. We view Ecobee's premium feature set and user experience as a key differentiator within our growing residential energy ecosystem, and further integration of our residential solutions with the Ecobee platform will continue with every new product we launch.

Importantly, we continue to expect Ecobee to deliver positive EBITDA contribution for the full year as the team further scales these products and solutions. Shipments of our energy storage systems also increased at a dramatic rate during the second quarter. We are very pleased with the progress we have made in Puerto Rico through 2025, as this has enabled us to build strong relationships on the island, which is the second largest storage market in the US behind California. In addition to our success in Puerto Rico, we began taking orders in the second quarter for PowerCell 2, our next-generation energy storage system, with first shipments of these products beginning earlier this month.

We are also making very good progress toward the launch of PowerMicro, our new microinverter product line, which we anticipate will begin shipping during the second half of this year. The impact of the One Big Beautiful Bill Act on residential solar and storage markets has been well documented over the last several weeks. Despite the policy-related changes that will reduce or eliminate incentive structures for these products, we continue to view these technologies as important elements in the residential energy ecosystem we are developing that is focused on providing the kind of resiliency and energy savings that homeowners are increasingly demanding.

The secular trends of rising power prices and declining component costs within the solar and storage markets provide an attractive long-term backdrop for these markets to further develop and grow as the overall economics improve, absent the incentives.

That said, we believe the residential solar market in particular will contract in the years ahead. And as a result, we are evaluating the adjustments necessary to recalibrate our level of investment in these technologies as we are laser-focused on significantly improving the adjusted EBITDA contribution of the residential energy technology portion of our business in the coming years. Now let me provide some commentary on our commercial and industrial product category. Sales to our domestic industrial distributors increased again during the quarter given resilient end-market demand and strong operational execution that drove further reduction in C&I product lead times.

We project quoting activity and win rates in this important channel also increased on a year-over-year basis during the first half of the year. We do expect, however, year-over-year shipment declines to develop in the second half of the year given continued reduction in backlog resulting from our accelerated production output in recent quarters. Shipments to our national telecom customers grew at a strong rate from the prior year during the second quarter, as this channel continues to recover and is expected to deliver robust growth for the full year 2025.

The telecom market remains a long-term growth opportunity for Generac Holdings Inc. given the secular and network hub counts and increasing reliance on wireless communications that require much higher power reliability. Replacement opportunities within the telecom channel are also becoming more relevant given our large installed base of product and our long history of serving this market. As expected, shipments to our national and independent rental equipment customers remained soft during the quarter. And we continue to anticipate weakness throughout the second half of the year. Despite the current cyclical softness with our rental customers, we believe that this end market has substantial runway for growth.

Given the critical need for future infrastructure-related projects that leverage our products sold into the rental equipment channel. Internationally, total sales increased 7% from the prior year due to higher intersegment sales and C&I product shipments in Europe, partially offset by softness in other international markets. Adjusted EBITDA in our International segment increased at a robust rate from the prior year, given the solid sales growth and favorable price-cost dynamics in certain markets. We expect the combination of recent order trends across multiple C&I product categories and the favorable impact. We also anticipate an incremental benefit beginning in the third quarter from the initial shipments of our new large megawatt generators to international data center customers.

With respect to the important development project around our new large megawatt generators, these products are expected to enable a very significant incremental opportunity for the global C&I part of our business. Particularly within the large and growing data center market. These mission-critical solutions are a necessary part of the substantial investment in data centers, which are enabling the accelerated adoption of artificial intelligence. Given the tremendous power requirements of increasingly large data center campuses, demand for backup power for these applications is expected to continue to grow at a dramatic rate for the foreseeable future. This rapidly growing demand for data center power infrastructure has resulted in market supply constraints for backup power equipment.

Highly competitive lead times and the strength of our reputation in the power generation industry contributed to the strong initial response to our formal entrance into this market during the second quarter. And we have quickly built a global backlog of more than $150 million for these applications. With momentum continuing to build around a growing and significant pipeline of new opportunities. We expect global shipments of these products to begin in the second half of the year, with the large majority of our existing backlog to be realized in 2026.

Additionally, further global market opportunities exist for these products within our traditional end markets, in particular providing backup power for large manufacturers, distribution centers, healthcare facilities, and other critical infrastructure that have higher backup power requirements. As we continue to ramp our capabilities for large megawatt generators, with our expected annual production capacity sitting well above our current backlog, we believe that we are well-positioned to take share in this market over time given our unique focus, which allows us to provide customized sales, engineering, and aftermarket support while also providing data center customers with a robust service network to ensure uptime for these critical applications.

In closing this morning, our second quarter results reflect strong execution in a dynamic operating environment. With broad-based strength across our product categories. We will continue to lean into our core corporate value of agility as we navigate the evolving market and policy conditions while maintaining focus on the significant growth opportunities that exist as we further execute on our enterprise strategy. The megatrends of lower power quality and higher power prices are being further supported by numerous underlying trends, providing incremental avenues for future growth in our business. And we firmly believe our portfolio of products and solutions is uniquely positioned to deliver value and protection to homes, businesses, and institutions around the world.

I'll now turn the call over to York to provide further details on our second quarter results and our updated outlook for 2025. York?

York Ragen: Thanks, Aaron. At second quarter 2025 results in more detail, net sales during the quarter increased 6% to $1.06 billion as compared to $998 million in the prior year second quarter. The combined effect of acquisitions and foreign currency had a slight favorable impact on revenue growth during the quarter. Briefly looking at consolidated net sales for the second quarter by product class, residential product sales increased 7% to $574 million as compared to $538 million in the prior year. This growth in residential product sales was driven by a strong increase in shipments of energy storage systems and Ecobee home energy management solutions.

Portable generator shipments also contributed to this sales growth, while home standby generator sales were flat with the prior year. Commercial and industrial product sales for the second quarter increased 5% to $362 million as compared to $344 million in the prior year. Core sales growth of approximately 4% was driven by strength in shipments to our domestic industrial distributor and telecom customers, as well as strong growth within Europe, partially offset by weakness in shipments to national rental accounts and other international markets. Net sales for the Other Products and Services category increased approximately 8% to $125 million as compared to $116 million in 2024.

Core sales increased approximately 6% due to Ecobee and remote monitoring subscription sales, and other installation and maintenance services revenue. Gross profit margin was 39.3%, compared to 37.6% in the prior year second quarter, primarily due to favorable pricing and lower input costs, partially offset by unfavorable sales mix. The favorable price-cost dynamics were partly due to the timing differences between the realization of recent price increases and the higher tariff-related input costs. In addition, gross margins exceeded expectations for the quarter, partially due to a lower tariff impact relative to our previous guidance. Operating expenses increased $33 million or 12% as compared to 2024.

This growth in operating expenses was primarily driven by higher variable costs due to higher shipment volumes, increased employee costs to support future growth across the business, and ongoing operating expenses related to recent acquisitions. Adjusted EBITDA before deducting for non-controlling interest as defined in our earnings release, exceeded expectations at $188 million or 17.7% of net sales in the second quarter as compared to $165 million or 16.5% of net sales in the prior year. I will now briefly discuss financial results for our two reporting segments.

Domestic segment total sales, including intersegment sales, increased 7% to $884 million in the quarter compared to $827 million in the prior year, which included approximately 1% sales growth contribution from recent acquisitions. Adjusted EBITDA for the segment was $158 million representing 17.9% of total sales, as compared to $140 million in the prior year or 16.9%. International segment total sales, including intersegment sales, increased approximately 7% to $197 million in the quarter as compared to $185 million in the prior year quarter, including an approximate 1% benefit from foreign currency. Adjusted EBITDA for the segment before deducting for non-controlling interests was $30 million or 15% of total sales, as compared to $25 million or 13.6% in the prior year.

Now switching back to our financial performance for the second quarter of 2025 on a consolidated basis. As disclosed in our earnings release, GAAP net income for the company in the quarter was $74 million as compared to $59 million for 2024.

Our interest expense declined from $23.3 million in 2024 to $18.2 million in the current year quarter, as a result of lower borrowings and lower interest rates relative to the prior year. GAAP income taxes during the current year second quarter were $15.4 million or an effective tax rate of 17.2%, as compared to $19.6 million or an effective tax rate of 25% for the prior year. The decrease in effective tax rate was primarily driven by a favorable discrete tax item related to an immaterial business disposition in the current year quarter. Diluted net income per share for the company on a GAAP basis was $1.25 in 2025, compared to $0.97 in the prior year.

Adjusted net income for the company, as defined in our earnings release, was $97 million in the current year quarter or $1.65 per share. This compares to adjusted net income of $82 million in the prior year or $1.35 per share. Cash flow from operations was $72 million as compared to $78 million in the prior year second quarter, and free cash flow, as defined in our earnings release, was $14 million as compared to $15 million in the same quarter last year. The change in free cash flow was primarily driven by higher working capital and capital expenditures causing a greater use of cash during the current year quarter, partially offset by higher operating earnings.

We expect working capital to be a use of cash again in the third quarter as we continue to replenish portable generator inventories for storm season, and prepare for our next-generation home standby product launch later this year. Additionally, we opportunistically repurchased approximately 393,000 shares of our common stock during the quarter for $50 million. There is approximately $200 million remaining on our current share repurchase authorization as of the end of the second quarter. On July 1, we amended and extended our existing Term Loan A and revolving credit facility, resulting in a new maturity date of 07/01/2030. This agreement updated the Term Loan A outstanding principal balance to $700 million and reduced the revolving facility borrowing capacity to $1 billion. In addition, the amendment eliminated a 10 basis point credit spread adjustment that was included in the previous agreement and also resulted in a more favorable pricing grid based on our leverage ratio. Quarterly principal payments on the Term Loan A will begin in October 2026, with a lump sum due at maturity in July 2030. Total debt outstanding at the end of the quarter was $1.4 billion, resulting in a gross debt leverage ratio of 1.7 times on an as-reported basis. With that, I will now provide further comments on our updated outlook for 2025. As disclosed in our press release this morning, we are updating our full year 2025 outlook given our first half actual results driving increased visibility to expected full year 2025 net sales. As a result of our second quarter outperformance, being mostly offset by lower pricing assumptions in the second half of the year, primarily due to lower than expected tariffs. We are narrowing our net sales growth guidance range while holding the midpoint of that range. In addition, we are increasing the low end of our adjusted EBITDA margin guidance range and raising our free cash flow conversion guidance for the full year 2025. This guidance includes the following important assumptions: We are assuming that current tariff levels that are in effect today stay in place for the remainder of the year. This includes 30% tariff levels for China, compared to 10% previously assumed. We continue to assume 10% reciprocal tariffs on all other countries, and the continued qualification of USMCA for Mexico and Canada, consistent with our prior guidance. Incremental tariffs have also been levied against steel and copper imports since our previous guidance update, and we have assumed higher market prices for these metals in the second half of the year as a result.

Finally, consistent with our historical approach, this outlook assumes a level of power outage activity for the remainder of the year in line with the longer-term baseline average and does not assume the benefit of a major power outage event in the second half of the year, such as a major landed hurricane or major winter storm. Considering all these factors, we now expect consolidated net sales for the full year to increase between 2% to 5% over the prior year, which includes an approximate 1% favorable impact from the combination of foreign currency and acquisitions. This compares to our previous guidance of 0% to 7% net sales growth over the prior year.

We now project full year 2025 residential product sales to be slightly lower compared to our previous expectation, given lower assumed tariff-related pricing in the home standby category. We also now project full year 2025 C&I product sales to be modestly higher compared to our previous expectation given second quarter outperformance and favorable foreign currency rates relative to our prior forecast. As a result, we now expect Residential Products and C&I Products net sales growth to be more level-loaded for the full year 2025 relative to our prior expectations.

From a seasonal pacing perspective, we expect third quarter overall net sales to be slightly ahead of the prior year, with fourth quarter overall net sales approximately flat versus the prior year. Recall that the prior year periods included the benefit of multiple major outage events, which results in a strong prior year comparison in particular for residential products. Looking at our updated gross margin expectations for the full year 2025, we now expect gross margin percent to increase approximately 50 to 100 basis points compared to the full year 2024, coming in at approximately 39.5% at the midpoint.

This represents an increase from our prior expectation of approximately 39% due to our second quarter outperformance and lower tariff assumptions relative to the prior guidance. Turning to our adjusted EBITDA margin expectations for the full year 2025, given the factors I outlined in our net sales and gross margin update, we are increasing the lower end of our guidance range for adjusted EBITDA percent to approximately 18% to 19% compared to our previous guidance range of 17% to 19%. In line with normal seasonality, we expect third quarter adjusted EBITDA margins to improve 150 to 200 basis points sequentially from the second quarter given the projected significant operating leverage on seasonally higher sales volumes.

Additionally, we are raising our free cash flow conversion forecast given the impact of the One Big Beautiful Bill Act on our federal income tax payments. Given the favorable tax impact of immediate expensing of research and development costs, and bonus depreciation on certain capital expenditures, we now expect free cash flow conversion from adjusted net income to be approximately 90% to 100% for the full year 2025 as compared to our previous guidance range of 70% to 90%. Importantly, this would result in over $400 million of free cash flow in fiscal 2025, which provides for further near-term optionality within our disciplined and balanced capital allocation framework.

As is our normal practice, we are also providing additional guidance details to assist with modeling adjusted earnings per share and free cash flow for the full year 2025. For full year 2025, our GAAP effective tax rate is now expected to be between 23% to 23.5%, a modest decrease from our prior guidance of 24.5% to 25%, due to the second quarter outperformance. Our GAAP effective tax rate for the remaining two quarters of the year is expected to be approximately 25%. Importantly, to arrive at appropriate estimates for adjusted net income and adjusted earnings per share, add-back items should be reflected net of tax using our expected effective tax rate of approximately 25%.

We continue to expect interest expense to be approximately $74 million to $78 million for the full year 2025, assuming no additional term loan principal prepayments during the year. This contemplates a lower interest rate due to our recent Amend and Extend transaction, mostly offset by modestly higher outstanding borrowings. This guidance is a significant decline from 2024 interest expense levels due to a decrease in outstanding borrowings and the full year impact of lower sulfur interest rates. Our capital expenditures are still projected to be approximately 3% of our forecasted net sales for the full year, in line with historical levels.

Depreciation expense, GAAP intangible amortization expense, and stock compensation expense are also expected to remain consistent with last quarter's guidance. Our full year weighted average diluted share count is expected to be approximately 59.4 million to 59.5 million shares as compared to 60.3 million shares in 2024. Finally, this 2025 outlook does not reflect potential additional acquisitions or share repurchases that could drive incremental shareholder value during the year. This concludes our prepared remarks. At this time, we would like to open up the call for questions.

Operator: Certainly. Star one on your telephone and wait for your name to be announced. In the interest of time, please limit yourself to one question. And our first question will be coming from Tommy Moll of Stephens. Your line is open.

Tommy Moll: Good morning, and thank you for taking my question.

Aaron Jagdfeld: Hey, Tommy. Good morning.

Tommy Moll: Aaron, on the recent entry into the data center market, sounds like things have gone pretty well so far, but I just wanted to ask for anything else you can give us there. When could these revenues start to be meaningful? Are the lead times for some of the incumbents there still as extended as they have been in recent years? What have you learned so far?

Aaron Jagdfeld: Yeah. Thanks, Tommy. So yeah. I mean, this has been something we have been talking about for the last few quarters. You know, the entry into this market and something, frankly, we have been working on for a couple of years. We have not been talking about it much because we wanted to get to the finish line. But it will begin to impact revenues this year in the second half. Our initial shipments in the international market will start in Q3. And then, you know, very late this year, we will start to get our first domestic shipments out to those customers. But much of an impact this year. It is really a 2026 story right now.

What we are being told, and this is just, you know, kind of to size the opportunity for us anyway. Because I think this is by far and away one of the biggest needle-moving opportunities that I have seen in my time here in my three decades with the company, just both in the size of the market opportunity that data centers in particular present, but also, obviously, the growth rate there.

And the fact that you know, this feels like something that is going to go on for a long time, combine that with the structural deficit in the availability of these backup power products, in our early conversations here over the last several months, nearly every data center developer, operator, owner, end customer has told us that there are two major components that they worry about the lead time for construction of new data centers. The first is transformers. And the second is backup generators.

So what we have learned, to answer your question, is that we believe, based on our conversations, there appears to be about a structural deficit just in 2026 of something on the order of maybe 5,000 machines. Based on current capacity in the market and based on current construction completion timelines for the projects that are underway for data centers. So obviously, 5,000 machines is a lot of machines. You know, if you look at kind of on the high side, every single copy of every machine would be about a million dollars all in. So it is a huge market just being served on an annual basis today, much greater in size than anything that we have ever approached.

And two, the structural deficit that is there, I think, will allow for a pretty rapid entry for us into the market. I am shocked at the, you know, over $150 million that we have already booked in hard orders. And the size of the pipeline that we are cultivating in this market. Been very well received with the, you know, not only just the product, but you know, I think our brand, our reputation, the quality of our distribution, the quality of our balance sheet, frankly, the ability to stand behind these products in these very critical applications I think we have been very well received initially here. We have got to deliver, we have got to execute.

So, you know, it is not we are not this is not a layup by any stretch of the imagination, but we are taking this very seriously. We do have good capacity, you know, to grow in the next year or so. But given the kind of situation that this market is facing from a structural deficit standpoint in terms of supply versus demand, we believe that, you know, based on our early learnings here and then our early success, we are going to have to make some potentially bold moves around additional capacity if we want that to be available for 2027 and beyond.

We think we are in really good shape for '26 and really probably even for parts of '27. But given the size of the deficit, that 5,000 machines just for next year, we think there is real opportunity for us if we lean into this and be aggressive. Again, like I said, I have never seen something that can move the needle like this. I think if we do things the right way, I think this part of our business, which has always been a good solid business. Right? It is over a $1.5 billion opportunity today. That is the size of the C&I products part of our business.

You know, that is something that I think can grow dramatically in the next several years. And this we could be in a situation in several years where the C&I products are larger than the rest of the company. So I think it is, you know, this is just an exciting time and something that we are, you know, we are going to lean into. And it is a global opportunity. And it is a global opportunity. I think that is the other exciting piece of that. Yeah. I am going to add.

Operator: Okay. One moment for our next question. Which will be coming from George Gianarikas of Canaccord Genuity. Your line is open, George.

George Gianarikas: Everyone, good morning, and thank you for taking my questions. I would like to concentrate on some of the comments you made around Ecobee and the solar market opportunity. There is at least to me, appears to be a little bit of a change in tone here around your willingness to continue to invest in the inverter market over the long term, over the medium term. I was just wondering if you can sort of paint a broad brush and help us understand a little bit around how you might be changing your philosophy around those markets. And maybe just update us on what the dilution was from the Cleantech business during the first half of the year. Thank you.

Aaron Jagdfeld: Yeah. Thanks, George. So, yeah, I do not know if it represents a change in tone. I perhaps. I you know, it is maybe that is the right way to characterize it. Let me say what has not changed. And I think the comments we wrote, the specific commentary was we are laser-focused on reducing the drag on earnings from this business, i.e., we want to get it to be in positive territory. We will get it to be in positive territory. Now we have to obviously recalibrate if the overall market size for solar in particular, if that is going to decrease. In the years ahead, and it is likely that it will, the question is how much? Right?

I think there are still some things that need to be vetted and understood as the One Big Beautiful Bill kind of now moves from, you know, it being passed as legislation into kind of interpretation by Treasury and what happens there. In terms of the actual impacts to the market. But clearly, the market is going to contract for solar. Just, is it going to contract 20%, or is it going to contract 50%? So but take a range. Maybe it is 20% to 50%. We believe that market, if you just step back, has been heavily impacted obviously by the incentive structures over the years. It has been distorted. The word we keep using internally here.

It is a market that has been frankly, this is one of the major problems you run into in terms of distortions that can happen in markets when you have subsidization for as long as you have had with this market. And the changing kind of timelines around those subsidizations, the changing quantums of those subsidizations, we actually believe the elimination of subsidies for solar is a good thing for the market. In the long run, it will help this market grow structurally grow in a way that normal markets grow. Right now, it does not look anything like a normal market. In fact, you can look at how a typical solar system is transacted.

That transaction almost looks like nothing else on the planet. In terms of how it is structured, the financial engineering, the craziness around it. And I think a lot of that has had a negative effect actually on the underlying structural integrity of the market in terms of, you know, it has had kind of a distorted effect on the overall ASP for a project. I think the ASPs for projects are higher. There is a reason they are considerably higher here in the US than they are in Europe.

And I think a lot of that has to do with the, you know, just the amount of subsidization, the amount of incentives that go into that and the structures that come out of those transactions with tax equity structures, and other elements. I think if we get rid of all of that, over time, what will be laid there is a market that can work. You can see what is going on in Europe. It works. Power prices are going up. You can look at your own power bill. Look at your neighbor's power bill. Look at power bills across the country. This is without a doubt a story that is underreported.

We can talk about power outages all we want, but at the end of the day, the cost of power is going up and there are lots of reasons. People can pick their reason and it differs by utility. It differs by region. It differs by type of customer, but at the end of the day, your power costs, my power costs have gone up over 30%. In the last five years, and are expected to double in the next ten or greater. You are already seeing this play out in parts of the country.

As power costs increase, and as the cost of these technologies, i.e., solar, storage, energy management, all of these technologies continue to come down rapidly in cost. They have done that over the last couple of decades, and they will continue to do so. You can get to economic outcomes there that are very beneficial. To homeowners and businesses by installing solar even without the incentive structures. And that, I think, is where this ultimately lands. Now there is going to be a couple more years of noise here. As the incentives taper off. Going to have some pull forward of demand with safe harboring maybe in the second half of this year.

And all of that has to wash through the system. But for us, we think that solar and storage are still important technologies in a residential energy ecosystem and parts of that. Now they are not the only parts. Okay? We believe EV charging is going to be an important going to play an important role. We believe that energy management with the Ecobee products are going to play an important role. We believe generators are going to play an important role. In the energy ecosystem. All of this linked together is how we are going to keep homeowners and businesses resilient and we are going to help them save money on their power bills.

We are going to give them a lot more independence going forward. It is going to take time to build that out. But we are not going to continue to lose money on this business in perpetuity. We have said that. The drag on this, I think, York, for the first half of the year, was about first half, three to four hundred points. But overall for the year, let us call it 300 to 350. That is our expectation. For the full year. For the full year. But continuing to improve. We have seen that improvement already in Ecobee, and we are going to continue to see that in the rest of the business.

Now we will adjust our spending. Right? If the market is smaller, we are going to have to adjust the level of our investment, recalibrate our investment. We have got a lot of new product coming to market this year. Won't have a lot of that new product cost, if you will, the development cost will start to taper, and we will go more into a sustaining mode on those new products. Going into 2026. So I think we are in a good place to make the recalibration that we need to make there.

But we are still committed to this being part of, you know, an energy ecosystem, we think, an important element for us to plant the flag in going forward, here at the company.

Operator: And one moment for our next question. Our next question will be coming from Mike Halloran of Baird. Your line is open, Mike.

Mike Halloran: Hey, good morning, everyone.

Aaron Jagdfeld: Good morning. Thank you, Mike.

Mike Halloran: Hey, Aaron. Can you just continue that train of thought then? What is the next call at twelve to eighteen months look like as far as the iterations go for how you get that back to kind of a neutral profitability level, the clean energy piece? What are the types of things you are thinking internally? Know, what is that timeline look like? Is this the clean energy piece specifically, or does that include Ecobee, which, correct me if I am wrong, but that is already at a profitable level. So is that the net of the two, or is that exclusive of Ecobee?

Aaron Jagdfeld: So yeah. No. So correct, Mike. You know, Ecobee is profitable year to date, and we expect to be fully profitable for the year. It is done. That team has done an outstanding job. And the growth rate there has been fantastic. It is a huge part, obviously, of our whole energy technology business when you look at it together. The big, you know, kind of drag remains in what we refer to as our clean energy products. Which are the storage products, the solar products where we have had very heavy development cycles ongoing to bring these new products to market.

As I said, kind of on the previous commentary, you know, those new product cycles of new product introduction costs in those cycles should start to taper as we get these new products in the market. So PowerCell 2, which is our new storage device, just started shipping here. Earlier in July. And our PowerMicro, our new microinverter product line, is going to hit the market later this year. So, you know, the development cycles, you know, are starting we are getting in the final innings of the development cycles, and that is where a lot of the spend has been.

Now transitioning that spend over to support right, and sustaining efforts, you know, is was kind of the next phase anyway. And so that was already kind of in the plan. And obviously, though, if the market is smaller, won't need as much support. You won't need as much, you know, in terms of sustaining in theory. And so I think there is an opportunity there to look at recalibrating, you know, that depending again on where we think the market is going to be. The answer to your question directly over the next twelve to eighteen months is difficult because we do not know where the market is going to be over the next twelve to eighteen months.

That is a piece that we are still, you know, kind of we are vetting out. We want to get a very clear understanding where it is going to go. We know it is going to contract from current levels. And by the way, current levels are depressed. I would just point out current levels are also depressed though because of two factors. One, you had the change in the net metering rules in California. From net metering 2.0 to 3.0. Which had an impact a negative impact on the market. Now that is largely started to wash through. But the second kind of effect that has been depressing the market is high interest rates.

And I think it is you could make a case that it is more likely than not that interest rates are going to go down as opposed to up in the future, which should provide a backdrop for a bit stronger market dynamics. Know, all things equal. In the clean energy types of products. So know, I do think the market is going to contract. There is no doubt. We are going to recalibrate spending. We are still targeting. We had said at our Investor Day, a couple years ago that by 2027, this was a profitable area for us. That is still our focus for the company.

We think that we have got to find a path to do that. Ecobee certainly has done their part. They are well on the way. In fact, I would say they are ahead of plan in terms of where we are coming out there, which is great. Now we have got to turn our attention to the rest of that part of the business. And, again, like I said, we are super excited about the new products we have got coming to market. And the receptivity we have had with our early discussions with the solar channel in particular. And, you know, we have got to see where the market kind of shakes out here, the overall market.

In terms of a forecast for 2026 in particular, but also know, as we think about the next three years.

Operator: Our next question will be coming from Jeff Hammond of KeyBanc Capital Markets. Jeff, your line is open.

David Tarantino: Hey, good morning, everyone. This is David Tarantino on for Jeff.

Aaron Jagdfeld: Hey, David.

David Tarantino: Hey, Dave. Maybe on home standby, could you give us more color on the underlying trends here and how we should expect the category to progress through the rest of the year? Particularly around what the dealers are telling you around the demand afterglow from outage events last year and how inventories look in the channel?

Aaron Jagdfeld: Yeah. Thanks, David. So, you know, home standby, it is pretty what is really amazing about home standby is you know, outages have been kind of light here in the first half of the year. We had a great second half of the year, obviously, in terms of outages. Very active. Not great, of course, if you experience those and some of the reasons why you experience them. But there to help our customers with our products. And, you know, we had a very active second half of last year. That as we would normally expect, right, we have always said six to twelve months of afterglow, if you will, from those big events.

And that is really kind of played out here. In the first half of the year, installations of products are up. To date, which is great. They were up in the second quarter. So they you know, we are kind of holding on to that new and higher baseline. We continue to add dealers, which I think is always one of those things that we watch very closely. Is the pace at which we can continue to add dealers has remained, you know, has remained robust. IHCs were down in the quarter, but you would expect that with lower outages. Seasonally, the second half of the year is really important. Right?

So no doubt we are watching with great attention what happens in the second half of the year. You know, we do not have just remember we do not put any major events in our guide. Which you know? So we are guiding our that business, that part of our business. We are guiding to a baseline level of outages which is generally significantly lower particularly in the back half if you do get major outages. So, you know, I would tell you that it is almost like there is a free option there on home standby if we do get some kind of event in the second half.

And we have always said those events are, you know, $50 and a $100 million impact. We saw that play out pretty much on point last year. And we would we would say that would probably be the situation again this year. I might I might say the only difference might be we have done a really nice job in portable generators. We have got a new team there that is leading that business. That part of our business, those products. And they have done a great job getting some really major wins at some incredible retailers and expanding our shelf space. So we are feeling really good about where we sit for our market share standpoint in portable gens.

So if we were to get some major outages, we might actually have a nicer tailwind there. We are going to be set from an inventory standpoint. A little bit of, you know, the cash flow in the quarter. You know, in terms of our working capital needs in Q2 were driven by kind of replanning portables, a heavy storm season from last year, but also getting ready for this year's storm season and the fact that we have got increased placement with our in the retail channel with those products. So what the market is telling us around home standby, though, is you know, it is and it is always been kind of a regional story.

So the Southeast remains pretty robust, right, coming out of last year. The activity there is great. Are other parts of the country where it is weaker because we have not had the outage activity. But, you know, I think if you were to stand back and you look at it on a whole and you look at kind of the home standby business or the products there as a segment, as a group, it has been incredible how it continues to grow. And after every one of those major events like we had last fall, it holds on to that higher baseline level. It grows from there.

Now it might be slower growth for a little bit of time here until we see another inflection point with more outages. But it is an incredible part of our business in terms of the ability to grow that business on the back of outage high-profile outage events and then to hold on to that growth. And move from there. So really pleased with kind of how that business has continued to pace.

Operator: And one moment for our next question. Our next question will be coming from Brian Drab of William Blair. Your line is open.

Brian Drab: Can you just talk about pricing and the so we have the 7% to 8% increase, I guess, in March, and you said that it had some positive impact on gross margin. But how is that received overall in the market, any effect on demand? And how are you adjusting your plan for pricing on the new product line given how tariffs have evolved?

Aaron Jagdfeld: Yeah. Thanks for the question, Brian. So pricing, you know, dynamic environment we are in. We are all kind of glued to the twenty-four-hour news cycle here on where these trade agreements are coming out, it sounds like the administration is making progress here. You know, it is slow going. Obviously, these are major deals. And it takes time to get these deals put together. But I think in the end, you know, we would put price into the market, in response to what we understood the tariff environment to be. Those were effective. I think it the April. That was roughly the seven to 8%, Brian, that you referenced there.

That is and I am talking specifically now about the home standby impact there. Did not see much material impact on demand. We did just to remind you, you know, we had updated our updated guidance at the time, did contemplate some demand destruction on higher price. For the remainder of the year. So, you know, there is some demand destruction that we built in, and, you know, I think we have largely based on our results, I think it is kind of played out the way that we saw it playing out. The second part of your question kind of where are we going from here? So we have a new product line coming out.

Second half of the year. It is our next-generation home standby product line, which is phenomenal, actually. The product itself is just so far advanced from even the existing platform and so far ahead of where the market is at today. We are super excited about that. There is a bit more cost to that product with some of the feature sets that we have added, which is good, but that will require some additional pricing adjustments. And, of course, we have got some new, you know, we have got additional knowledge on the tariff, the trade deals that have been inked so far and where we are sitting.

So there is probably as we release product into the market, we just announced the availability of our new 14-kilowatt and 18-kilowatt units. That is the first part of the new product line to be released. Those just went on order here this week. As a matter of fact, early this week, the order book opened on those, and we will begin shipping those next week.

And those contain a price increase somewhere in the depending on the SKU and the mix, five to 7%, call it, additional price that will go in kind of, you know, again, mostly because of the additional feature sets that we are including with the products, but there is a little bit of kind of rebalancing with some of the tariff information that is now known that was not known back when we did the last round of pricing in April. We still have a good chunk of the product line to be released. Here in the second half of the year, our larger nodes. Everything from the 20-kilowatt nodes all the way to the 28-kilowatt nodes that product offering.

And so we have not released pricing on those nodes yet, continue to watch the tariff environment. We may have to go back and touch pricing again. On the fourteenth and eighteenth if something changes, but probably not material at this point. It is probably small. So we feel pretty good about where we are sitting with respect to pricing. And, again, the demand destruction, if you want to call it that, that have occurred. We think that played out largely in line with our guide.

Operator: Okay. One moment for our next question. Our next question comes from Mark Strouse of JPMorgan. Mark, your line is open.

Mark Strouse: Thank you. Good morning. A couple questions. Going back to the data center opportunity, can you just kind of talk about the backlog that you have so far in the initial conversations that you are having, are those with kind of larger hyperscaler type data centers? Are they more traditional data centers? Any color there you can provide?

And then going back, Aaron, to your comments about potentially expanding capacity, can you just talk about kind of looking at your footprint, looking at your supply chain, you know, other factors that go into that, how I do not want to use the word easily, but, you know, how quickly can that be done in you talk about the CapEx requirements if you are going double capacity, triple capacity, whatever it ends up being, how we should be thinking about that? Thank you.

Aaron Jagdfeld: Yeah. Thanks, Mark. So just on the pipeline, our opportunities include both the I would call it traditional data center owner-operators as well as hyperscalers. But we are getting traction is with the hyperscalers because they are their power needs are greater. And frankly, that is where the biggest part of the deficit in the market seems to exist is around those. But it is a market-wide deficit in terms of supply versus demand. So we are seeing those opportunities manifest.

I would say some of our more interesting conversations are with we are talking about '27 and beyond at this stage because they are planning out obviously, they are trying to lock up supply, further out and they are, you know, I mean, they are out '27, '28, some cases 2029. The conversations are out. So then the second part of your question on footprint. So we have nine facilities around the world that are capable of producing commercial and industrial products. And so we have three here in the US, we have one in Mexico, one in Brazil, one in India, one in China. We have a facility in Italy and a facility in Spain.

I think that is nine if I did my math right. And so those facilities are capable of producing C&I products. Not all of them are capable of producing the large megawatt products. But what I would say is by expanding capacity in the mid-range of our products, we are able to create additional capacity opportunities for large megawatt. I will give you an example. Here in North America or here in the US, we just opened a new plant here in Wisconsin. Our biggest plant in the US, 345,000 square feet in Beaver Dam, Wisconsin. We just commissioned that plant back on April 1, cut the ribbon on it, locally here just this past, last week.

And so that plant is operational. What that plant allows us to do, it is focused on our mid-range gensets up to basically, to one megawatt. And so that is going to be more of our traditional market, end markets like telecom, you know, and some of our traditional back markets. What it allows us to do is take product that we are currently manufacturing, those higher output products that we are currently manufacturing in one of our other facilities nearby Oshkosh, Wisconsin, and free that facility up to be focused not quite 100%, but close to the opportunities that exist with these large megawatt units.

And so by the very nature of that, we have added a lot of capacity in the system by bringing this new plant on even though the new plant was not maybe aimed directly at the large megawatt product. That plant that we just brought online is about a $65 to $70 million investment. All in. So, you know, as we think about and it took us about fifteen months. Bring the plant on, twelve to fifteen months depending on it is pretty actually, to twelve months than fifteen to bring it up to speed. And, to get it constructed and get it going. So as we think about the future, and again, 2026, we are fine.

We have plenty of capacity. We are well over $150 million backlog we have got, and we are going to get, you know, orders of magnitude over that in terms of what our raw capacity is globally. For these large systems. When we think about the opportunity that exists for '27, '28, and beyond, I want to get ahead of this. And I want to get ahead of it now. And so, you know, we are going to have to take, you know, and make some big bold bets on additional capacity. You know, and that could come through organic efforts. You know, we could build some factories. We could buy some buildings, we can do some things there.

That are frankly in our wheelhouse in terms of, you know, again, I referred to this in my prepared remarks, but our core corporate agility, one of them is a Jill or core corporate value is agility. We just move fast at the company. We know how to do that. We are comfortable with that. It is a legacy of serving kind of honestly, it comes from our residential side of our business where it is a legacy of being able to react to exogenous events that happen. You know, I we think that our supply chain we have got a, you know, we have got great partnerships built in the supply chain for these large megawatt units.

And they are prepared. They have got a lot of capacity already. They are prepared to add more. What we need to do is continue to look at all elements of the value chain there end to end to make sure that there are not other constraints that exist. And if there are, how do we solve for them? So this is going to be an all-out effort by the company to figure out how we grow this segment of our business very, very quickly in the years ahead. And it is going to come we are going to need to invest. The good news is we have got a really great balance sheet generate a lot of cash flow.

We generate, you know, $400 million this year. So And we have ahead steam. And we have got ahead of steam. Yeah. In terms of our momentum going forward here. So with our backlog. So we feel like we are well-positioned to, you know, maybe you want to call it a rotation of investment, you know, somewhat out of some of the energy technology things we have been focused on and into this C&I opportunity, which we just want to we just think we can win there. With our approach. So super excited about that.

Operator: And our next question will be coming from Keith Housum of Northcoast Research.

Keith Housum: Morning, guys, and thanks for the opportunity here. Hey, you hope you guys could perhaps just dimensionalize a little bit the current industry capacity for these data centers. You mentioned deficit of about 5,000 devices. How much can the market do today? And then perhaps, what is your capacity? Is it $300 million $400 million as you guys currently have it built?

Aaron Jagdfeld: Yeah. Thanks, Keith. So the overall market size again, is there is a lot of there is a lot of moving pieces there, but, you know, it is significantly above the 5,000 deficit, obviously. But it is you know, it continues to evolve. And a lot of that is going to be it is going to be defined by how quickly the data centers can come online. You know, one of the challenges that still has to be solved by the data centers is the ability to connect to the grid. Right? So what we are seeing, and I think what you yeah.

For those of you who track some of the companies in the marketplace that provide different solutions for what we refer to as bridge power. Right? Maybe unique solutions, individual solutions that can create a somewhat independent, almost microgrid, if you will, for a data center site. And they can stand up that microgrid, that data center and bring it online more quickly. A lot of the overall size of the market is being dictated by how quickly can these data centers be put into service, either by connecting to the grid or through their self-sufficiency with some kind of bridge power solution until they can connect to the grid. So it is a moving number.

It is a moving target. Again, the 5,000 deficit that we reference is kind of based on what the individual market participants have told us that they believe and not market participants in terms of genset participants, but the customers, for data centers, what they believe that to be a deficit in the market. So they are not telling us how big the whole thing is. They are just saying they believe there are, you know, there are thousands and thousands of units short here even for 2026.

Our own capacity just kind of looking at what we think we can do in terms of capacity for next year, I think it is, you know, easily north of $500 million in terms of what we have as capacity today. Based on the nine facilities we have, based on bringing Beaver Dam online here, this year and also some expansion that we are doing investing in some areas in some of our other plants to allow them to do even more to expand their capacity of large megawatt product in particular. Either through additional test capacity, which is generally the constraint or through some of the other production capacity.

What we need to do is size that with our supply chain as well. We think right now, our supply chain could keep up with that. This is where I think real quick. Very quickly. Yeah. You think about $500 million. I mean, that is a third of our entire C&I business today. You know? So, I mean, it is a again, I keep using the term needle-moving because that is truly a needle-moving opportunity. But the good news is, you know, we have got good capacity in put in place. We have got, as York mentioned, momentum. And we are willing to commit to additional capacity as the market grows and as our participation grows alongside of it.

Operator: And one moment for our next question. Our next question will be coming from Dimple Gosai of Bank of America. Dimple, your line is open.

Dimple Gosai: Thank you. I appreciate the time today. You raised EBITDA margins to 18% to 19% from 17% to 19% previously. My question is what is driving the confidence in margin expansion, right? How much of this is due to structural improvements, say, input costs or temporary tailwinds from mix pricing? As opposed to uplifts from tariffs. Right? And how sustainable are these margins into 2026?

York Ragen: Yeah. No. I think, what we have been our gross margin performance has been quite strong, I would say, for the last four quarters. Yeah. So we have demonstrated that we can execute on strong gross margin. So that alone gives us confidence that can continue on. Now from a tariff standpoint, you know, the market has absorbed the pricing. And you can see from our Q2 performance that we were able to withstand that. We believe in the second half, we will continue that. We have got confidence that the impact of tariffs will get offset by price, and that will allow us to hold those strong margins.

And I think the increase from our prior outlook is just a function of holding those margin dollar levels on slightly lower sales, on slightly lower pricing. So that alone will drive your margins up. But what we have seen today is we believe we can offset those tariff impacts.

Aaron Jagdfeld: I would say I would add to that, Dimple, that when you think about longer-term margins, from some of the energy tech products that we talked about earlier. And then if we, you know, if as that C&I business begins to rapidly grow, the leverage that we are going to get from that growth is going to also be, I think, a positive overall for our margins. So the combination of those two factors as well gives me confidence longer term that our margins have the opportunity to continue to expand. I mean, we had laid that out also at our last IR event. You know, we were targeting higher margins even than where we are operating today.

We believe that is still very achievable. You know? And that is even kind of before we get to some of the potential opportunities within the data center market that we have been talking about this morning. Definitely in the on the EBITDA line. Definitely. On the EBITDA. Yeah. The operating leverage on the EBITDA line will be large. Absolutely.

Operator: And one moment for our next question. Our next question will be coming from Sean Milligan of Janney. Your line is open.

Sean Milligan: Thank you for taking the question, guys. In terms of the data center piece, you just kind of hit on it, but I was trying to understand how we should think about margins for that book of business. You know, are they I guess, both from a gross and the EBITDA side within the C&I piece, like, are they going to drag that margin profile higher over the next couple of years also?

Aaron Jagdfeld: I think at the gross margin line, if you just looked at those projects on their own, you know, they do not look tremendously different than our C&I product margins. You know, they are maybe a little bit softer than that on a percentage basis, but, actually, they are quite a bit stronger than our initial business case going into this market. Presented. We thought that those percentages would be more challenging, and they would be potentially dilutive at the gross margin line. I do not necessarily see it happening that way with C&I products now.

Given where because of the structural deficit in the market, pricing of those products to the market has gone up from our initial business case and is putting us in a place with gross margins on those products that look a lot more like our traditional C&I products. And as a result and even, you know, even if we were to the business case that we if we were talking about the business case we originally had, we were going to see accretion on the EBITDA margin line because of that leverage. Going to see it.

It is going to work out even better now because gross margins also will be stronger than we had initially planned for, and you will get the leverage on the operating leverage at the EBITDA margin line. So net, Sean, I think it is, you know, this is again where kind of my previous answer to Dimple's question. Why I have got confidence that our EBITDA margins can continue to expand in the future is in particular on the back of what we are looking at doing here in data centers. Even on a consolidated basis. Even on a consolidated basis.

Maybe slightly maybe dilutive about the gross margin line on a consolidated basis, but accretive to accretive on a consolidated basis EBITDA margin for sure.

Operator: Thank you. One moment for our next question. Which will come from Joseph Osha of Guggenheim Partners. Joseph, your line is open.

Joseph Osha: Hi. Thanks. I am wondering if you could talk a little bit about your diesel source strategy. I am wondering whether for starters that supply chain is showing some signs of stress as well given how busy data centers are and also how you are thinking about where you might procure, in particular, what your opportunities are outside of China?

Aaron Jagdfeld: Yeah. Thanks, Joe. It is a great question because, obviously, at the heart of every one of those machines, is a lot what we refer to as a large bore diesel engine. That produces, you know, the kind of output that is required in each of these machines. And these are engines that have been around a long time, but they have been traditional and they have been used in power generation in the traditional market sense. But, typically, you see them in rail. You see them in mining. You see them in marine, in those larger power applications. You know, when you look across the planet, there are a handful of manufacturers of these large diesel engines.

And, you know, a couple of them are very well known. Caterpillar, Cummins, you know, and they also have very well-known power generation divisions or groups. That are leading the charge forward on, you know, kind of, you know, serving the data center markets. But that is where the constraints lie. And for them, you know, they both Cat and Cummins have announced expansion plans for capacity in those diesel engine in the diesel engine production capacity that will come online in the next several years. And that is somewhat unique for them because normally those markets the primary markets of rail, marine, and mining can be cyclical. Right?

And in the past, I think the reticence to add capacity in those large bore diesel engines for manufacturing capacity, it is expensive. And so it is a capital-intensive, a bit expensive to add capacity. So typically they have kind of, you know, I think held the line on doing that and just, you know, waited for markets to roll over. In terms of cycles. But this time, they I think they all view it differently. I think which is actually a very bullish sign.

I think overall that there is a belief that this part of the market is going to run for a lot longer and is, you know, going to be relevant in a big way going forward and is worthy of making that next level of capacity investment. That said, our supply chain, Generac Holdings Inc., you know, we work very hard over the last few years to put a deal together with a supplier there that is not new to the market but maybe new to the US market. And so we have been working with that partner to get those products qualified US certification.

They were qualified last year for use in Europe, and that is why our European team is maybe a quarter or two ahead of where we are at in the US. And the products are now qualified for duty here in the US market. It is a world-class manufacturer and they have a tremendous amount of capacity they have a very large appetite for additional investment. So we feel that we are paired there with a very confident supplier and one that is going to give us a lot of room to run. In terms of, you know, with this initial foray into the market.

One of the major reasons why we have been successful is we have been able to quote, you know, considerably shorter lead times and where the markets have maybe half the lead time of the market today. And, you know, that is great. But that is not what you build a business on. You know, we have got to build a business on a reputation that states by our performance as well.

Performance of the equipment itself, but also the uptime of the equipment and our ability to serve and support those customers in a way that, you know, we think we know how given our long history in serving some areas like telecommunications, as an example, on a direct basis. So we think our supply chain is in really good shape there, Joe. We think we have got the right partner. And again, I think we are poised for some significant growth.

Operator: I would now like to turn the conference back to Kris for closing remarks.

Kris Rosemann: We want to thank everyone for joining us this morning. We look forward to discussing our third quarter 2025 earnings results with you in late October. Thank you again. And goodbye.

Operator: And this concludes today's conference call. Thank you for participating. You may now disconnect.

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DATE

• Wednesday, July 30, 2025, at 10 a.m. EDT

CALL PARTICIPANTS

• President and Chief Executive Officer — Marty Freeman
• Chief Financial Officer — Adam N. Satterfield

Need a quote from one of our analysts? Email [email protected]

RISKS

• LTL tons per day declined 9.3%, directly impacting operating leverage.
• Operating ratio deteriorated by 270 basis points to 74.6% in Q2 2025 due to deleveraging effects and increased overhead costs.
• Employee benefit costs rose to 39.5% of salaries and wages versus 37.2% in the prior year, primarily driven by higher group health and dental plan expenses.
• “We had some losses in the second quarter [on fleet asset sales],” Satterfield stated, with continued pressure expected, driving up miscellaneous expenses in Q3 2025.

TAKEAWAYS

• Total Revenue: driven by volume declines, partially offset by increased yield.
• LTL Tons per Day: LTL tons per day fell 9.3% in Q2 2025, while LTL revenue per hundredweight rose 3.4%.
• Sequential Changes: All were below ten-year averages.
• Monthly Sequential Trends: April declined 3.7% versus March. May rose 0.5% versus April, and June dropped 0.6% versus May, each underperforming the respective ten-year seasonal averages.
• July Month-to-Date Performance: LTL tons per day were down 8.5% year-over-year in July 2025.
• Operating Ratio: Worsened by 270 basis points to 74.6% in Q2 2025, reflecting deleverage from lower revenue, with overhead costs rising 160 basis points as a percent of revenue.
• Depreciation and Miscellaneous Expenses: Depreciation increased by 80 basis points, and miscellaneous expenses increased by 40 basis points as a proportion of revenue, attributed to ongoing capital expenditures and higher asset sale losses.
• Direct Operating Costs: Increased 110 basis points, primarily due to employee benefit plan expenses.
• Employee Benefit Costs: Equaled 39.5% of salaries and wages, up from 37.2% in 2024.
• Cash Flow from Operations: Capital expenditures were $187.2 million in Q2 2025 and $275.3 million for the first six months of 2025, respectively.
• Shareholder Returns: Share repurchases and dividends totaled $59 million in Q2 2025 and $118.5 million for the first six months of 2025, respectively.
• Effective Tax Rate: guidance for continued 24.8% in the next quarter.
• On-Time Performance: Maintained at 99% with a cargo claims ratio of 0.1% in Q2 2025.
• Pricing Outlook: Satterfield projected, “yield ex fuel will probably be up in the 4% to 4.5% range in Q3 2025,” with consistent sequential increases expected.
• Overhead Expense Guidance: Overhead costs expected to “tick up even further,” following a reported $310 million in the second quarter.
• Seasonality Context: The ten-year average sequential change from Q2 to Q3 is typically flat to up 50 basis points in operating ratio, but Satterfield expects a sequential increase in the operating ratio in the 80 to 120 basis point range from Q2 to Q3 2025, partially due to revenue softness.

SUMMARY

Management stressed a disciplined approach to pricing, even as volumes and revenue remain under sustained pressure. Strategic investment in network capacity, technology, and workforce continues despite weaker short-term profitability, positioning Old Dominion Freight Line (NASDAQ:ODFL) for long-term demand recovery, even as competitive pressures and industry overcapacity persist.

• Satterfield described discretionary spending as tightly managed, noting that “we just got to continue to stay disciplined really throughout all areas of the operation.”
• Freeman emphasized that “Delivering superior service at a fair price” is foundational, supporting both customer relationships and yield management.
• Management conveyed cautious optimism about improving volume trends relative to easier future comparisons but refrained from forecasting a near-term demand inflection, highlighting ongoing economic uncertainty.
• Continued investment in capital expenditures -- cited as approaching $2 billion over this three-year downturn -- is expected to provide leverage as demand eventually recovers.
• Satterfield explained that much of the operating leverage remains intact, as “about 70% of our cost or so right now are variable,” and sequential incremental margins reached 60% on even modest revenue improvement.
• Executives see no structural change in LTL’s competitive position or lasting market share loss, citing proprietary data and continued customer wins, while actively managing fleet capacity and overhead.

INDUSTRY GLOSSARY

• LTL (Less-than-Truckload): Freight shipments that do not require a full truck; multiple shippers’ goods share trailer space for efficiency.
• Revenue per Hundredweight: A key pricing measure in LTL, representing revenue earned for every 100 pounds shipped.
• Operating Ratio (OR): Operating expenses as a percentage of revenue; a lower OR indicates higher operating profitability in transportation.
• Yield ex Fuel: A yield metric adjusted to exclude fuel surcharges, offering insight into underlying pricing trends.

Full Conference Call Transcript

Marty Freeman: Good morning, and welcome to our second quarter conference call. With me on the call today is Adam Satterfield, our CFO. After some brief remarks, we would be glad to take your questions. Old Dominion's second-quarter financial results reflect continued softness in the domestic economy. Although our revenue decreased in the quarter due to a decline in our volumes, our yields improved as our in-class service continues to support our disciplined approach to pricing. I want to thank our outstanding team for their unwavering dedication to our customers and continued commitment to executing the core elements of our long-term strategic plan.

Although the challenging economic environment has persisted for longer than we anticipated, we have remained focused on what we can control as we work to ensure Old Dominion continues to deliver superior service to our customers while also operating efficiently. In addition, our ongoing investments in our network, technology, and our OD family of employees put us in an unparalleled position to respond to an inflection in demand when it materializes. Delivering superior service at a fair price to our customers is the cornerstone of our strategic plan and has been central to our success for many, many years.

Doing so consistently through the ups and downs of the economic cycle has strengthened our customer relationships over time and allowed us to keep our market share relatively consistent over the extended period of slower economic activity. As a result, we were pleased to once again provide our customers with 99% on-time performance and a cargo claims ratio of 0.1% in the second quarter. This consistency of our execution and our commitment to creating value for our customers doesn't happen by accident. It is a product of our unique culture and the result of the hard work of the OD family of employees. Across our company, our team is focused every day on adding value for our customers.

By keeping our promises to our customers, we help them create value for their own customers. Our commitment to service excellence continues to support our long-term yield management initiatives. With a focus on individual account-level profitability, our approach to pricing is designed to offset cost inflation and support our ongoing investments in our network, our fleet, and our people. Although these investments have created headwinds to our profitability in the short term, we are confident that our consistent reinvestment back into our business for growth is the right long-term approach. We know that having available capacity to grow with our customers and support them during periods of stronger demand is an important component of our value proposition.

We also believe that these investments are critical to stay ahead of what we expect to be favorable long-term demand trends for our industry. I'm very proud of our team and how they continue to find ways to reduce costs and operate efficiently. When volumes decrease, it can lead to increased operating costs due to the loss of operating density. While that was the case in the second quarter, we continue to believe that our business model contains meaningful operating leverage, and we remain confident in our ability to improve our operating ratio over the long term. We expect this to become more apparent over time.

Our customers have recognized the value of our service by giving us more of their business. Looking forward, we believe that the consistency of our execution, unique culture, and our team's daily commitment to excellence will allow us to be the biggest market share winner over the next decade as well. Our position is as strong as ever to respond to an improvement in the demand environment, revenue growth, and drive increased shareholder value over the long term. Thank you very much for joining us this morning. And now Adam will discuss our second quarter in greater detail.

Adam Satterfield: Thank you, Marty, and good morning. Old Dominion's revenue totaled $1.41 billion for 2025, which was a 6.1% decrease from the prior year. Our revenue results reflect a 9.3% decrease in LTL tons per day that was partially offset by a 3.4% increase in LTL revenue per hundredweight. On a sequential basis, our revenue per day for the second quarter increased 0.8% when compared to 2025, with LTL tons per day increasing 0.1% and LTL shipments per day increasing 0.8%. For comparison, the ten-year average sequential change for these metrics includes an increase of 8.2% in revenue per day, an increase of 5.3% in LTL tons per day, and an increase of 6% in LTL shipments per day.

The monthly sequential changes in LTL tons per day during the second quarter were as follows: April decreased 3.7% as compared to March, May increased 0.5% as compared to April, and June decreased 0.6% as compared to May. The ten-year average change for these respective months is a decrease of 0.7% in April, an increase of 2.5% in May, and an increase of 2.1% in June. For July, our current month-to-date revenue per day is down 5.1% when compared to July 2024, with a decrease of 8.5% in our LTL tons per day. As usual, we will provide the actual revenue-related details for July in our second quarter Form 10-Q.

Our operating ratio increased 270 basis points to 74.6% for 2025, as the decrease in our revenue had a deleveraging effect on many of our operating expenses. This contributed to the 160 basis point increase in our overhead cost as a percent of revenue. Within our overhead cost, depreciation as a percent of revenue increased 80 basis points while our miscellaneous expenses increased 40 basis points. The increase in depreciation cost as a percent of revenue reflects the ongoing execution of our long-term capital expenditure program, which we believe will support our ability to grow with customers in the years ahead.

Our direct operating cost also increased as a percent of revenue despite our team's best efforts to manage these variable costs. The 110 basis point increase in these costs was primarily due to higher expenses associated with our group health and dental plans. As a result, our employee benefit cost increased to 39.5% of salaries and wages during 2025, compared to 37.2% in the same period of the prior year. Overall, we continue to be pleased with how our team has remained focused on controlling what we can until the demand environment improves. The OD team has continued to deliver best-in-class service while operating very efficiently, and we've also managed our discretionary spending.

We will, however, continue to make the investments that we believe are necessary to ensure that our business remains well-positioned for the long term. Old Dominion's cash flow from operations totaled $25.9 million for the second quarter and $622.4 million for the first six months of 2025, respectively, while capital expenditures were $187.2 million and $275.3 million for those same periods. For our share repurchase program during the second quarter and first six months of 2025, respectively, while our cash dividends totaled $59 million and $118.5 million for those same periods. Our effective tax rate for 2025 was 24.8% as compared to 24.5% in 2024. We currently expect our effective tax rate will be 24.8% for the third quarter.

This concludes our prepared remarks this morning. Operator, we'll be happy to open the floor for questions at this time.

Operator: Thank you. We will now begin the question and answer session. Our first question will come from Chris Wetherbee with Wells Fargo. Please go ahead.

Chris Wetherbee: Hey, thanks. Good morning, guys. Appreciate the comments. Maybe we could just start with your thoughts around operating ratio. Obviously, it's a challenging environment from a tonnage at least year over year. Kind of how do you think about sort of the normal progression from 2Q to 3Q on the OR? And maybe kind of how you feel like you can fare, you know, given the circumstances we're in from a macro backdrop?

Adam Satterfield: Sure. Yes, the ten-year average is for us, it typically flat to up 50 basis points from the second quarter to the third. But that's typically based on sequential revenue growth of about 3%, which is what we typically see. So obviously, the demand environment, what you just said, we've not really seen that positive inflection yet, unfortunately, with our revenue this year. But so I'm kind of thinking that revenue per day, if it continues to stay flattish on a per day basis, much what we saw in the second quarter that continues into the third. But we'll probably see an increase in the operating ratio somewhere in the 80 to 120 basis point type range.

So a little worse than what our normal sequential change would be. But just a couple of things to point out for that. I'm expecting that we'll see an increase in our salary wages and benefits line. And some of that, as you know, we give a wage increase that's the first September every year. So that's always in there, but we typically have that revenue that offsets a little bit. But I'm also expecting that we'll see continued pressure with our free benefit costs. So, I'm thinking that will be part of the driver.

I also think that we'll see our operating supplies and expenses will probably tick up a little bit our overhead costs, and we talk about that a lot, but I'm expecting that our overhead cost in aggregate will be up a little bit further in the third quarter. They were about $310 million in the second quarter. We've been running about $305 million. So I'm expecting that we'll see those tick up even further in the third quarter. Probably some pressure in the miscellaneous expenses line will continue. But obviously, the overhead cost is revenue-dependent. So I'm anticipating if it's flattish revenue, then those costs will tick up a little bit further.

But if we can see some revenue start to come in a little bit better, and obviously, we'll continue to give our mid-quarter update then that's something that eventually, over time, we'll get leverage on.

Operator: Thank you. Our next question will come from Eric Morgan with Barclays. Please go ahead.

Eric Morgan: Hey, good morning. Thanks for taking my question. I wanted to ask about the market share commentary. Just if we look at the ATA's shipment index, it actually turned positive in the past couple of months, at least for April and May. So I don't know if that's kinda the best data to use, but it's what we have. And obviously, it's a bit different from what we're seeing from you as well as your publicly traded peers. So kind of less real-time insight they've been responding to this downturn, if that's changed at all in recent months.

Adam Satterfield: Yeah. The best data that we probably get from an industry is really from transport topics. And so that's the data that you'll see most typically quote in the team ks about the size of the industry and so forth. And so you really only get an annual read on some of those carriers. Without the month-to-month trend. And the ATA is good, but I think it typically has always had a much higher report of revenue for the entire industry, and it includes I believe, some ground business from some of the other parcel carriers. So that's why we typically have used Transfer Topics.

But I think when we look at that information, Transport Topics just published recently, and we saw a pretty consistent trend from market share for us. And we've got granular level detail that we get through proprietary database that's out there as well. And overall, I'd like to think that our market share, when you look through this downturn, our strategy is that we want to maintain market share in periods of economic weakness while also getting increases in our yields. And think when we go back and look at kind of where things were in '21, '22, that's effectively what's happened. And it always moves up or down a little bit here and there.

But the key will be continuing to execute our strategy like we've done in the past. And then May 2014, 2015, same thing with 'seventeen and 'eighteen. We've been able to outperform the market from a tonnage growth standpoint. Anywhere from 1,000 to 1,200 basis points. So we just need a little help from the economy to get back to where we really see that demand environment inflecting back to the positive. And obviously, macro factors are starting to settle a little bit. With respect to the tax deal. Trade. Hopefully, at some point soon, we'll get an interest rate decrease.

Think once some of those measures of certainty come back into the market, it will create opportunities for our customers. That will create opportunities for us to start growing our volumes again. Thank you.

Operator: Our next question will come from Jonathan Chappell with Evercore ISI. Please go ahead.

Jonathan Chappell: Thank you. Good morning. Adam, one of the things you mentioned in response to Chris' question was you expect pressure on operating supplies and expenses. You said the same thing in April and operating supplies and expenses actually improved by 80 basis points as a percentage of revenue in 2Q. So did something happen in 2Q that really help you on that cost line item that you expect to reverse and in 3Q? Or, you know, how do we kind of match up the pretty big sequential improvement in 2Q to, you know, ongoing pressure expected in March.

Adam Satterfield: Yeah. I would say that, we continue to see really good performance from our repairs and maintenance. Our team has done a great job I think, with managing those costs. And I had the expectation that we would see some pressures there from 1Q to 2Q. Anticipating that some of our part cost might be increasing due to the impact of tariffs and so forth. But I think what we've seen is just some continued changes with our fleet. We've continued to take some of our older equipment out that would have had really high repair cost, if you will. And so we've continued to pare back some of our fleet in that example.

And then just in general, our cost per mile, we've seen improvement this year. And if you go back the last few years, we up double digits. From a cost per mile standpoint, '22 and '23. So I think that was some of the better sequential performance that we had if you will, from 1Q to 2Q. But I'd say part of that driver is I'm thinking from 2Q to 3Q. Right now, or at least in the second quarter, our average price per gallon for fuel was like 3.56 and we're seeing that elevated right now.

So I think that's something where those costs as a percent of revenue, fuel kind of continues to hold at about the range where we are now, fuel is obviously a big driver in that operating supplies and expense line. Historically, what you see and probably the comment of why I wanted to give both those together, we always talk about, as fuel changes, usually, you'll see corresponding increase. I like to look at our direct cost in total and how we manage through those. So in the short term, if you see if fuel surcharge goes up, our fuel expenses percent of revenue might also go up.

But you would see the direct labor cost, in particular, kind of an offsetting decrease there. And typically, the second quarter to third quarter, too, that's where kind of see those costs all in. Or kind of flattish, if you will. But I'm expecting to see some continued pressure there at the salary, wages and benefits line. Somewhat like I mentioned, we've got the wage increase. We'll get one month of that for the full quarter. Typically, have a little bit of sequential revenue growth that will offset that.

And we may still have that for this coming quarter, but if we got flattish revenue growth and that puts a little pressure on that line item, but we've also seen higher fringe benefit cost for the past few quarters, and I'm expecting that trend to continue. And to probably be even a little bit higher in the third quarter than what we just saw in the second.

So those couple of factors and as well as the miscellaneous expenses some of the miscellaneous expenses back to kind of making changes on the fleet think we may see some more losses, if you will, coming through on that line item in the third quarter to put a little bit more pressure overall I would just say, in that big bucket of overhead cost.

Operator: Thank you. Our next question will come from Jordan Alliger with Goldman Sachs. Please go ahead.

Jordan Alliger: Hello, Mr. Aleker. Your line may be muted. Can you hear Go ahead, sorry. Yes. So just sort of curious, sort of you gave some color and commentary around the OR revenue per day sort of flattish. I mean given the easy comps, think that are coming up both in terms of tonnage per day and revenue per day I'm assuming as we look forward from July, those trends on a year-over-year basis I would think have the opportunity to get quite a bit better. But just curious your thoughts on the latter half of this quarter. Against those comps.

Adam Satterfield: Yes. They would, Jordan. So in the second quarter for the full quarter, we were down just call it, 6%, 6.1%. Right now, I would say July, just call it, we're down five. So it's already getting a little bit better. If we stay, the second quarter per day average was about $22 million revenue per day. So if we stay in that same ballpark, then we'd be down a little over 4%, you know, if you just sort of held revenue at that $1.4 billion that we just did in the second quarter, if you say that was exactly the same that's kind of what the trend would be.

I'll say that the July performance so far, when I look at kind of where our tons are and just the revenue per day, level, July is normally a weak month from a tons per day standpoint, we're usually down about 3% versus June. We're trending down about a little over 2% right now. So we're a little bit better what our normal sequential trend, is. Now I'm not ready to make a call to say that things will turn around and we'll get the acceleration that we typically would see in August and September. I think that gives us a little bit sense of cautious optimism to say, it's it's outperformance kind of on the downside.

Will we see some of that acceleration come through? I think that remains the question. I think it will get answered as we go through the quarter and we give our mid-quarter updates and so forth. So if we were to perform at normal seasonality, and I think that's a big if right now, not saying that, that would be the case, then that number would come back more in comparison to revenue with the third quarter last year. Think it full seasonality, we'd be down about 1.5%.

So we'll just continue to monitor it, and maybe we'll be somewhere in that 1.5% to 4%, just depending upon how things continue to materialize as we make our way through the quarter.

Operator: Thank you. Our next question will come from Tom Wadewitz with UBS. Please go ahead.

Tom Wadewitz: Yeah. I so wanted to see if you could offer a little more perspective just on pricing, kind of how you think about revenue per hundredweight ex fuel. In 3Q. And just whether the pricing I mean, your commentary pretty consistent over time that you see stability and discipline in the market. But is anything changing on that front? Is there you know, any kind of, areas where you see increased competition as the downturn expense? Thanks.

Adam Satterfield: Yes. I would say overall just really we've got to go by whatever everyone reported in the first quarter. But I think most carriers their reported yields have continued to be positive overall. And obviously, we continue to execute on our plan and I think our plan is different. We look at things from a cost base standpoint, and we want to be consistent through the cycle. And feel like getting those consistent cost-based increases are obviously important to the long-term operating ratio improvement that we've had. So right now, for the third quarter, I'm kind of looking at I think that number will probably be the yield ex fuel will probably be up in the 4% to 4.5% range.

And that's about where we are in July. So I think we'd expect to see consistent sequential increase in that reported number. But it will probably come in a little bit. And that's not a reflection on any kind of change or anything like that. It's just a function of kind of where we were last year and But we continue to expect to see increase and we're getting increases when we go through renewals. And that's one of the things that's been tough about this environment back to thinking about that market share question from earlier. But as we're going through our renewals, we're continuing to win business.

We get reporting for our national accounts the business that we've won or business that we've lost. And we're continuing to keep customers and get increases on those accounts that we're keeping. But we're also winning some new business. Overall, obviously, the volumes are down. But I think that, that lends itself to maybe a quick turnaround, if you will, when we do see that volume environment reflect back to the positive. And I think a lot of people believe that, that's coming sooner than later. And obviously, we felt like it was coming before.

We've had a few head fakes from an economic standpoint, but now that some of the bigger picture, things are being resolved from a macro standpoint. I feel like some of the optimism that we saw late last year and kind of saw it in the improvement in ISM in the early part of this year we hope to see kind of that turn back around and that optimism come back to the market and lend itself to increased freight opportunities.

But I think that's part of our value proposition is having capacity And while capacity is not at a premium right now, just given how weak demand has been for so long, We have heard commentary from customers about some competitors that aren't able to make pickups consistently in some markets. And increasingly calling us. And so I feel like when you have true demand recovery, those inbound calls will likely accelerate, and that's what we've seen in the past. And I referenced some of those periods earlier, but you go back to 2014 when we grew tons at 17%, the market is up 5%. In 'eighteen, we're up 10%. The market's up 1.5%.

You know what we did through the '21 and '22 cycle. Where we put $2 billion of cumulative revenue growth books then. So we feel like we're sitting in a great position to capitalize. We need a little bit of help from the economy right now.

Operator: And our next question will come from Daniel Imbro with Stephens Inc. Please go ahead.

Daniel Imbro: Yes. Hey, good morning. Marty, Adam, Jack. Hope you're doing well. Adam, maybe following up on that last discussion just on competition out there. I mean, you guys specifically have been a leader in a lot of the high service parts of the industry, whether SMB or grocery, of anything with the must arrive by date. A lot of your peers are talking about trying to grow here. So I guess, are you seeing the better offerings from some of your peers making any encroachment on your business as you go to market?

And I guess if not, what do you think the public markets underappreciate about why that will be harder for others to take from you guys being the leader there? Thanks.

Adam Satterfield: You know, I think that any customer that we have obviously, we've got a target on our backs, if you will, And but we're competing with every account. We're competing with the other carriers. And we have been for years. So I don't think anything has changed with that. I think there's this perception that we've got some secret segment of the market that the other carriers haven't figured out until now. And that's just not the case. Mean, we're competing with all the other national carriers in some markets with the regional carriers as well.

So our service product when you think about the fifteen years of Masstio wins, there's more to service than just being able to pick up and deliver on time and without damages. And we do those core things better than anyone else. But it's continuing to figure out ways that we can add value to our customers. And ultimately, that's the business that we're in, is how do we work with our customers create win-win scenarios, where we can help each other and add value. And so I think those are the things that we'll continue to look at and leverage.

We've got about 12% market share and there's a tremendous amount of share opportunity out there within an industry that we think continues to have tailwinds for it. So we continue to believe that e-commerce effect on supply chains will continue to shrink shipment sizes. And have truckload to LTL conversion. I think if nearshoring and reshoring opportunities continue to play out, that creates inbound and outbound opportunities. For us as well. And just supply chain sophistication with the interest rates higher, today, there's a cost of carrying inventory. And so that's that's a value add that we can have where our customers know they can rely on our own time and claims-free service.

So it's figuring out how to go into each and every customer account, figuring out the problems that they're having and delivering a solution for that customer. That's what we I think we do better than anyone else. And that's why we're so confident in what our long-term market share opportunities are.

Marty Freeman: Daniel, as you referenced, in the retail industry, including grocery, there's a penalty if the spray is not on the shelf on time and in full they're called fines. And many of our competitors, they can go out and talk about meeting those expectations with fancy marketing material and so forth. But until they can stop those fines in our customers' pocketbooks, nothing's going to change. And we figured out how to do that many, many years ago, especially in the grocery industry. So, don't see don't see anybody getting close to what we can offer from a service standpoint in retail industry.

Operator: Thank you. Our next question will come from Ken Hoexter with Bank of America. Please go ahead.

Ken Hoexter: Great. Good morning, Marty, Adam, Jack. Want to understand maybe a little bit more on the backdrop here. The stock's down about 8%. Easier comps are coming up right? Revs are down 5% in July. You expect to get that to maybe flat for the quarter. Others reported a deceleration in tons and pricing despite easier comps. Pierre mentioned this morning they're implementing an early GRI. So think you mentioned deceleration in yields at 4% to 4.5% So that's also a deceleration versus history. Are we getting a more competitive environment that just consistently is beating this market while we're in a decelerating market? Just want to understand your view of the backdrop.

And then holding share, I'm still confused by that one because every public carrier reported stronger percentage gains. Does that mean we're looking at just the private guys? I want to revisit that question earlier. Is it just the private guys that are losing relative share? Maybe if you can just expand a little more on.

Adam Satterfield: I think that, one, with respect to the yields, I think what we're looking at will be a continued increase sequentially. And so if we are kind of in the middle of that 4% to 4.5% range, that'd be up 1.5% to 2% sequentially. In the last few years, when you look at the ten-year average, the sequential increase there from 2Q to 3Q is a little bit stronger. But when you look at kind of the last five years, that really skews that average. So to speak. So if you kinda looked at a ten-year average sort of pre-COVID, are thinking about being.

So we're not seeing any change with respect to what our thinking is from an overall yield management standpoint. And I think that when you think about the industry as well, I think most carriers have kind of figured out that yields are important. Those that you get back over the last ten, fifteen years that when they taken the focus off yield, it's had pretty negative impacts on their overall profitability. And so I think that's why we've seen such consistency in the industry over this last three years where demand has been soft overall.

From a market share standpoint, I think that since really Yellow closed their doors, I think there's been a lot of choppiness in terms of figuring out where share is. And we obviously report that and report it by region. Overall in our deck that's out on our Investor Relations website. And so you can kind of see how share maybe be changing in one region versus the next. But it's something that when we look at the overall market, again, kind of factoring in what I just said, about using the data out of transport topics, it looks like our share is relatively consistent with where we've been really over the last couple of years.

And it's not to say that when we've gone through periods in the past of slow markets that were flat or could be down slightly, whatever, it's about the same. We've continued to execute a plan. We've continued to manage our cost. Our service has gotten better. And I think we're in a really strong position. It's just overall change that we sort of look at. And so we feel good about where we are, but feel better about what the opportunities looking forward will be.

Operator: And our next question will come from Scott Group with Wolfe Research. Please go ahead.

Scott Group: Hey, thanks. Good morning. This is a big picture question, and maybe it's similar with what you just sort of answered. But, you know, if you look at the numbers, you're one of the leaders on yields right now. You're the biggest laggard on tonnage, at least among the public guys. And I guess you might say, hey. That's very normal in a more in a softer market that gets a little bit more competitive. We stay more disciplined on price than anybody. But I guess what feels different is just, like, the duration of this environment like, we're three years into this, and we're now we still have, you know, tonnage down high single digits.

Does that does the duration of this change your thoughts at all in any way, or is it, hey. We'll just gonna do it. We keep doing, and we'll wait this out, and eventually, the cycle will come. Or because the cycle's lasting so much longer, do you think about it any differently?

Adam Satterfield: Yeah. I mean, obviously, it's it's been, we talk about these numbers from a quarterly perspective, annual perspective. There's a lot of day to day that's going on behind the scenes that doesn't get the discussed. I mean, every day, working with customers and figuring out ways to identify new opportunities. And it's been a tough few years going through this soft demand. Initially. And then you had the big industry event that happened. And so the flux of being down, being up short-lived and then being down again. You know, there's been a lot to try to manage through. I'd love for revenue to be higher. And I'd love for this cycle to turn.

There have been a couple of times that we felt like it was turning. And I think back to late '23, we had started reinvesting, running our truck driving schools and hiring folks to be prepared for what we thought was going to be sustained improvement there. And then kind of hit another roadblock from a demand standpoint.

But overall, when I think about our model and how important revenue is, I mean, you just look at the sequential performance through the second quarter, we don't normally talk about sequential incremental margins, but the reality is little bit of revenue that we put on the books between the first and second quarter we had about 60% incremental margins on that business. So it shows, I think, the power of the model once we start getting revenue on the books, but we don't feel like we need to go out and try to chase bad revenue that doesn't fit in our thinking for the long term. And so I think that's what we've done.

We've also continued to manage our costs very well. When I talk about splitting our operating ratio, apart, the 74.6% that we just did in the second quarter, about between 52-53% of revenue were our direct variable cost. That's pretty much the same where we were in the 2022 when we did a sub-seventy operating ratio. And so we've been able to control what we can. Our team has done a phenomenal job, think, of protecting service managing our cost in a very weak environment. That's hard to do when you don't have density in the network. So I'm really pleased with that.

Our overhead cost really are what's accelerated and we just need a bigger revenue base to get leverage on those costs again. But that part of our model and our strategy, too. We like to invest through the cycle. And we've got more capacity than we probably have ever had right now from service center network standpoint. And so yes, we're carrying a lot of excess cost. Our overhead cost as a percent of revenue were about 22% here in the second quarter. Back in 2022, they were about 17%. So therein lies the leverage for the model once we get back to a strong demand environment. So I'm pleased everything we've done.

Obviously, we'd love to be able to flip a switch and see the demand environment improve. But I think from where we sit when we look at what the other carriers are doing and kind of how revenue has trended. For some of the others, we're hanging in there. We've not seen any true variance in our volumes relative to what the entire industry has done. If I look and see the industry is down about 15% from where we were in 2022, our performance is pretty much right in alignment with what the industry has done overall on a net-net basis.

Operator: Our next question will come from Jason Seidl with TD Cowen. Please go ahead.

Jason Seidl: Thank you, operator. Marty, Adam, Jack, good morning, gentlemen. One clarification, I think you guys mentioned you expect losses on asset sales. Did I catch that correct?

Adam Satterfield: Yes, Jason. We've been trying to reduce size of our fleet a little bit just in coordination with where freight volumes are trending. And so we had some losses in the second quarter. That was part of the reason why you may have seen our miscellaneous expenses ticked up a little bit higher. Normally, costs are about 50 basis points or so. And so we saw those costs trend a little bit higher in the second quarter. They were up to 90. And I'm thinking that we'll see some continued pressure in the third quarter. On those.

Jason Seidl: I was just a little confused because I know other carriers are actually reporting gains on sale. And so, maybe you could walk us through, the difference between you and them.

Adam Satterfield: Well, in many cases, we're selling a tractor on average. We use a tractor for ten years. So there's probably not as much demand for that may be more of a truckload thing, but there's not as much demand for a ten-year-old million-mile, single axle day cab tractor.

Jason Seidl: And I guess when you mentioned the sequential move between June and July being slightly better than the historical average, is any of this due to maybe some pull forward when people were worried about the tariffs potentially resetting again in August? Clearly, we're getting through some of these or some deals, but did you get that feedback from any of your shippers that was occurring?

Adam Satterfield: Yeah. There may be, some of that. We've not heard material feedback on that. But, like, when I look at it by region, know, it's not like we saw a big change in, like, outbound business out of California, for example. Most of our regions are trending in about the same kind of range from a revenue performance standpoint. So there's don't know that there's a big outlier that may be driving that.

Operator: Thank you, Mr. Seidl. Our next question will come from Bruce Chan with Stifel. Please go ahead.

Bruce Chan: Yes. Thanks, operator, and good morning, everybody. Maybe another bigger picture question here. You know, we've been hearing pretty regularly in the past couple quarters from, you know, some of the other carriers about AI and dynamic routing. I know that, you know, the OD style has always been to kinda quietly implement those things as part of the overall, you know, playbook. In many cases, much earlier than peers. But maybe just helpful to get an update on any optimization projects that you've got going on right now you know, generally, how you're feeling about the various systems in your tech stack, anything incremental that we should be thinking about as an opportunity?

Adam Satterfield: Yeah. I think, like you said, I mean, we're always looking at technology. It's a key part of our business and I think has been to help us with our operating ratio. And just to kind of keep reminding our operating ratio is about 1,500 basis points better than the company average or industry average, I should say. So regardless of what the other carriers have got as opportunities, we're still materially outperforming there. And I think that technology has been a key part of that. And you're right. I mean, we don't normally try to announce everything and give totally our playbook away. But we're looking at ways to keep getting better.

Continuous improvement is a key component for our foundation of success. And we've always got to look at ways that we can make investments that are really going drive change from a service standpoint. Ultimately or add value through the lens of driving operational efficiencies? And you mentioned line haul optimization. That's kind of been the Holy Grail and the buzzword for the twenty-one years I've been in this industry. But that's something that we continue to look and we've got some tools that we continued to implement and try to refine to drive some optimization there. Same thing within our pickup delivery operations and on the dock.

And I think our increased use of some of those technologies is part of the reason why we've been able to keep those direct costs. And those direct costs are the primarily variable costs, but the direct costs associated with moving freight. And to think that we've been able to manage those costs basically consistent with where we were when our business was running extremely at optimal state at the time back in 2022 with a sub 70 operating ratio, I think, is pretty astounding when you think about the loss of density in our network now versus what we had in the network then.

And so it's not just one thing to point to, but think we've got a great team in the field. And I think we've got a great group in our technology team that's always looking for ways to get better, to work with their business. To work with our customers. Another key part of the technology investment is how can we do things differently. And add value and add stickiness with our customer base as well. That differentiate us from our competition. So all of those things, I think, will continue to be strategic advantages for us and will be part of the story of how we get our operating ratio back towards that 70% threshold.

But continue marching forward and drive long-term improvement there in the operating ratio. While we continue to improve density and yield.

Operator: Thank you, Mr. Chan. Our next question will come from Bascome Majors with Susquehanna. Please go ahead.

Bascome Majors: Thanks. Good morning. Just as a housekeeping item, can you remind us of typical revenue and margin seasonality for the fourth quarter? And Adam, if you look at longer term, not necessarily calling when the cycle will turn, but just thinking about what you think the business will respond like when it does. Can you update us on, you know, sort of the incremental margin or really other sort of profile you think you can deliver when we get some tonnage to flow through all the cost adjustment work that you've done over the last couple of years? Thank you.

Adam Satterfield: Yes. So typically, our revenue per day the ten-year average is a decrease of 0.3%, so 03% decrease in revenue per day. And then our operating ratio is typically up 200 to 250 basis points. And obviously, that we always have. We do an annual actuarial study. So there could be changes plus and minus on that insurance and claims line in the fourth quarter. Last year, we had a pretty big unfavorable adjustment that we had to take there. But nevertheless, we kind of exclude that from the averages, if you will. So that's what the normal performance is.

And I think from just kinda looking forward, in terms of what we can do from an incremental margin, I just mentioned that sequential incremental margin. I expect 60% to be the norm. But just thinking about our cost structure and what it is laid out from a direct cost versus overhead cost and overhead is mainly fixed. But there are some variable costs in there. Overall, about 70% of our cost or so right now are variable, and that's how we've been able to protect our margins through this downturn is continuing to manage those.

But anyways, the 53% of revenue being our direct variable cost and you kind of do the math, that's how we've been able to do sort of 35% to 40% incrementals when we're coming out of kind of on the early side of that demand inflection. And then eventually, you kind of get back to the point where you've got to add more equipment, you've got to add more people and so forth. And it starts compressing back. Our longer-term average incremental has been 35%. And so I think that still seems reasonable.

And that would continue to imply that if you run that out for several years of a recovery in revenue growth that we would get back to that sub-seventy type of threshold.

Operator: Thank you. Our next question will come from Ravi Shanker with Morgan Stanley. Please go ahead.

Ravi Shanker: Hey, guys. Thanks for the time. I know this topic has been discussed a fair bit, but if I can hit it again in a slightly different way. You guys have been masters of calling the cycle over the years and have shown your operating prowess as well. But to kind of Scott's point, it's been three years of a downturn. And even now, I think some of the deals and rails actually sounding a little bit better on volumes in the cycle, even though nobody is gonna high fiving here. How can you guys tell if there is something bigger and more structural going on with the LTL space here rather than just a cycle?

Maybe some more with the same level of volumes or higher in up cycle?

Adam Satterfield: Yeah. The what you just said there at the end is, you know, the confidence that we have in our long-term market share really is just driven by those customer conversations and how we think supply chains will continue to trend over time. We've seen some market share shift, I think, from LTL to truckload through this cycle. And when you look at some statistics in the truckload industry in terms of what they're charging revenue per mile versus cost per mile, they're willing to operate it at breakeven or worse. And I think that's what you're seeing with some of the operating ratios that have been published as well.

So but I think that's some of the trend that we've got to continue to watch is that business starts picking back up, they get busier, the rates start going back up, I think that's when you'll start seeing some of this unwinding. Effect in some of those, truckload carriers that they don't really wanna move multiple shipments on the back of their truck and make multiple stops. That's not their preference. And they don't have the network that's set up to really handle it. They only do it when times are tough and they need some payload. To make a truck payment. And so I think you'll see that business move back into LTL.

And then we'll continue to see kind of our customers that are continuing to if we go through a customer, we're seeing a lot of wins, like I mentioned, from just a customer-specific standpoint. And customers are continuing to award us the same lanes of business that they've had before. But their overall business levels might be down. And whether that's just the demand for their product some we know are taking advantage of this truckload opportunity. It's kind of going to be a multiple items that I think are driving the increase in demand. in prior cycles. So we feel like we're ahead of it though from a capacity standpoint.

I mentioned the network capacity from a service center standpoint. But I feel like we're in really good shape in regards to our fleet. We're probably heavy there. In all honesty. But I feel like from a people capacity standpoint as well, we've got a team that in position and ready. And that's the best incremental margin you can get is when we've got a driver that's already making a stop at our customer. And now instead of picking up one shipment, they're picking up three. And that's typically what we've seen in cycles past and how our volumes can accelerate so quickly on the front end of the inflecting economy.

And that's what we'd expect to see whenever this economy does eventually inflect back to the positive.

Operator: Our next question will come from Richa Harnane with Deutsche Bank. Please go ahead.

Richa Harnane: Hey, gentlemen. Thanks for the time. So I appreciated all the color around your positioning being as strong as it's ever been to respond to an improving environment. And the OD model really makes hay when the sun shining. So maybe you can talk to us. I get that, you we're a little reticent speak to some of the green shoots given all the head fakes you've had. But just customer conversations, you talked about maybe fatigue on the tariff side. Reactions to the recent bill that passed in Washington to spur growth. Interest rate cuts? Like, what are shippers telling you about their appetite to give you more business? In the future?

And then if you can maybe parse out kind of what industries you're maybe more optimistic about versus industries where you're really seeing more malaise set in or more negative trends? Thanks.

Adam Satterfield: Yeah. I think that, it's been the uncertainty that's been hanging out there over the economy that I think has resulted in just the lack of freight volumes overall. Again, I mentioned industry volumes are down about 15% from where we were back in '21, '22. So it's something that everyone's had to contend with. But I think we saw kind of going back to the fall of last year, we saw some initial optimism with respect to the industrial economy. And 55% to 60% of our revenue is industrial related, so that's important to us. And we saw that acceleration in the ISM in December. And then know, it was positive for a couple of months.

But then all the tariff conversation started, and then that just created more uncertainty that seemed to kind of throw cold water on what was developing at the time. And it's hard from a pure manufacturer, for example, to figure out what the cost structure is gonna be when you don't really know what the final tariff cost might be. And so I think that's something that we've had a lot of customers trying to figure out and solve for. And in some cases, you just try to wait things out. And so that's why we've got a little cautious optimism now that we've seen the tax deal be finalized.

And the bonus depreciation is something that I think can spur some further investment here. If we start seeing some trade deals come to fruition, that will be something that provides a little bit more confidence for customers. And I think the final piece will be do we get some relief on interest rates. And so customers that are going through all of their financials and figuring out do they invest or not and what kind of return can they expect on their investment. All those, once you get clarity on those big picture items, I think that's what it's going to take to really kind of spur the economy forward. So we feel like we're closer to that.

Now that we're getting clarity on some of these items and but we want to turn that feeling into true freight. And see it coming on board. And I mentioned that we're seeing a little bit better performance right now in July. And we'll just continue to watch and see does that really manifest into seeing some sequential improvement. Versus just what our business has been like for the last three years of kind of flattish to down month over month.

Operator: Thank you. Our next question will come from Stephanie Moore with Jefferies. Please go ahead.

Stephanie Moore: Hi, good morning. Thanks, guys. Just one real quick here. Look, any thoughts on where the LTL industry fits in, in general with this potential transcontinental railroad or potentially two? Obviously, most are talking about these deals, you know, deal impacting long haul truckload, but where does LTL sit here at all? Would love your perspective. Thanks.

Adam Satterfield: Yeah. I don't know that I would expect to see any material impact on LTL overall. Meant something that it could be ultimately downstream, something we'll continue to watch and engage with customers on. But I think that's kind of on the other end of the supply chain. And not necessarily seeing changes with respect to the rail industry kind of filter down to where we can find a correlation any changes in our business levels.

Operator: Thank you. Our next question will come from Ari Rosa with Citigroup. Please go ahead.

Ari Rosa: So I know in reference to Bascome's question, you mentioned the normal seasonal trends from third quarter to fourth quarter. Was just wondering, it's been such a weird year. We've obviously seen some abnormal seasonal trends so. And then also how the wage increases play into that and kind of how much discretion you have around that and what's kind of plan, how much pressure that puts on the OR? Thanks.

Adam Satterfield: Yes. I mean, obviously, our costs will be going up. With respect to the wage increase. And third quarter, and then you got the full quarter effect in 4Q. But that's it's usually one point, one point type of increase if you look at that two fifty change that's going to be a big driver there. And but keep sounding like a broken record, I think it's just going to be revenue dependent. You know, the fourth quarter, if we can kind of continue to maintain our revenue per shipment or not revenue per shipment, but just revenue per day rather. In the same realm of where we are. We'll continue to manage our costs like we have.

And I think by the fourth quarter, would hope to see some of this increase that we've had in overall cost overhead cost rather. Start to come in a little bit. And so those are some other things that can help. But it's just continuing to manage our costs, manage our operating efficiencies, which our team is doing a great job. I kind of mentioned before, we're controlling our variable cost. We've got to continue to do that. And typically, you see volumes a little bit softer. In 4Q. So it just presents even more of a challenge to our ops team. But we just got to continue to stay disciplined really throughout all areas of the operation.

And everybody's got to participate, and we've to continue to manage our discretionary spending. And think through. If we're spending $1 what is the purpose behind it? And is it going to improve customer service? Is going to help us over the long term? And those types of investments we're willing to make. Even though we're trying to protect the short term we really got to think and we do think bigger picture and longer term for what's going to be to the best benefit of Old Dominion. Over the long run. And that's why you've continued to see us make investments and continue to execute on our CapEx program.

I've mentioned this three-year down cycle, but the end of this year, we'll have spent probably close to $2 billion on capital expenditures and to do so in a soft environment. That's created its fair share of cost headwinds to something that we've managed through. And I think we'll be happy that we've done these when we get on the other side of this economy. And you'll see that the leverage that can come through just like what we saw in the second quarter for that short-term benefit.

Operator: Thank you, Mr. Rosa. This will conclude our question and answer session. I would like to turn the conference back over to Marty Freeman for any closing remarks.

Marty Freeman: All right. Well, you all for participating today. We appreciate your questions, and feel free to call us if you have anything further. Thanks, and have a great day. The conference has now concluded.

Operator: Thank you for attending today's presentation. You may now disconnect.

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DATE

• Wednesday, July 30, 2025, at 10 a.m. EDT

CALL PARTICIPANTS

• Chairman & Chief Executive Officer — Christopher A. O’Herlihy
• Senior Vice President & Chief Financial Officer — Michael M. Larsen
• Vice President, Investor Relations — Erin Linnihan

Need a quote from one of our analysts? Email [email protected]

TAKEAWAYS

• Total Revenue: Increased 1% in Q2 2025, including a 1% positive impact from foreign currency translation, while product line simplification (PLS) reduced revenue by 1%.
• GAAP EPS: GAAP EPS was $2.58 for Q2 2025, representing a second-quarter record, according to management's prepared remarks.
• Operating Income: GAAP operating income was $1.1 billion for Q2 2025, also noted as a record for any second quarter.
• Operating Margin: Achieved GAAP operating margin of 26.3% for Q2 2025, with enterprise initiatives contributing 130 basis points to operating margin.
• Organic Growth Rate: Organic growth rate was essentially flat for Q2 2025; indicated as a sequential improvement of more than one percentage point in organic growth rate compared to Q1 2025.
• Geographic Performance: Asia Pacific revenue up 9% in Q2 2025, with China up 15%; North America declined 2% organically in Q2 2025 and Europe fell 3% organically in Q2 2025.
• Sequential Revenue Growth: Revenues increased 6% from Q1 to Q2, accompanied by incremental margins above 50% on a sequential basis.
• Free Cash Flow: $449 million in free cash flow for Q2 2025, representing a 59% conversion rate, which management described as modestly below historical averages due to timing of one-time items.
• Automotive OEM Segment Revenue: Up 4% in Q2 2025; organic growth was 2% in the quarter, offset by a more than 1% decline from PLS; North America declined 7% in Q2 2025, China grew 22% in the segment.
• Automotive OEM Operating Margin: Increased 190 basis points sequentially to 21.3% for Automotive OEM in Q2 2025, the highest margin since 2021 in this segment.
• Food Equipment Segment Revenue: Grew 1% organically; North America up 5% in the quarter, international revenue was down 5%.
• Welding Segment Organic Growth: 3%, with equipment sales rising 4% in Q2 2025 and consumables up 1% in Q2 2025; segment operating margin remained at 33.1% for Q2 2025, flat year over year.
• Polymers & Fluids Revenue: Polymers organic revenue down 5% in Q2 2025 and fluids plus automotive aftermarket organic revenue down 3% each in Q2 2025.
• Construction Products Revenue: Fell 6% globally, including a 1% headwind from PLS; operating margin improved 140 basis points to 30.8% for Q2 2025 despite regional declines (North America -7%, Europe -5%, Australia/New Zealand -10%) in organic revenue.
• Specialty Products Revenue: Grew 1% with flat organic growth; equipment sales rose 8% in Q2 2025; operating margin improved 70 basis points to 32.6% in Q2 2025.
• Full-Year 2025 GAAP EPS Guidance: Raised GAAP EPS guidance by $0.10 at the midpoint to a range of $10.35 to $10.55 for FY2025.
• Organic Growth Guidance: 0% to 2% for the full year, with total revenue projected up 1% to 3% for the year due to favorable foreign exchange rates.
• Segment Expectations for Second Half: All seven segments are projected to grow revenue and improve margins in the second half of 2025 relative to the first half, with test and measurement and electronics expected to see the highest margin expansion.
• Enterprise Initiatives: Projected to contribute at least 100 basis points to operating margin in the second half of 2025, independent of volume.
• Guidance Assumptions: Management stated, “our projection factors in current demand levels, incremental pricing related to tariffs, our updated automotive build projections, and an easier year-over-year comparison in the second half of the year.”
• PLS Headwind: Management confirmed a continued 1% headwind to organic growth for the full year 2025 due to product line simplification activities.

SUMMARY

Illinois Tool Works (NYSE:ITW) reported record operating income, GAAP EPS, and operating margin for Q2 2025, with results bolstered by operational efficiencies from enterprise initiatives and strategic pricing actions. The company raised full-year GAAP EPS guidance and expects continued revenue and margin improvement across all segments in the second half, projecting organic growth of 0%-2% and total revenue growth of 1%-3%. Geographically, China accounted for material outperformance, contributing 15% growth in the region and 22% growth in the Automotive OEM segment. Segment results highlighted exceptional operating margin expansion in Automotive OEM, Construction Products, and Specialty Products despite volume pressures and regional market declines. Management emphasized that both price actions and enterprise initiatives are the primary margin drivers for the year, with organic demand and end market conditions showing signs of stabilization, but no significant acceleration embedded in outlook assumptions.

• Management stated that Pricing actions, while positive for EPS, were modestly dilutive to margin, with recovery of any margin impact described as a “timing issue.”
• Chairman O’Herlihy explained that over 90% of what the company sells is produced where it is sold, minimizing direct tariff exposure and allowing for mitigation strategies in response to tariff uncertainty.
• Management confirmed “enterprise initiatives were particularly effective, contributing 130 basis points to the operating margin.”
• Customer-back innovation (CBI) was cited as a driver for segment outperformance, with management asserting that the CBI yield is tracking toward the 2.3%-2.5% annual goal.

INDUSTRY GLOSSARY

• Product Line Simplification (PLS): Strategic discontinuation or streamlining of lower-margin, lower-growth, or non-core products to optimize the company’s portfolio for higher profitability and growth potential.
• Customer-Back Innovation (CBI): A process focused on delivering organic growth by developing and launching new products in direct response to specific customer needs, typically measured as a percentage contribution to overall revenue growth.

Full Conference Call Transcript

Christopher A. O’Herlihy: Thank you, Erin, and good morning, everyone. As you saw in our press release this morning, the Illinois Tool Works Inc. team outpaced underlying end market growth and delivered solid financial performance in the second quarter. Total revenue increased 1%, as foreign currency translation increased revenue by 1% while product line simplification, or PLS, accounted for a 1% reduction. We achieved GAAP EPS of $2.58, operating income of $1.1 billion, and an operating margin of 26.3%, which are all second-quarter records. We continue to execute well in controlling the controllables, as evidenced by enterprise initiatives contributing 130 basis points to operating margin, and pricing actions that more than offset the tariff cost impact in the quarter.

Furthermore, I am very encouraged by the meaningful strategic progress we made in the first half of the year, diligently advancing our next phase growth priorities to make above-market organic growth powered by customer-back innovation a defining characteristic. We remain firmly on track to deliver on our 2030 performance goals, including customer-back innovation yield of 3% plus. These results are a direct testament to the strength of the Illinois Tool Works Inc. business model, the quality of our diversified and resilient portfolio, and the unwavering dedication of our global Illinois Tool Works Inc. colleagues to serving our customers and executing our strategy with excellence. Looking ahead, Illinois Tool Works Inc. is inherently built to outperform in uncertain and volatile environments.

Therefore, we are raising our full-year guidance, confident in our ability to successfully navigate the current environment and deliver differentiated performance through 2025 and beyond. I will now turn the call over to Michael to discuss our second quarter performance in more detail as well as our updated full-year guidance. Michael?

Michael M. Larsen: Thank you, Chris, and good morning, everyone. The Illinois Tool Works Inc. team achieved solid operational and financial performance in Q2. Our top line saw a 1% increase in total revenue, driven in part by a 1% positive impact from foreign currency translation. The organic growth rate was essentially flat, marking an improvement of over one percentage point from Q1. Geographically, while North America posted a 2% organic revenue decline and Europe was down 3%, Asia Pacific stood out with a 9% increase with impressive growth of 15% in China.

We experienced encouraging sequential revenue growth of 6% from Q1, along with some positive signs in end markets such as semiconductors, electronics, welding, specialty products, equipment, and an improved outlook for auto builds. On the other hand, more consumer-oriented end markets, notably construction products, remained challenging. The Illinois Tool Works Inc. team continued to demonstrate strong execution on all controllable factors, positively impacting our bottom line. Our enterprise initiatives were particularly effective this quarter, contributing 130 basis points to the operating margin of 26.3%. Although our decisive pricing actions more than cover tariff costs and positively impacted EPS in Q2, the overall price-cost dynamic was modestly dilutive to our margin.

Finally, we generated $449 million in free cash flow, representing a 59% conversion rate. Although this was modestly below our historical average, primarily due to the timing of certain one-time items, we're still on track to reach 100% plus conversion for the full year as planned. To summarize the quarter, we continued to significantly outperform our underlying end markets in a tough macro environment. Our solid financial performance includes organic growth of 1%, excluding PLS, incremental margin of 49%, operating margin of 26.3%, and GAAP EPS of $2.58. Let's turn to Slide four for a closer look at our sequential performance from Q1 to Q2, which was quite encouraging. Notably, we expanded operating margin sequentially, with three segments exceeding 30%.

Let's dive into our segment results, beginning with Automotive OEM. Revenue here was up 4%, driven by 2% organic growth in the quarter. Strategic PLS reduced revenue by over 1%. Regionally, while North America was down 7%, our local team continues to innovate and gain market share in the rapidly expanding EV market, with customer-back innovation efforts driving increased content per vehicle. We anticipate this strong momentum will carry into 2025 and beyond. For the full year, we project the Automotive OEM segment will outperform relevant industry builds by 200 to 300 basis points as we continue to consistently grow our content per vehicle.

More positive auto build forecasts are as follows: Worldwide auto builds are now projected to be about flat, with North American builds down mid-single digits and Europe down low single digits, partially offset by mid-single digit growth in China builds. Overall, our relevant markets are expected to be down in the low single digits in 2025, which is an improvement from the down mid-single digit projection in our prior guide. The bottom line performance was a significant highlight for Automotive OEM, with operating margin improving 190 basis points to 21.3%. This marks our highest margin since 2021, firmly placing us on track to achieve our long-term goal of low to mid-20s operating margin by next year.

Turning to Food Equipment on Slide five, revenue increased 2% with 1% organic growth. Equipment sales were flat, while our service business grew by 3%. Regionally, North America grew a solid 5%, driven by 4% growth in equipment and 6% in service. The growth was notably strong in the institutional end markets. International, however, was down 5%. For Test and Measurement and Electronics, revenue was up 1% as organic revenue saw a 1% decline. Demand for our test and measurement capital equipment continues to be challenging. However, we noted encouraging order activity late in the second quarter. Meanwhile, our electronics business grew 4%, fueled by heightened activity in the semiconductor-related businesses that achieved double-digit growth.

Despite being impacted by one-time items this quarter, operating margin is projected to recover to the mid- to high 20s in the second half. Moving to slide six, Welding was a bright spot, delivering 3% organic growth. Equipment sales increased 4% with strong new product contributions, while consumables grew 1%. These represent the highest growth rates for both businesses in two years. Industrial sales also increased 1%, with every region contributing to growth this quarter. North America was up 1%, and international sales grew 11%, largely driven by 28% growth in China, a direct result of new product introductions targeting the energy sector. Our 33.1% operating margin remained essentially flat year over year, demonstrating sustained strong profitability.

Revenue in Polymers and Fluids declined 3%, which included a percentage point headwind from PLS. Organic revenue was down 5% in polymers and 3% in both fluids and the more consumer-oriented automotive aftermarket. Let's look at construction products on slide seven. Global demand challenges led to a revenue decline of 6% in markets we estimate are down even more significantly and were further impacted by a 1% reduction from strategic PLS. Regionally, organic revenues in North America declined 7%, Europe was down 5%, and Australia and New Zealand decreased 10%. However, despite these persistent market headwinds, the segment demonstrated remarkable resilience, improving its operating margin by 140 basis points to 30.8%, a testament to strong execution in a difficult environment.

For specialty products, revenue increased 1% with flat organic revenue this quarter due to a challenging 7% organic growth comparison with last year. Revenue also included over one percentage point from strategic PLS. On a positive note, equipment sales, which rose 8%, were fueled by sustained strength in our packaging and aerospace equipment businesses. Operating margin improved 70 basis points to 32.6%, significantly benefiting from enterprise initiatives. With that, let's move to Slide eight for an update on our full-year 2025 guidance. We've often reiterated our high confidence in successfully navigating challenging macroeconomic conditions and delivering solid financial performance.

Our decision to raise GAAP EPS guidance by $0.10 at the midpoint, narrowing the range to $10.35 to $10.55, serves as clear evidence of this capability. We're well-positioned to outperform our end markets and continue to project organic growth of 0% to 2%. Per our usual process, our projection factors in current demand levels, incremental pricing related to tariffs, our updated automotive build projections, and an easier year-over-year comparison in the second half of the year. Total revenue is now projected to be up 1% to 3%, reflecting current more favorable foreign exchange rates.

As we look at the second half, we fully expect to continue to execute at our usual high level on all the key profitability drivers within our control. This includes already implemented pricing actions, which we project will more than offset tariff costs and favorably impact EPS. Additionally, we expect our enterprise initiatives to contribute 100 basis points or more to the operating margin independent of volume. Notably, all seven of our segments are projected to grow revenue and improve margins in the second half relative to the first half. Our full-year GAAP EPS cadence remains consistent. We expect 47% in the first half and 53% in the second half.

This reflects our typical business seasonality, along with expected benefits in the second half from stronger pricing and more favorable foreign exchange rates. Implied in our guidance is solid second-half financial performance with reasonable organic growth, substantial margin improvement, and strong free cash flows. To wrap up, we're confident that the inherent strength and resilience of the Illinois Tool Works Inc. business model, coupled with our high-quality, diversified business portfolio and, crucially, our dedicated people, equip us to decisively and effectively manage the current environment, no matter how it evolves, all while steadfastly pursuing our long-term enterprise strategy. Erin, I'll turn it back to you.

Erin Linnihan: Thank you, Michael. Janine, will you please open the call for questions and answers?

Operator: Thank you. At this time, I would like to remind everyone to ask a question. Please press star and then the number one on your telephone keypad. Your first question comes from the line of Tami Zakaria from JPMorgan. Please go ahead.

Tami Zakaria: I just wanted to ask about the new operating margin outlook. I think you reduced it at the midpoint. I just wanted to get some color on it. Are price increases causing more than expected volume headwind, which is driving the reduced operating margin outlook? Or is there anything that you didn't anticipate but now are seeing and are expecting for the back half? So any color on what's driving that outlook versus the last time you spoke?

Michael M. Larsen: Yes, Tami. It's a pretty straightforward answer. Essentially, while our price actions to offset tariffs have been quite successful and we are ahead on a dollar-for-dollar basis, as you know, that can mean that it is still dilutive from a margin standpoint, which is what I mentioned in the prepared remarks. That price cost was modestly margin dilutive in Q2. And so that's really what's driving it.

And I think just taking a step back, if you look at the last time we were together, we said that we expected price cost to be neutral or better, and I think our teams have done a great job putting us in a position where these price actions are EPS positive in the updated margin guidance. Now that, to us, is just a timing issue. We will recover that margin just like we did, whether that happens by the end of the year or next year, you know, I think is a little uncertain at this point. But we will offset the cost impact and eventually recuperate the margin impact as well.

So that's what you're seeing in our updated margin guidance.

Tami Zakaria: Got it. That's very helpful color. And a follow-up on the auto segment specifically. I think margins came in at least better than what I was modeling. So as I think about the back half, should we expect sequential improvement versus Q2?

Michael M. Larsen: I think we're very pleased with the progress in our automotive segment, both on the top line in the quarter and the improved outlook for the back half. And also on the margin side. 21.3%, an improvement of 190 basis points. I think as you look forward into the balance of the year, I think we'll be solidly above 20% both for the second half and likely for the full year as well, which puts us in a great position to reach our long-term goal, kind of a low to mid-20s, you know, sometime next year.

Christopher A. O’Herlihy: I just support that, Tami. The other thing I would say on auto is that when we looked at our auto margins back at Investor Day, we forecast that we get ongoing significant contributions from enterprise initiatives and from higher margin innovation. And that's very much what's playing out here in 2025.

Tami Zakaria: Understood. Thank you.

Operator: Thank you. Our next question comes from the line of Jamie Cook from Truist Securities.

Jamie Cook: Hi. Good morning. I guess two questions. It sounds like on CBI, you guys think you're doing you're sort of gaining traction there. So can you help me understand outside of automotive where you're seeing the most success? And do we still expect CBI to contribute the 2.3% to 2.5% that you initially laid out? And then I guess my second question, just a follow-up, Michael, just what's implied in the new guide in terms of FX? I know initially it was, I think, a negative $0.30 headwind and it went neutral last quarter. Just trying to understand what's implied in the new updated guidance.

Michael M. Larsen: Let me answer the FX question. So, basically, what we've incorporated now are current foreign exchange rates. And so we've gone from anticipating a significant headwind going into the year to now expecting some modest favorability based on rates as we sit here today. Now I say modest because on a year-over-year basis, you know, the contribution to EPS in Q2, for example, was about $0.03 a share. So we're not talking about a huge tailwind from foreign exchange, but that's kind of the modeling assumption. Current foreign exchange rates and assuming that they stay where they are, which obviously can change quickly as we've seen this year. And with that up, on the CBI side, Chris?

Christopher A. O’Herlihy: Sure. So, Jamie, on CBI, we're certainly encouraged by the progress that we're making across the company. Great pipeline of new products really across all seven segments. It's one of the reasons that we would say we're outperforming our end markets at the enterprise level. Several successful product launches this year across the portfolio. You asked for some segment color. I would say welding has been a standout. You've seen that in terms of, you know, welding growth of 3%. We believe our CBI contribution in welding is above 3% right now.

But also, food equipment where we continue to have product launches across all our product categories, you know, all real tangible areas like energy and water savings, and then automotive where we see it particularly in China, we're certainly growing market share through CBI. So off to a solid start here in 2025. To your question, well on track to deliver on our CBI yield goal of 2.3% to 2.5% this year.

Operator: Okay. Thank you. Thank you. Our next question comes from the line of Andy Kaplowitz from Citigroup. Your line is open.

Andy Kaplowitz: Chris or Michael, you mentioned encouraging sequential growth of 6%. I think usually you get a couple percentage points of growth sequentially Q1 to Q2. I think you had one extra selling day, if I remember correctly, for Q2. But would you say you're seeing incremental continued improvement in short cycle businesses such as semicon that you saw last quarter? And how are your longer cycle customers? What are the conversations like? You mentioned welding a little bit better. You mentioned test and measurement getting better at the end of Q2. Maybe give a little more color on that.

Michael M. Larsen: Yes. I think, Andy, those are fair points on the sequentials. I think really the point of putting that slide in there was that this is certainly not a company that's slowing down. We were really encouraged. You know, if you look back to where we were on the last earnings call, we're talking about the slowdown and some real concerns around tariffs. I think at this point, we're talking about some really encouraging positive momentum. And you can see what happens when you get just a little bit of growth, you know, 6% growth, you equate it to 12% income growth on a sequential basis. Incremental margins sequentially are above 50%. And year over year, 49%.

So that was really the point that we were trying to make here. I think we still see some challenges, as you heard, as we went through the segment on the consumer-oriented side. Construction product is the obvious one, which I think is not gonna be a surprise to anybody at this point. A little bit of softness, maybe in automotive aftermarket, which in polymers and fluids, which also tends to be more consumer-oriented, but also some positive signs as we went through the quarter in the kind of the more general industrial CapEx space. We saw order activity really pick up in test and measurement.

Towards the end of the quarter, we saw a significant increase in the number of big orders that were taken last quarter. We saw some good progress also in welding. We talked about the growth rates there. Semi, which is a fairly small percentage of our total revenues, about 3%, I think it is last time we looked at it, growing double digits. And so that's really what we want to try to highlight, that there are some positive things going on here. The automotive build forecast improved. And I think all those things are obviously not just market tailwinds, but it's all the work that we're doing around customer-back innovation and new products to gain market share.

And if you were an optimist, you would say we're seeing the first encouraging signs that this is really working. And it gives us a lot of confidence not only going into the back half of the year but also going into next year and the commitments we've made in terms of our long-term performance goals that even when macro conditions are maybe not very supportive of the growth that we're trying to achieve, we're still delivering solid performance and in a position where halfway through the year we can raise our guidance. So that's how I would characterize it, Andy.

Andy Kaplowitz: Michael, to that point, you've always been good in China, but it seems like you're getting better, you know, particularly in China automotive. Chris talked about CBI. You know, if I look by region, China is just such a standout versus your other regions, especially versus other industrial peers. So is it really just CBI or maybe it's just China EV? You know, is there anything that you can do for the other geographies to really sort of support or improve that growth and maybe the durability? I think you just answered it, Michael. Durability in China seems there.

Christopher A. O’Herlihy: Yeah, Andy, and I would just add to that you know, we would certainly see you saw a 15% growth in China, 22% in automotive. But the growth is really sustainable for a number of reasons and not just automotive. Our business in China across all segments is highly differentiated. The proof point that I would offer here is that you know, our margins in China are at the same level as North America or Western Europe. Which really speaks to the whole kind of focus on differentiation. We have very strong customer-back innovation efforts in China. China actually generates a disproportionate percent of our patents, protecting customer solutions. We have these very strong long-lasting customer partnerships in China.

As an example, our auto business in China has been there close to thirty years. A reminder, again, produce in China for the China market. But last, and I say by no means least, you know, we have a very highly tenured, highly talented, and experienced leadership team who are Illinois Tool Works Inc. business model experts and who execute for the company every day. So we really feel well-positioned across all seven segments in China. Innovation is certainly a part of it, but I think our customer relationships, the quality of our team, and most importantly, our focus on sustainable differentiation is really what underpins future growth prospects in China.

Andy Kaplowitz: Thanks, guys.

Operator: Thank you. Our next question comes from the line of Julian Mitchell from Barclays. Your line is open.

Julian Mitchell: Oh, yes. Hi. Good morning. Maybe just my first question, trying to understand the sort of FX dynamics in the EPS guide. I think maybe sort of versus the beginning of the year, there's about a $0.03 to $0.04 tailwind to EPS from the FX change. What are sort of the offsets in that sort of blunting that because the drop through to the overall EPS guide is much smaller, and I think price cost is dollar positive.

Michael M. Larsen: I think, Julian, we're still taking a fairly cautious approach here. I think as we said in Chris' opening remarks, I mean, we remain in a really uncertain and pretty volatile environment where things can change quickly, whether it be the tariff environment or foreign exchange rates. And so, I think the reason why you're not seeing us take guidance up by $0.30 is exactly that, that, you know, we're maintaining an appropriately conservative approach here given the current macro conditions that we're dealing with. And I would say given, again, the conditions that we're dealing with, you know, we feel pretty good about the type of performance that we're putting up.

And the confidence that we're trying to convey in the second half, which, you know, based on everything I talked about, you know, we're gonna be putting up some reasonable organic growth implied in our guidance is kind of 2% to 3% organic growth, 100 basis points plus of margin improvement year over year in the back half. Really strong incremental margins, and also really strong free cash flows. So given the conditions we're dealing with, we feel like we're in a pretty good position here going into the back half of the year.

Julian Mitchell: That's helpful. Thank you, Michael. And then maybe just a second one, kind of trying to follow-up on sort of within the back half, third versus fourth quarter. I'm yeah. I know there was a little bit of conversation of that already. But any sort of shift in terms of demand patterns let's say, in recent weeks into Q3, and when you're thinking about that price cost margin headwind, how are we thinking about that in sort of the third versus the fourth quarter? Maybe just sort of flesh out anything about that, please.

Michael M. Larsen: I think, Julian, I mean, from Q3 to Q4 is kind of our typical sequentials. You know, we typically, revenues go up a little bit from Q2 to Q3 and into Q4. The kind of the traditional run rates are not as accurate as usual because of all the price that we're getting. So if you think about these price-related tariff-related price increases, those are really only starting to flow through here in Q3 and Q4. And so that's why we're effectively guiding to something that's a little above our typical run rate.

But, again, we should expect, like we talked about on the last call, good sequential improvement from Q2 into Q3, Q3 into Q4, both, you know, really on all the key elements here, the top line, margin improvement. I think we talked about every segment improving margins. And revenue. In the second half relative to the first half. And that's not assuming a pickup in demand. That's basically, like I said, current run rates, it's the price. Current FX rates, which I think you asked about. And then an updated outlook for automotive, and then a more, you know, about half a point of easier comps. In the back half of the year.

So you put all that together, that's how we end up with a pretty solid second half. Just to wrap up your question around what did you see in Q2, nothing really unusual going through the quarter other than in June, June was our strongest month. It typically is. And then some of these more positive signs that we talked about around some of the order activity, in the CapEx equipment businesses became more encouraging as we went through towards the end of the quarter.

Julian Mitchell: That's great. Thank you.

Michael M. Larsen: Sure.

Operator: Thank you. Our next question comes from the line of Stephen Volkmann from Jefferies. Your line is open.

Stephen Volkmann: Good morning, guys. Thank you. Good morning. I guess I'm trying to say I know you don't like to talk in too much detail about this, but I'm assuming in your 0% to 2% organic, your volumes must be down like low to mid-single digits or something. And the reason I'm curious about that is because, obviously, you're putting up pretty good incrementals on lower volumes, I guess. So I'm trying to think about when volumes do come back, you know, did the enterprise initiatives mean we'll have higher incremental margins, or how should I think about that? Sorry. It's a little complicated.

Michael M. Larsen: No. That's okay. Let me just start by saying that your volume assumptions are not entirely correct. Even though we don't guide volume versus price. And then your second point, we put up incremental margins of 49% year over year in Q2. And that is, you know, some of these price cost actions related to tariffs are basically coming through at a fairly low incremental. So if that's the case, you have to believe that the core incrementals are significantly higher at this point in time relative to our kind of historical 35-40%. And I think you can see in a couple of places here, you know, automotive is maybe the better example this quarter.

What happens when we get just a little bit of growth? I mean, with 2% organic, margins are up 190 basis points. And so you look at the sequential growth and incrementals from Q1 to Q2. So to answer your question, it's reasonable to assume that incrementals are above historical and you'll see some of that in the second half. But we expect, you know, reasonable kind of two to 3% organic growth with some very strong incrementals.

Christopher A. O’Herlihy: And, Steve, over the past two the long term, the incremental is strong incremental is predominantly driven by the quality of the portfolio and continuous improvement in the quality of the portfolio and execution of the business model against that portfolio. Is ultimately what drives the incremental hire.

Stephen Volkmann: Got it. Okay. Thank you. And then maybe specifically on construction, sort of amazing to see a 140 bps of growth on 6% decline in revenue. And doesn't look like there was a geographic mix issue there. Was that all just kind of enterprise or CBI or there some sort of mix there? Is it any detail there would be great.

Michael M. Larsen: Yeah. I mean, the biggest driver is as usual are the enterprise initiatives. We're well above company average. At about 150 basis points. So that's really the key driver. I think that, yeah, we agree with you that the fact that have a construction business that, you know, for over a year has been putting up margins in that 29, 30% range in some of the most challenging end markets that we've seen in a long time is pretty remarkable. And I think the team, frankly, gets a lot of credit for trying to find a way to make the best of a tough macro. So yeah.

And all underpinned with great brands and technology, very focused on the most attractive parts of the construction market.

Stephen Volkmann: Got it. Alright. Thank you, guys.

Michael M. Larsen: Thank you.

Operator: Thank you. Our next question comes from the line of Mig Dobre from Baird. Sir, please go ahead.

Mig Dobre: Yes. Thank you for taking the question, and good morning. Good morning. Q2 was just such a strange quarter, not so much in your reporting, but just the broader backdrop. Right? I mean, we started in April with Liberation Day and a lot of volatility, I guess, in the financial markets, and then we exited feeling very different. And I'm kind of curious how your business experienced all of this. Have you at any point in time through the quarter, maybe actually felt an economic effect from this tariff uncertainty? And, obviously, the quarter of all in on a surface looked fine.

So I'm wondering about the cadence and the reason why I'm asking the question is because if we end up with another wave of disruption related to these tariffs, based on your learnings from Q2, how disruptive do you think that could end up being?

Christopher A. O’Herlihy: Yeah. So, Mig, I would say that just, I suppose, as a reminder, and you characterized Q2 very accurately in terms of how it played out. But from our standpoint, and particularly relating to the tariffs, we go back to the point that we're over 90% produced what we sell. So the direct impact of tariffs is largely mitigated. And to the extent that we need to get price, you know, both in 2018 and in this past round, you know, tariffs were manageable for us. And based on what we know today and even if tariffs were increased, we'd expect the tariff cost to be manageable going forward.

Certainly, we would hold to our EPS neutral or better, I'd say, no matter what happens in here on.

Mig Dobre: Okay. But you didn't experience that whole customer freezing up or anything of the sort as they were seeking for more clarity. That was just not a factor in your business, you're saying?

Christopher A. O’Herlihy: Yeah. There was a little bit of that in one segment. We have one segment where we have some shipments to China from the US, particularly relating to customer requests for us to do it that way. And certainly, you know, with the enormous China tariffs at the beginning of the quarter, there certainly was a freeze. And that has now freed up since then. And also, we've had several, you know, through our read and react capabilities in our businesses, we've been able to read and react very successfully to that. If it was to happen again, we'd have mitigation plans in place where it wouldn't be as much of an issue.

Mig Dobre: Got it. And my follow-up, if I may, just kind of a bigger picture capital allocation. Question. I'd love to hear as to how you're thinking about your M&A pipeline and in terms of returning capital to shareholders if M&A is not available for whatever reason, is there an argument to be made for taking a more aggressive approach at this point in a cycle where maybe you're dealing with lower growth, knowing that obviously, as growth reaccelerates, eventually, you'll be able to hopefully create some value with more aggressive buybacks in this lower part of the cycle. Thank you.

Christopher A. O’Herlihy: Yeah. So with respect to M&A, Mig, what I would say is that, first and foremost, we're very confident in our the ability of our current portfolio to grow at four plus over time. And so we feel comfortable in really sticking to our disciplined portfolio management around M&A. We've got a very clear well-defined view of what we think fits our strategy. So it's just a matter of us finding the right opportunities, you know, focused on those high-quality acquisitions that could extend our long-term growth potential to grow at a minimum at 4% plus at high quality while being able to leverage the business model to improve margins. That's typically how we think about these things.

Now we do review opportunities on an ongoing basis, but we continue to be very selective. And very selective being mindful of the fact that we've got all this organic growth potential that we're working on. We're very active in terms of reviewing M&A opportunities to the extent that we find the right opportunities, then will certainly be appropriately aggressive in pursuing them. I would say. And, you know, obviously, MTS was one that we did. That's the criteria we use to evaluate and to acquire MTS, and it's proved to be a really great acquisition for us on that basis.

And that's the lens by which we look at acquisitions, remaining selective, but appropriately aggressive when we see the right ones.

Michael M. Larsen: And I would just add on to the other elements of our capital allocation strategy, Mig, we obviously constantly review, debate, discuss our strategy and we are still coming to the conclusion that it's pretty optimal. And pretty well aligned with our enterprise strategy with the number one priority being the internal investments to support all the organic growth initiatives that are going on inside the company and maintain core profitability in these highly differentiated core businesses. We have an attractive dividend. You look at our payout ratio, we're probably and rightfully so, towards the higher end of the peer group just given our margins and our best-in-class balance sheet and highest credit rating in the peer group.

We'll continue to grow that dividend in line with long-term earnings. And then we allocate surplus cash to the buybacks, which is about $1.5 billion this year, about 2% of our outstanding shares. And so as we sit here today, we feel like we've optimized this. And as Chris said, we'd love to do M&A, you know, given the criteria that Chris outlined. And as you know, this is it's not an easy market, you know, given often the valuations are what's making this pretty challenging.

Mig Dobre: Understood. Thank you.

Operator: Thank you. Our next question comes from the line of Sabrina Abrams from Bank of America.

Sabrina Abrams: Hey, good morning. I think my understanding was that there would be some more restructuring in the first half. So I think there were comments about 80% of the full year 15% to 20% zero $15 to zero $20 headwind in the first half. So I guess just looking at the components of the margin bridge, it doesn't seem like we had I think restructuring year over year was a tailwind. This quarter, and there wasn't a ton in 1Q. So just any color you could provide on restructuring this year how it's changed? Is that still the right full year number? And how is the cadence evolved relative to your expectations? Thank you.

Michael M. Larsen: Yeah. Hey, Sabrina. So I think restructuring with everything going on in the quarter, a couple of things did move around. At the end of the day, we ended up spending $20 million in the first half of this year, which is the same as what we spent in the first half of last year. These are all projects tied to kind of our 80-20 front-to-back process, all projects with less than a one-year payback. We had a few projects that just from a timing standpoint moved into July. Those have been approved and are well underway. We expect that we'll spend about, you know, another $20 million here or 5¢ a share.

So it's pretty small relative to our overall earnings. We'll spend about $20 million here in the second half and on a year-over-year basis, that will be about flat year over year.

Sabrina Abrams: Okay. Thank you so much.

Michael M. Larsen: Sure.

Sabrina Abrams: And then just how much PLS is in the guide this year? I think there was a 100 bps this quarter. I think there was 50 bps in 1Q. I think you started the year with a 100 bps of PLS in the guide. Just how are we thinking about that now?

Michael M. Larsen: Yeah. That's unchanged. We still have a fair bit of activity in as you saw this quarter in automotive, specialty, as well as construction. And so we're still at about a percentage point of headwind to the organic growth rate from strategic PLS. But, obviously, huge tailwind in terms of positioning the portfolio for future growth as well as if you look at the margin improvement in the segment that I just talked about, you can see kind of the benefits associated with these PLS efforts.

Operator: Thank you. Thank you. Our next question comes from the line of Joe O'Dea from Wells Fargo. Your line is open.

Joe O'Dea: Hi. Good morning. First one, on margins and second half of the year. And when we look at sort of the walk from Q2 into the back half, about a 100 bps improvement. Can you just outline the cadence of that? Is that sort of 50 bps sequentially over the back half of the year in each quarter is kind of reasonable? And then be driving that, presumably test and measurements are the ones where we should see the biggest contribution.

Michael M. Larsen: That's exactly right. Test and measurement is the biggest step up sequentially from the first half into the second half. I'd rather the segments that are above 30% already, you know, kind of in the you know, we got three you know, at 33, 31, 33%. You know, you may not see the same type of step up in those. But other than that, pretty broad-based. And we expect some sequential improvement from, like I said, from Q2 into Q3 with also some improvement on a year-over-year basis. And then, frankly, a slightly bigger step up in Q4 on the margin front on a year-over-year basis.

So you take all of that this is implied in our guidance, so I'm not telling you something you couldn't figure out yourself as, you know, that's external operating margins of about 27% in the back half of the year. And that's with some reasonable improvement year over year. These are improvements on already best-in-class operating margins with not a whole lot of help from macro conditions. And that's why we talk about these being such differentiated results. There are without bragging, there are not many companies that could put up this type of margin performance given the top line and the macro that we're dealing with.

And just look at the incremental margins this quarter and implied for the full year.

Joe O'Dea: Got it. That's helpful. And then wanted to come back to some of the more kind of CapEx order activity that you're talking about and maybe specifically on welding and just trying to parse kind of CBI and share versus underlying end market. I think a lot of what we hear out there is MRO trends are stable. Bigger spend projects, elongation, between quote to order, it doesn't really sound like in broad strokes we're hearing much of a sequential acceleration. Sounds like you're seeing it a little bit more. You know, early days.

But the degree to which, you know, you can talk through some of the end markets within welding, what you're hearing from those customers, versus kind of CBI, and that's really the answer to the better growth.

Christopher A. O’Herlihy: Yes. In short, Joe, I would say CBI is the better to the growth. And we see some pickup in activity on the industrial side, but in general, the big driver of our growth and building right now is CBI.

Michael M. Larsen: Yeah. And I'd just go back to what we talked about earlier. I think the more consumer-oriented businesses certainly are dealing with some more challenging end market conditions. The general industrial, more CapEx, you know, set aside some of the delays that Chris talked about early in the quarter when those kind of peak tariffs angst. I think we're seeing some positive signs in general industrial, in the semi space, as well as in automotive. But, you know, these are short cycle businesses. Things can change very quickly. We're dealing with a pretty challenging underlying market demand. You know, we estimate our end markets on average are down three to four. And we're holding organic flat.

We improved the organic growth rate sequentially from Q1 to Q2. So that's kind of the environment that we're dealing with. And so that's why it's so important that we continue to do what we said we were gonna do from an execution standpoint and continue to make progress on the enterprise initiatives and the things we can control, including CBI, price cost, and so forth.

Joe O'Dea: Okay. Great color there. One last quick one. Just China really strong growth in auto. Just talk a little bit about other parts of China exposure?

Michael M. Larsen: Yeah. I think China was up 15%, as I said in the prepared remarks. I mean, the biggest driver by far is the automotive business, but there's also some solid double-digit growth in test and measurements, polymers of fluids, and welding. And where we're seeing this is in the businesses that have the highest contribution from new products. So there's a real correlation here in terms of being able to outperform end markets is really a result of great progress on CBI. And I think maybe that explains there was a question earlier in terms of our performance in China and not seeing the same results in other with some of our peers, and maybe that's part of the explanation.

Joe O'Dea: Thank you.

Operator: Thank you. Our last question comes from the line of Steven Fisher from UBS. Your line is open.

Steven Fisher: Just to follow-up on one of those last questions there. I mean, in terms of the pickup maybe at the end of the quarter and some of the capital, I guess just to achieve the 2% to 3% organic growth that you have in the second half, are you guys assuming that there will be a continuation of some of that strong order levels that you saw at the end of the quarter? Or is it really just sort of that was kind of a one-time thing? Or I'm guessing if it's really CBI, as you said, you would think it would be maybe a continuation, but just curious how you'd frame that.

Michael M. Larsen: Yeah. I'd go back, Steve, to kind of our usual process for giving guidance, is based on current levels of demand in our businesses. We have more price than usual coming through in the back half associated with these tariffs. Have some easier comps in the second half than we did in the first half by about half a point. But we're not factoring in any further acceleration from current levels of demand. And so if that were to happen, that'd be great news. That would suggest that our guidance is conservative. If we have another round of tariffs, as somebody suggested, and things slow down, then that would be bad news.

But overall, I think as we sit here today, we are confidently raising our guidance, and we're well-positioned for a solid second half, as I think we said earlier.

Steven Fisher: Okay. Terrific. And then just to follow-up on the CBI and I think maybe Chris mentioned three plus percent in the long term, 2030. Do you still think of CBI and net market penetration as two separate growth buckets? And if so, can you sort of help us differentiate between these two things? I think you had a 1% to 2% target on net market penetration and 2% to 3% on CBI in the longer-term targets?

Christopher A. O’Herlihy: Yeah. Steve, we bucket them differently, CBI and net market. And the way we think about it is that, you know, CBI is revenue new product revenue in the next three years. After that, it's market penetration. And so the way to think about it is that the CBI revenues of today into the market penetration revenues of the future. It's kind of how we think about it.

Steven Fisher: Okay. Terrific. Thank you very much.

Michael M. Larsen: Thank you.

Operator: Thank you for participating in today's conference call. All lines may disconnect at this time.

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DATE

Tuesday, July 29, 2025 at 12:00 a.m. ET

CALL PARTICIPANTS

Chief Executive Officer — Jim Reuter

Chief Financial Officer — David Della Camera

Investor Relations — Nancy Vermeulen

Need a quote from one of our analysts? Email [email protected]

TAKEAWAYS

Net Income: $71.7 million, or $0.69 per diluted share, for Q2 2025.

Net Interest Margin: 3.32% on a fully tax-equivalent basis for the second quarter. 3.26% excluding purchase accounting accretion, up 12 basis points sequentially.

Loan-to-Deposit Ratio: 72% loan-to-deposit ratio at quarter end, indicating significant on-balance sheet liquidity.

Other Borrowed Funds: $250 million outstanding as of Q2 2025, down $710 million sequentially and $2.2 billion year-over-year.

Yield on Average Loans: 5.65%, representing a sequential six basis point increase due to continued repricing and payoffs of lower-yielding loans.

Noninterest Income: $41.1 million in noninterest income for Q2 2025, down $900,000 from the prior quarter, includes a $7.3 million valuation allowance on Arizona and Kansas loans moved to held for sale, and a $4.3 million gain from outsourcing the consumer credit card product.

Noninterest Expense: $155.1 million, down $5.5 million sequentially, driven by lower payroll taxes and incentive-based compensation, includes $1.5 million in property valuation adjustments and lease termination fees.

Net Charge-Offs: $5.8 million, equal to 14 basis points of average loans on an annualized basis. provision expense reduced by $300,000.

Classified Loans: Declined $24.4 million, or 5.1% sequentially. criticized loans increased $176.9 million, or 17.2%, mainly due to multifamily projects with slower lease-up.

Common Equity Tier 1 Capital Ratio: 13.43% at the end of the second quarter, up 90 basis points from the prior quarter. expected to increase by an additional 40 basis points upon closing the Arizona and Kansas branch transaction, anticipated in Q4 2025.

Loan Balances: Declined by $1 billion, impacted by $338 million in loans moved to held for sale for the branch transaction, $74 million in credit card loans sold, $73 million indirect loan amortization, and large intentional payoffs.

Deposits: Declined $102.2 million and remain approximately flat versus the prior year, after adjusting for temporary 2024 deposits.

Dividend: Declared $0.47 per share, representing a 7% annualized yield.

Net Interest Income Guidance: Management expects a high single-digit increase in net interest income in 2026 compared to 2025, assuming generally flat total loan balances and ongoing net interest margin expansion from asset repricing.

Expense Guidance: Full-year 2025 noninterest expense growth guidance was revised down to 0%-1% from the previous 2%-4% range, compared to the reported 2024 number, due to continued operating discipline and reduced staffing costs.

Branch and Product Optimization: Consumer credit card portfolio outsourced; Arizona and Kansas branch transaction expected to close in Q4 2025, with anticipated tangible book value accretion of approximately 2%, and increase CET1 by 30-40 basis points.

Deposit Market Share: 93% of deposits are in regions where the bank has a top-ten market share. 70% of deposits are in markets growing faster than the national average.

Earning Asset Levels: Earning asset levels are expected to bottom in Q3 2025, with loan declines moderating and a near-term increase in investment securities allocation.

SUMMARY

First Interstate BancSystem, Inc. (NASDAQ:FIBK) posted higher net interest margin and an improved capital position, with management attributing margin gains to disciplined asset repricing and proactive liability management. Executives reaffirmed a flat-to-lower loan outlook in the near term, citing large, intentional payoffs and continued strategic repositioning, while projecting a modest step-down in earning assets tied to the Arizona and Kansas branch transaction closure. Classified loans declined sequentially, but criticized loan balances increased, primarily linked to multifamily loans facing slower lease-ups, with management emphasizing comfort in underlying collateral and guarantor strength. Guidance signals confidence in net interest income expansion for 2026 compared to 2025, supported by further asset repricing and margin improvement. The company also reduced its 2025 expense growth expectations to 0% to 1% following operational discipline and timing-related benefits. Management highlighted that capital levels are set to rise further after the branch transaction, providing strategic flexibility for deployment options not yet determined.

Reuter said, "we're now on offense, have some specific promotions, and we're seeing some good activity in the pipeline," suggesting a shift in lending focus following portfolio clean-up.

Della Camera clarified that the valuation allowance on Arizona and Kansas loans was "purely reflective of rate," not credit risk.

Executives stated that the high single-digit 2026 net interest income growth guidance "does not include the divestiture impact" and that they "don't believe that materially alters that figure."

Della Camera indicated incremental securities purchases will have "Lower risk-weighted density, and no credit risk," with new loan production yields "somewhere in that 7% range."

There is no material deliberate loan runoff remaining except for multifamily construction expected to be sold into the secondary market after stabilization, as Reuter affirmed, "Most of that has already happened."

Della Camera confirmed Management expects earning asset levels to trough in Q3 2025, with minimal further step-down linked to the branch deal.

Capital deployment options remain open, as management referenced share buybacks and balance sheet restructuring as potential actions if organic growth opportunities are insufficient.

Management's proactive credit review and "new credit committee process" were noted as key drivers for the observed changes in portfolio metrics and future credit discipline.

INDUSTRY GLOSSARY

Classified Loans: Loans designated as substandard or doubtful due to elevated credit risk, typically tracked closely for potential losses.

Criticized Loans: Loans deemed to have weaknesses which, if unaddressed, may jeopardize repayment, including special mention, substandard, and doubtful loan categories.

Net Charge-Offs: The dollar amount of loans written off as uncollectible, net of recoveries, for a given period, typically annualized as a percentage of average loans.

Net Interest Margin (NIM): The difference between interest income generated and interest paid out, expressed as a percentage of average earning assets.

Held for Sale (HFS): Loans or assets the bank intends to sell rather than hold to maturity, reflected separately on the balance sheet.

Purchase Accounting Accretion: Incremental interest income recognized due to fair value adjustments from previously acquired portfolios.

Common Equity Tier 1 (CET1) Capital Ratio: A regulatory measure of a bank’s core equity capital compared with its total risk-weighted assets, indicating financial strength.

Full Conference Call Transcript

Nancy Vermeulen: Thanks very much. Good morning. Thank you for joining us for our second quarter earnings conference call. As we begin, please note that the information provided during this call will contain forward-looking statements. Actual results or outcomes might differ materially from those expressed by those statements. I'd like to direct all listeners to read the cautionary note regarding forward-looking statements contained in our most recent annual report on Form 10-K filed with the SEC and in our earnings release, as well as the risk factors identified in the annual report and our more recent periodic reports filed with the SEC.

Relevant factors that could cause actual results to differ materially from any forward-looking statements are included in the earnings release and in our SEC filings. The company does not undertake to update any of the forward-looking statements made today. A copy of our earnings release, which contains non-GAAP financial measures, is available on our website at fibk.com. Information regarding our use of the non-GAAP financial measures may be found in the body of the earnings release, and a reconciliation to their most directly comparable GAAP financial measures is included at the end of the earnings release for your reference.

Again, this quarter, along with our earnings release, we've published an updated investor presentation that has additional disclosures that we believe will be useful. If you have not downloaded a copy yet, we encourage you to do so. Unless otherwise noted, all of the prior period comparisons will be with 2025. Jim?

Jim Reuter: This remains an exciting and busy time at First Interstate. This quarter, we continued our efforts to refocus our capital investment, optimize our balance sheet, and improve core profitability. In addition to our decision in the first quarter to stop new originations and indirect lending, followed by our April announcement of the Arizona and Kansas branch transaction, we signed an agreement this quarter to outsource our consumer credit card product and the underlying loans moved off of our balance sheet. We continue to take steps to refocus the franchise in our core markets where we enjoy strong market share and believe there is high growth potential.

First Interstate has a strong brand and branch network located in growth markets, a market-leading low-cost granular deposit base, and a team of strong community bankers. We believe these attributes, when combined with recent strategic actions, branch optimization, future organic growth through relationship banking, and the continued repricing of our assets, will lead to higher profitability. We continue to take a proactive approach to credit risk management. This quarter, we were pleased to see stability in nonperforming asset levels, modestly lower classified asset levels, and 14 basis points of annualized net charge-off. Criticized loans did increase, generally reflective of slower lease-up in our multifamily book, and we will discuss that in more detail later in the call.

Our recent strategic decisions have led to strong levels of capital and liquidity, providing us with a solid and flexible foundation. We ended the quarter with a 72% loan-to-deposit ratio, minimal short-term borrowings on the balance sheet, and no brokered deposits. Capital has also continued to meaningfully accrete with our common equity tier one capital ratio ending the quarter at 13.43% with an expectation for continued accretion through 2025. Later in the call, David will address new commentary we have added to our guidance regarding our expectation for a high single-digit increase in net interest income in 2026, supported by our expectation for continued margin improvement assuming generally flat total loan balances in 2026.

We are sharing this color to highlight what we believe is the impact of our disciplined approach to repricing maturing assets, as we continue to focus the organization on organically growing loan balances over the long term. We have also added a slide to our investor presentation this quarter highlighting the strength of our deposit profile, which we believe is the key driver of the long-term value of the franchise. 93% of the deposit base is located in areas where we have top 10 market share, and about 70% of our deposits are in markets that are growing faster than the national average, supporting long-term organic growth.

We opened one additional branch this quarter in Columbia Falls, Montana, which is a small example of our future efforts to drive organic growth. We did not announce any branch consolidations in the second quarter, but we anticipate sequential action moving forward as we progress through 2025 and into 2026. With that, I will hand the call off to David to give more details on our quarterly results and to discuss our guidance. David?

David Della Camera: Thank you, Jim. I will start with our second quarter results. For the second quarter of the year, the company reported net income of $71.7 million or $0.69 per diluted share. Interest income was $207.2 million in the second quarter. This increase is primarily driven by a reduction in interest expense from reduced other borrowed funds balances, partially offset by lower interest income on earning assets resulting from a decrease in average loan balances. Our net interest margin was 3.32% on a fully tax-equivalent basis, and excluding purchase accounting accretion, our net interest margin was 3.26%, an increase of 12 basis points from the prior quarter.

Other borrowed funds ended the second quarter at $250 million, a decline of $2.2 billion from a year ago and $710 million from the end of the prior quarter. Yield on average loans increased six basis points from the previous quarter to 5.65% in the second quarter, driven by continued repricing and payoffs of lower-yielding loans. Interest-bearing deposit costs declined one basis point in the second quarter compared to the first quarter, and total funding costs declined nine basis points due to improving mix shift, driven by the reduction in other borrowed funds. Noninterest income was $41.1 million, a decrease of $900,000 from the prior quarter.

Results this quarter include a $7.3 million valuation allowance related to the movement of Arizona and Kansas loans that are included in the branch transaction to held for sale. This was partially offset by a $4.3 million gain on sale related to the outsourcing of our consumer credit card product. Results were generally in line with our expectations, excluding these items. Noninterest expense declined in the second quarter by $5.5 million to $155.1 million. This decline compared to the prior quarter was due to lower seasonal payroll taxes and reductions in incentive-based compensation estimates. Results include roughly $1.5 million in property valuation adjustments and lease termination fees associated with properties in Arizona and Kansas.

We continue to exhibit expense discipline related to our staffing levels, driving results favorable to our prior expectations. As part of that discipline, we are thoughtfully developing efficiencies as we move forward, which includes our ongoing analysis related to the branch network and our carefully controlling staffing levels and other marginal spend. Turning to credit, net charge-offs totaled $5.8 million, representing 14 basis points of average loans on an annualized basis. We recorded a reduction to provision expense for the current quarter of $300,000 driven by lower loans held for investment. Our total funded provision increased to 1.28% of loans held for investment, from 1.24% at the end of the first quarter.

Classified loans declined $24.4 million or 5.1%, and nonperforming loans also declined modestly. Criticized loans increased $176.9 million or 17.2% from 2025, driven mostly by some of our larger multifamily loans, generally reflective of slower lease-up. Broadly, we are comfortable with the underlying value of the properties and guarantor's ability to support in these circumstances, but lease-up timelines are slower than initially anticipated at underwriting, driving movement into the criticized bucket. Turning to the balance sheet, loans held for investment declined $1 billion, which included the impact from the strategic moves we've discussed.

The decline was influenced by $338 million in loans related to the Arizona and Kansas transaction that moved to held for sale, $74 million of loans sold with the consumer credit card outsourcing, and $73 million from the continued amortization of the indirect lending portfolio. The remaining reduction was influenced by higher larger loan payoffs, including loans we strategically exited. We are remaining diligent in adhering to our pricing and credit discipline. While competition is always strong for great clients, we are seeing initial indications of increasing pipeline activity. We do believe that loans will decline in the near term, but remain optimistic that we will stabilize and return balances to growth in the medium term.

Deposits declined $102.2 million in the second quarter and are approximately flat compared to the prior year, adjusted for a larger temporary deposit on our balance sheet at the end of 2024. Finally, in the second quarter, we declared a dividend of $0.47 per share or a yield of 7%. Our common equity tier one capital ratio improved 90 basis points. Moving to our guidance, our guidance as displayed includes the impact of the consumer credit card outsourcing and excludes the impact of the branch transaction, which we anticipate closing in the fourth quarter. Broadly, the consumer credit card outsourcing reduces the major lines of the income statement and is mostly neutral to forward net income.

We have updated our guidance to reflect our current assumption of one 25 basis point rate cut for the remainder of 2025. As of the end of the second quarter, our balance sheet has shifted from slightly liability sensitive to mostly neutral. We do not believe the rate cut included in our guidance is meaningful to the net interest income forecast we have presented for 2025. Our net interest income guidance reflects an anticipation of continued margin improvement, with an expectation of fourth quarter net interest margin, excluding purchase accounting accretion, approximately 3.4% compared to the 3.26% figure reported in the second quarter.

Compared to the prior quarter's forecast, in addition to the impact from the outsourcing of consumer credit card, the net interest income forecast was modestly impacted by lower risk-weighted density. Our guidance now assumes a more meaningful near-term asset allocation into the investment portfolio versus loan balances, as loans have declined more than previously anticipated. We anticipate beginning to reinvest into the investment portfolio in this quarter. We have added commentary in our guidance noting that we anticipate net interest income to increase in the high single digits in 2026 compared to 2025, supported by our expectation for continued margin improvement, assuming generally flat loan balances in 2026.

We're sharing this to highlight what we believe is the impact of our disciplined approach to repricing maturing assets, and continue to believe we will grow loan balances over the long term. To provide additional detail, we've included a slide in our presentation detailing near-term fixed asset maturity and adjustable rate loan repricing expectations. Note that loan balances represent maturities in the case of fixed rate loans, and maturities or repricing events in the case of adjustable rate loans. These figures displayed do not include contractual cash flow or any prepayment expectations.

We expect loan yields to continue to benefit from the tailwinds of fixed rate repricing, a key component of our expectation for continued net interest margin and net interest income improvement. The investment security figures displayed represent current market expectations for total principal cash flows during each period, which provides another source of anticipated net interest income expansion. Noninterest income guidance is modestly lower than the prior quarter, impacted by the outsourcing of our consumer credit card. Finally, we reduced our noninterest expense guidance from an expectation in the prior quarter for a 2% to 4% full-year increase to 0% to 1% for the full year of 2025 compared to the reported 2024 number.

In addition to favorability in the second quarter expense levels to prior expectations, we are carefully controlling staffing levels and other expense levers, while continuing to invest in production-driven areas as we look to drive our balance sheet growth. These areas of continued focus have reduced our forward expectation of expenses in the near term. While near-term loan levels are lower than previously anticipated, leading to some modest pressure in net interest income in the near term, we are carefully controlling the expense base as we look to drive an efficient return profile for our shareholders.

Turning to the Arizona and Kansas branch transaction, we stated in our previous earnings call that we anticipate tangible book value accretion of roughly 2% at the close of the branch transaction, an improvement in our common equity Tier one ratio of approximately 30 to 40 basis points. As noted, we modestly increased the loans associated with the transaction since the prior quarter, together with the anticipated recognition of the deposit premium in the fourth quarter, which would occur concurrent with close, we continue to anticipate total tangible book value accretion of approximately 2% from the transaction, which would include the impact of the held for sale valuation allowance recognized this quarter.

We now anticipate our CET1 ratio to increase at the high end of the noted range given the additional loans included. With that, I will hand the call back to Jim. Jim?

Jim Reuter: Thanks, David. We are diligently focused on continuing to make sequential progress on our strategic plan and added a slide in our presentation to outline our focus areas, which include refocusing capital investment and optimizing the balance sheet. We believe earnings will continue to improve through 2026 and into 2027, and the ongoing remix of our balance sheet is providing us with liquidity and capital flexibility. We are actively working through our asset quality levels and are optimistic that we are beginning to see positive underlying credit developments, evidence of our disciplined proactive work on asset quality.

We will continue to work diligently to improve the earnings profile of our institution, and we look forward to sharing our progress with you. Now I will open the call up for questions.

Operator: Thank you. Ladies and gentlemen, we will now begin the question and answer session. If you wish to decline from the polling process, please press star followed by the two. And if you are using a speakerphone, please lift the handset before pressing any keys. The first question comes from Jeff Rulis at DA Davidson. Please go ahead.

Jeff Rulis: Thanks. Good morning. Appreciate the color in the deck and the commentary that's helpful. I have a tough question, but I want to try to get the timing on the loan portfolio stabilization. It seems like it's a lot of heavy lifting up front here with the runoff, but maybe some further drift. But thinking about when the portfolio runoff kind of by year-end, or are you thinking that's a first half of next year event in terms of the loan portfolio stabilizes?

David Della Camera: Hi, Jeff. So a couple of things here. Good question. I think to start, there was, as we think about the balances in the quarter, of course, we had the held for sale. We had the indirect and the credit card. We also mentioned large loan payoffs. The other thing you'll note in one of our slides is we did see some line utilization that was a little bit lower this quarter. Adjusted for all of that, the change in loans quarter over quarter, we think was more of a mid 1% number versus the reported on HFI. So as we think about going forward, we do anticipate modestly lower loans in the third quarter.

That's what's incorporated in our guidance. We're hopeful for more stability in the fourth quarter from a reported held for investment level. And then, of course, we're optimistic we can grow.

Jim Reuter: And, Jeff, this is Jim. Good morning. To add on to that, when I look at the payoffs in the quarter, there were four larger loans. A few of those were frankly intentional in that it's the type of lending we don't want to do on a go-forward basis. And one was also a multifamily that went to the secondary market. So, as I've discussed the past two quarters, we completed a deep dive on credit, set up a new credit committee process, to get everybody on the same page. And I can confidently say we're now on offense, have some specific promotions, and we're seeing some good activity in the pipeline.

Jeff Rulis: That's great. Maybe a related question and trying to back into some of the NII guidance sounds like a pretty good commitment on the security side. Any effort to try to peg where earning asset levels could be at year-end? My guess is it sounds out from here.

David Della Camera: Yeah. Good question. So our borrowings ended the quarter about $250 million short-term borrowings. So we think the third quarter is where we bottom in earning asset levels, you know, to your point, a higher level of investment securities than previously near term given the balance sheet trends. Long term, we'd, of course, like to mix shift that into more loans. But third quarter view is the bottom of earning assets. That's Arizona Kansas, so you might get a little bit of a step down into the fourth quarter, but modest. And we think we're around the bottom there.

Jeff Rulis: Okay. And just a last one on the capital side. I think you mentioned the high end of the range of guidance. Maybe CET1 possibly by year-end given the branch deal should be behind you. But I guess, that's part one is maybe a CET1 at year-end. And then part two is just if you wouldn't mind kind of going through the capital priorities from there as you've got a pretty high level building here.

David Della Camera: So I think at year-end, to your point, so 13.4% was the June 30 number. We think we are around the 40 basis point number of additional accretion from the branch transaction. And then modestly lower loans in the near term. So that does get you to a higher number from here, all else equal. As we think about capital, we certainly acknowledge we have strong capital levels, and it creates significant optionality for us. We're very pleased with that. We're looking at a variety of options. So we're looking at all the different capital deployment options from here and considering how we can utilize that to enhance return.

So, you know, more to come there, but we're looking at our different options.

Jeff Rulis: Okay. Thanks. I'll step back.

Operator: Thank you. The next question comes from Andrew Terrell at Stephens Inc. Please go ahead.

Andrew Terrell: Hey, good morning.

Jim Reuter: Morning.

Andrew Terrell: Hey. I wanted to start off just, I mean, it was good to see the classified loans down sequentially, but, you know, I think it was a bit surprising to see special mention step up so much this quarter, I think, particularly given the work you guys have done over the past, you know, six, nine months or so regarding kind of the credit review process. I was hoping you could just talk maybe a little bit more about what drove that special mention migration that they kind of lost content you would or would not expect? And then does it feel like we should continue to anticipate continued migration into criticized classified?

Jim Reuter: Yeah. Good morning, Andrew. I'll take that. You know, we saw, as you mentioned, the step up in the criticized. A lot of that was driven with new information on some multifamily projects. That, you know, as we've mentioned, primary source of repayment is what we focus on. And the builder's original plans for absorption and how that project would go are not being met. I've actually looked at two of the three larger ones that are in the group that moved up, been by and seen them personally. Still feel good about the collateral. Really like the guarantors. So it's really that primary source of repayment.

Otherwise, it was fairly flat, and I can tell you that I see the fruits of our proactive management of credit.

Andrew Terrell: Okay. Great. I appreciate the color, Jim. And I could also just ask on kind of the expense guidance. It feels like lots of kind of moving pieces here, but David, you just maybe talk a little more about kind of near-term expectations? It seems like the guidance implies there should be kind of a core lift on expenses in 3Q. And then can you remind us just the maybe expense saves from the branch divestiture that's scheduled in the fourth quarter? And I think I would assume that there are no branch consolidation efforts reflected in kind of the expense guidance. So should we think about those as potentially a positive to the current kind of stated guidance?

David Della Camera: Sure. So first on the I'll kind of take that backwards to forward. So there are no branch divestitures outside, included in the guidance. You're correct there. So anything that occurs there. Again, just given timing, we think that's more of a 26 impact than a 25 impact actually on the expense figure. But you're correct. No expectation is included in that. Related to Arizona, Kansas to remind on the commentary from the prior quarter, about a mid twos number as a percentage of the deposit base is how we view that annualized cost impact. After close there.

Quarter to quarter, as we think about our expenses, you're correct that we do anticipate third and fourth quarter to be a higher reported number than second quarter for expenses. A couple drivers there includes things such as our medical insurance. We generally see a little bit higher in the back half than the front half. That'll be included in there. There was some timing in the second quarter on some of the salary and wage items that will be modestly higher in the third quarter. And then we had some benefits in our tech spend in the second quarter that we'll see a little bit higher in the third quarter.

Nothing generally unusual, but some timing items as well that will cause that increase.

Andrew Terrell: Got it. That's really helpful. I appreciate it, David. And then if I could ask also just on the guidance. One, I appreciate you guys putting, you know, some of the repricing detail into the presentation this quarter. That's really helpful. On the comment for the net interest income, high single-digit growth in 2026. Does that factor in the, I would presume, kind of NII headwind from the branch divestiture in 4Q and would that, you know, materially alter the high single-digit 2026 expectation?

David Della Camera: So it does not include the divestiture impact. We don't believe that materially alters that figure. Broadly, loans and deposits associated with the transaction don't look dissimilar than the bank's loans and deposits as a whole. So we wouldn't view that change as materially different. And, again, the capital raised with the transaction, there's different options related to that, of course. So at this time, that high single-digit would be excluding any decision there related to the loans, deposits, and capital.

Andrew Terrell: Got it. Okay. I appreciate the color, and thanks for the questions.

Operator: Thank you. The next question comes from Kelly Motta at KBW. Please go ahead.

Kelly Motta: Hey, good morning. Thanks for the question. In terms of the expense base, circling back to that, I appreciate the color on the expense saves regarding the branch divestitures. Wondering how you're thinking about the reinvestment of the savings versus flowing to the bottom line. And, specifically, with regards to frontline hires, if you have the right talent to, you know, start to drive the inflection in growth as we look to next year.

Jim Reuter: Yes. Good morning, Kelly. You know, David walked through some of the color around the expense saves, but, you know, there's a couple things here. When we look at growth, and NII and different things, obviously, another lever we manage is our expenses. And so we're going to pay attention to that closely as we drive for stronger NII. But we will not sacrifice having the right people on the team and being able to do the things we need to grow. We do have the right people on the team, so the cost saves are not, you know, coming at the expense of talent.

So, anything we need to do to invest to grow, it's going to be a priority.

Kelly Motta: Got it. That's helpful. And then in terms of I appreciate the color that the NII outlook includes more securities purchases given the slowdown in loans. Maybe for David, if you could provide color as to what your the new yields you're getting on the loans you are booking now.

David Della Camera: Sure. So on the security side, the incremental purchases won't look holistically dissimilar than what we currently have in the book. The way we broadly think about that is just given the structural rate sensitivity position of the company, shorter duration similar to what we have today, broadly. Lower risk-weighted density, and no credit risk. So that's kind of limited to no credit risk. That's broadly how we think about that. From a yield perspective, you know, if you kind of think something like a mid-duration MBS as an example, and there's, of course, a variety of different things we would be purchasing. That's five year plus 80 to 90 today. That'll move, of course, but something in that range.

New loan production, somewhere in that 7% range. It's going to be to that five to seven year point on the curve, but that's broadly where we are today.

Kelly Motta: Got it. That's helpful. Last question for me, and then I'll step back into the queue. On the loan side, I appreciate the color on some of the larger payoffs you had, some of which was intentional. Looking at the line for commercial that was down pretty, and I know you noted some drop down in the utilization there. Can you provide additional color as to what you're seeing on the commercial side? And if there was any sort of just like end of quarter flows that we should be keeping in mind in terms of thinking about the average balance sheet? Thank you.

David Della Camera: Yes. Thanks for the question. So I'd note a few things there. First, would note the, to your point, the utilization, that did have an impact there. Second, would note there was one of the larger payoffs we referenced was in that segment. So that was an impact as well. The other impact is the loans that moved to held for sale. There were some commercial real estate, some C&I. So there was some impact there as well quarter over quarter related to that. So we don't believe that's reflective, of course, of our anticipation going forward and changing that category. Certainly a focus as we think about small business. But some one-time movement in the quarter.

Kelly Motta: Great. Thanks for the color. I'll step back.

Operator: Thank you. The next question comes from Jared Shaw at Barclays. Please go ahead.

Jared Shaw: Hey, good morning. It's just as we're looking just to confirm as we're looking at year-end '25, loan levels as an exit. That, including everything, is, like, down 10 to 12% when include the loan sales, include the indirect, include some of that payoff activity? Is that the right way to think about it?

David Della Camera: Yeah. So how we're thinking about that is the guide of six to eight is the excluding the other items and an additional one to one and a half on indirect and then the held for sale balances, we anticipate, of course, leaving in the fourth quarter. When we anticipate that transaction to close. So that would be a marginal about 2% impact. That's correct.

Jared Shaw: Okay. Alright. And then you look at the valuation allowance, that you took on those loans, can you give any color on what the rate versus credit impact of that could have been?

David Della Camera: So that valuation allowance was a rate mark on the loans. It was purely reflective of rate. And yeah. So that's just a rate mark there.

Jared Shaw: Okay. Thank you.

Operator: Thank you. The next question comes from Matthew Clark at Piper Sandler. Please go ahead.

Matthew Clark: Hey, good morning. I appreciate the questions. First one for me on the loans transferred to held for sale. $338 million. I think you called it out as being related to the branch sale, but I think when you announced the branch sale, it was only $200 million of loans. So are those all tied to those branches, or did you guys also move some additional loans into HFS?

David Della Camera: They were all tied to the branches. There were some additional loans during the quarter that were identified related to the transaction, some relationship-related loans, so all related to the branch transaction.

Matthew Clark: Okay. Great. And then in terms of the loan portfolio, can you quantify what's left in the book that you would argue is not relationship-based and would prefer to write off? We, you know, obviously see the consumer credit portfolio being the latest piece of it. But trying to get a sense for any way to ring-fence some kind of deliberate runoff from here?

Jim Reuter: Yeah, Matthew. I don't see a lot of deliberate runoff left in the book. I do think the one challenge we have is multifamily that are construction that once they're leased up and fully stabilized, some of those have an intention to go to the secondary market. So we'll see some of that. But, you know, our message to our team is, because something leaves doesn't give us a bogey to not find a replacement and grow the bank. So I would say the bigger loans that, when I arrived at, I had a preference would leave the balance sheet. Most of that has already happened.

Matthew Clark: Okay. And then on the slide deck, the deposit market share slide, does that imply that you'd like to exit some additional markets where you're not in the top five? It's about 30% of the total. Not to say you'd exit all 30%. But or is it more to illustrate an opportunity to grow market share? It just looks like Colorado kind of stands out in some of those markets as not being the top one.

Jim Reuter: Matthew, it's not to illustrate where we want to exit. It's to illustrate where we have existing density, which gives us an advantage. And if you look at a lot of those states, and MSAs and areas, they're growth areas. So we think it's a positive that we have that type of market share. And we hope to gain it in other areas as well. So where you see less of it, it's not an indication we're going to retreat. It's an indication of where we need to make progress.

Matthew Clark: Got it. Okay. Thank you.

Operator: Thank you. The next question comes from Timur Braziler from Wells Fargo. Please go ahead.

Timur Braziler: Hi, good morning. Looking at the capital priorities and examining the options here on a go-forward basis, I guess, Jim, you made it pretty clear that M&A is off the table. Looking at the dividend, you guys already have one of the highest dividends out there. I guess that would leave share buybacks or some sort of balance sheet restructure. One would be a slower use of capital, one would be a more kind of acute use of capital. I'm just wondering kind of where the thought is between those two, the mix of, and then to the extent that some balance sheet restructure is in the cards, how much of that might be included in the 2026 NII guidance?

Jim Reuter: Yeah, Timur. That's a good question. You know, as you've already pointed out, we have strong capital levels, and it's going to increase, as we've already talked about, which gives us a lot of flexibility. And so obviously, dividend is important to us. We've demonstrated that historically and currently today. Organic growth will be our focus. If we can grow the bank and make use of the capital. But all that said, if we're not able to utilize the capital in that fashion, we will look at all on the table, including all the things you mentioned. So, you know, we have a focus on creating shareholder value, and so that will be an active conversation for us.

David Della Camera: And, Timur, the 26 guide, that does not include or looking at the loans specifically that are maturing and or resetting through 26, I calculate that to be about 12% of the outstanding loan book. Do you guys view that as an opportunity, or is there a potential threat that maybe some of those either get refi-ed away into the secondary market or still some composition of, quote, unquote, the type of lending that you don't really want to do?

I'm just trying to get a sense of this elevated portion of resets that are coming due in the next eighteen months and what effect that might have on balance sheet composition and your expectations for average earning assets here to stabilize in the not too distant future?

Jim Reuter: Yeah, Timur. That's a good question. And, as I mentioned earlier, I don't see a lot of loans that don't fit our profile in that mix. There is some multifamily that, as I mentioned, that when stabilized, the borrower's intent was to go to the secondary market. Obviously, we're not going to compete with the secondary market from a rate and structure perspective. And so that's why we show loan growth fairly flat. But our intent is to replace that with production and growth. And as I mentioned, we're seeing good activity in the pipeline, and, you know, C&I owner-occupied and different things. So that's where we're headed there. And optimistic that we can replace a lot of that.

Timur Braziler: Okay. And then just last for me around credit. Just looking at the recent trends in criticized loans coupled with your unchanged net charge-off guidance. I guess, what's giving you comfort to the fact that the increase in criticized that are now over 7% of the loan book isn't going to drive some volatility around charge-off activity, either in the back end of '25 or into '26?

Jim Reuter: Yeah, Timur. What continues to give us confidence in that area is that a lot of the movement into criticized has been that primary source of repayment. We still like the collateral and the guarantors that are backing those credits, and they're well located, which is part of why we like the collateral. So that's why we continue to be confident, and, I think, you know, again, I've mentioned this before, proactive credit management, I think, is one of the tenets of running a good bank in all economic cycles, and that's what you're seeing in play here.

Timur Braziler: Great. Thank you for the questions.

Operator: Thank you. We have no further questions. I will turn the call back over to Jim Reuter for closing comments.

Jim Reuter: All right. Thank you, and thank you, everybody, for your questions. And as always, we welcome calls from our investors and analysts. So please reach out to us if you have any follow-up questions, and thank you for tuning into the call today.

Operator: Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines.

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DATE

• Tuesday, July 29, 2025, at 5:00 p.m. EDT

CALL PARTICIPANTS

• Chairman & Chief Executive Officer — David M. Overton
• President — David M. Gordon
• Executive Vice President & Chief Financial Officer — Matthew Eliot Clark
• Vice President, Investor Relations — Etienne Marcus

Need a quote from one of our analysts? Email [email protected]

TAKEAWAYS

• Consolidated Revenue: Total revenues were $956 million for Q2 FY2025, with both total revenues and adjusted net income margin exceeding the high end of prior guidance.
• Cheesecake Factory Comparable Sales: Increased 1.2% in the second quarter, driving record average weekly sales and unit volumes of nearly $12.8 million.
• Cheesecake Factory 4-Wall Restaurant Margin: Improved to 18.5% in the second quarter, up 80 basis points year-over-year and noted as the highest in eight years.
• North Italia Annualized AUV: Rose 2% to $8 million in Q2 2025; North Italia comparable sales declined 1% in the second quarter, with price +4%, mix -1%, and traffic -4%.
• North Italia Mature Restaurant Margin: Restaurant-level profit margin for adjusted mature North Italia locations improved 290 basis points from the prior year to 18.2% in the second quarter.
• Flower Child Comparable Sales: Increased 4% in Q2 2025, with average weekly sales of $91,400 and annualized AUV exceeding $4.8 million.
• Flower Child Mature Location Margin: Restaurant-level profit margin for adjusted mature Flower Child locations reached 20.4% in Q2 2025.
• External Bakery Sales: $12.9 million in the second quarter.
• Restaurant Openings: Opened 8 new restaurants in Q2 2025 (2 Cheesecake Factory, 1 North Italia, 3 Flower Child, and 2 FRC); plans for up to 25 new units in 2025 remain on track.
• Preopening Expenses: Preopening costs were $9 million in the second quarter, compared to $7 million in the prior year period, aligned with higher unit openings.
• Adjusted Diluted Net Income Per Share: Adjusted diluted net income per share was $1.16 for Q2 FY2025; GAAP diluted net income per share was $1.14.
• Liquidity Position: Ended Q2 2025 with approximately $515.3 million in available liquidity, including $148.8 million in cash and $366.5 million undrawn on the revolving credit facility.
• Total Debt Outstanding: Total principal amount of debt outstanding was $644 million as of Q2 2025, consisting of $69 million in 2026 convertible notes and $575 million in 2030 convertible notes.
• Q3 Revenue Guidance: Projected total revenues of $905 million to $915 million for Q3 FY2025.
• Q3 Margin and Cost Outlook: Adjusted net income margin expected at a 3.25% midpoint for Q3 FY2025; effective commodity and labor inflation both forecasted in the low to mid-single-digit range for FY2025; G&A estimated at $61 million for Q3 FY2025; preopening expenses targeted at $7 million to $8 million for Q3 FY2025.
• Full-Year 2025 Revenue Guidance: Estimated at approximately $3.76 billion at the midpoint for FY2025, with adjusted net income margin expected to be 4.9% for FY2025.
• CapEx Outlook: Capital expenditures of $190 million to $200 million are expected for FY2025 to fund unit development and maintenance.
• Cheesecake Factory Effective Menu Pricing: Cheesecake Factory net effective menu pricing in the second quarter was approximately 4%, with traffic at -1.1% and mix providing the remaining difference. Menu pricing for the second half of FY2025 at The Cheesecake Factory is expected to decline to around 2%-2.5%, with increased negative mix from new lower-priced items.
• Cheesecake Rewards Metrics: Month-over-month acquisition continues to exceed internal expectations; members show higher check averages, greater frequency, and higher Net Promoter Scores than non-members.
• Labor Retention: Both staff and management retention are at or above pre-pandemic highs in Q2 2025, contributing to improved productivity and lower turnover-related expenses.
• Off-Premise Sales: Represented 21% of Cheesecake Factory sales in Q2 2025, consistent with the average of the prior four quarters.

SUMMARY

Management affirmed that unit development, menu innovation, and digital loyalty remain central to The Cheesecake Factory Inc.'s (NASDAQ:CAKE) long-term strategy. Commentary from company executives emphasized continued operational improvements, including elevated employee retention that is driving labor cost leverage and enhanced guest experiences. The strategic focus on Flower Child and North Italia was underscored by strong margin gains, accelerated expansion, and early new-unit sales outperformance in Q2 2025.

• Matthew Eliot Clark indicated pre-opening expenses for the year are estimated at approximately $34 million, reflecting sustained expansion plans.
• G&A is projected to remain flat as a percentage of sales year-over-year for FY2025, with depreciation expected to be about $109 million for FY2025.
• Cheesecake Factory menu innovation now includes 14 new items across two categories—bowls and "Bites"—aimed at increasing traffic and offering new purchase opportunities as of Q2 2025.
• North Italia's new Boise location produced average weekly sales about 40% higher than the system average in Q2 2025, supporting broader geographic expansion potential.
• Flower Child’s most mature stores are generating annualized unit volumes between $6.5 million and $7 million, with operational enhancements cited as key margin drivers in Q2 2025.
• Share repurchases were modest at $0.1 million for Q2 FY2025, with $14.3 million returned via cash dividends.
• Convertible note dilution risk was addressed by Matthew Eliot Clark: At $8, a $10 increase over the strike price would result in about 1.5% dilution, suggesting management sees limited near-term EPS impact from conversion scenarios.
• Company maintains a cautious, data-driven approach to marketing, loyalty, and menu strategy as consumer environment conditions remain steady but not uniformly strong across the industry.

INDUSTRY GLOSSARY

• AUV (Average Unit Volume): Annualized average sales per restaurant location, used to benchmark performance within restaurant concepts.
• 4-Wall Margin: Profit margin calculated at the restaurant (unit) level, before allocating corporate overhead and other non-unit expenses.
• FRC (Fox Restaurant Concepts): A portfolio of restaurant brands owned and operated by The Cheesecake Factory Incorporated, including Flower Child, North Italia, and others.
• Net Promoter Score (NPS): A customer loyalty metric measuring the likelihood of guests to recommend a brand or concept.
• Preopening Expenses: Costs directly associated with opening new restaurants, including staff training, supplies, and local marketing, incurred prior to launch.

Full Conference Call Transcript

David Overton will begin today's call with some opening remarks, and David Gordon will provide an operational update. Matt will then review our second quarter financial results and provide commentary on our financial outlook before opening the call up to questions. With that, I'll turn the call over to David Overton.

David M. Overton: Thank you, Etienne. Our second quarter results exceeded expectations with consolidated revenues and adjusted earnings per share, setting new milestones for the company. These solid financial results are fueled by operational excellence and sustained demand across our differentiated high-quality concepts. Second quarter comparable sales at The Cheesecake Factory restaurants increased 1.2%, driving record high average weekly sales and further elevating our industry-leading and realized unit volumes to nearly $12.8 million for the quarter. Strategic innovation in our menu has always been a key pillar of our success, reflecting that ongoing focus, we are now introducing our latest menu, which features 14 new dishes across 2 innovative categories.

And tomorrow, in celebration for National Cheesecake Day, we are launching our newest Cheesecake Peach Perfect with Raspberry drizzle. We believe our continued focus on culinary innovation keeps our menu highly relevant without relying on discounting and combined with the strength of our best-in-class operators positions us to stand out competitive landscape. Thanks to the outstanding execution of our operators, we delivered strong flow-through and meaningful improvement in profitability. In fact, Cheesecake Factory's 4-wall restaurant margin increased to 18.5%, up 80 basis points year-over-year and the highest level recorded in 8 years. Turning to development, we successfully opened 8 restaurants in the second quarter, including 2 Cheesecake Factory restaurants, 1 North Italia, 3 Flower Child and 2 FRC restaurants.

Subsequent to quarter end, we opened 1 FRC restaurants and 1 international Cheesecake factory restaurant in Mexico under our licensing agreement. We are pleased with the progress we've made on new unit growth so far this year and continue to expect to open as many as 25 new restaurants in 2025. Additionally, we anticipate 2 Cheesecake Factory restaurants to open internationally under a licensing agreement. As we look ahead, the strong demand for our distinct dining experiences reaffirms our confidence in the long-term trajectory of our portfolio. Our results clearly demonstrate the strength of our platform and the effectiveness of our strategy to deliver sustainable growth and value.

With that, I will now turn the call over to David Gordon to provide an operational update.

David M. Gordon: Thank you, David. Our performance this quarter reflects the operational strength and disciplined execution of our teams who continue to manage their restaurants with precision and excellence. Notably, both hourly and management retention increased year-over-year, driving improvements in labor productivity, food efficiencies and wage management. As we've noted previously, our success in staffing continues to be a key driver behind the improvement in guest satisfaction scores. Ultimately, it's our team members who make it all possible, bringing our vision to life and delivering exceptional dining experiences every day.

To this point, our internal Net Promoter Score metrics improved across nearly all key areas this quarter including in both the dine-in and off-premise channels with notable gains in pace of experience, staff service and food quality. Record Cheesecake Factory average weekly sales in the second quarter were supported by off-premise sales of 21%, consistent with the average of the prior 4 quarters. And our newest Cheesecake Factory restaurant in Naperville, a suburb of Chicago, open to remarkable demand, underscoring the strong affinity for the brand and the enduring value of our distinctive dining experience.

As David Mentioned, strategic menu innovation remains core to our success and we're bringing that to life with the launch of 2 new menu categories, bowls and Bites. Our new bowl selection includes 6 thoughtfully crafted options, such as the Teriaki Salmon bowl, orange color flower bowl and the Peruvian Chicken bowl. We also introduced a lineup of 8 new bites, smaller plates offered at an attractive price point. These are designed to drive interest and offer new ways to enjoy the menu. With items like New Orleans cajun shrimp, chicken and biscuits and meatball sliders. These new offerings reinforce the relevance of our menu and the strength of our innovation strategy.

Together with our best-in-class operational execution, they drive sales and traffic and reinforce our leadership and experiential dining. Moving to Cheesecake Rewards. The program continues to perform well with strong member growth and high satisfaction. As we evolve the program, we've shifted from large-scale testing to a more targeted data-driven strategy, delivering personalized offers aligned with member behavior and preferences. This refined approach has driven meaningfully higher engagement and deeper loyalty. Turning to North Italia. Second quarter annualized AUVs increased 2%, reaching $8 million.

Comparable sales declined 1%, reflecting some continued impact from the Los Angeles fires weighing more heavily on performance due to the concept's smaller comp base relative to the Cheesecake Factory as well as some sales transfer impact from new restaurants. We also successfully opened a new North Italian Boise, Idaho during the quarter, marking our entry into another market. Early performance exceeded expectations with average weekly sales trending approximately 40% above the Q2 system average, reaffirming strong consumer demand for the concept. Restaurant level profit margin for the adjusted mature North Italian locations improved 290 basis points from the prior year to 18.2%.

The margin expansion was primarily driven by operational improvements as well as more favorable commodity and labor inflation. Flower Child continues on a strong upward trajectory with second quarter comparable sales increasing 4%, significantly outperforming the Black Box fast casual dining index, which was essentially flat for the quarter. The improvement resulted in average weekly sales of $91,400 for an annualized AUV of over $4.8 million, a new milestone for the concept. We also opened 3 new Flower Child locations during the quarter, including 2 in new markets, Collectively, these restaurants averaged nearly $82,900 in weekly sales, translating to a solid AUV of approximately $4.3 million annualized.

Operational enhancements continue to support strong performance with restaurant level profit margin for adjusted mature Flower Child locations reaching 20.4% in the second quarter. Our strong portfolio performance, fueled by sustained sales momentum, operational excellence and margin expansion positions us well to deliver on our long-term growth ambitions. And with that, let me turn the call over to Matt for our financial review.

Matthew Eliot Clark: Thank you, David. Let me first provide a high-level recap of our second quarter results versus our expectations I outlined last quarter. Total revenues of $956 million and adjusted net income margin of 5.8%, both exceeded the high end of the guidance ranges we provided. Now turning to some more specific details around the quarter. Second quarter total sales at the Cheesecake Factory restaurants were $683.3 million, up 1% from the prior year. Comparable sales increased 1.2% versus the prior year. Total sales for North Italia were $90.8 million, up 20% from the prior year period. Other FRC sales totaled $90.2 million, up 22% from the prior year and sales per operating week were $136,800.

Flower Child sales totaled $48.2 million, up 35% from the prior year. and sales per operating week were $91,400. And external bakery sales were $12.9 million. Now moving to year-over-year expense variance commentary. In the second quarter, we continued to realize some year-over- year improvement across several key line items in the P&L. Specifically, cost of sales decreased 70 basis points, primarily driven by favorable commodity costs. Labor as a percent of sales declined 20 basis points primarily driven by the continued improvement in retention, supporting labor productivity gains and wage leverage, partially offset by higher group medical costs. Other operating expenses increased 40 basis points, primarily driven by higher facility-related costs.

G&A increased 10 basis points from the prior year. Depreciation remained relatively flat as a percent of sales. Preopening costs were $9 million in the quarter compared to $7 million in the prior year period. We opened 8 restaurants during the second quarter versus 5 restaurants in the second quarter of 2024. And in the second quarter, we recorded a pretax net expense of $1.2 million related to FRC acquisition-related items and impairment of assets and lease termination expenses. Second quarter GAAP diluted net income per share was $1.14, and. Adjusted diluted net income per share was $1.16. Now turning to our balance sheet and capital allocation.

The company ended the quarter with total available liquidity of approximately $515.3 million, including a cash balance of $148.8 million and approximately $366.5 million available on our revolving credit facility. Total principal amount of debt outstanding was $644 million, including $69 million in principal amount of convertible notes due 2026 and $575 million in principal amount of convertible notes due 2030. CapEx totaled approximately $42 million during the second quarter for new unit development and maintenance. During the quarter, we completed approximately $0.1 million in share repurchases and returned $14.3 million to shareholders via our dividend. Now let me turn to our outlook.

While we will not be providing specific comparable sales and earnings guidance, we will provide our updated thoughts on our underlying assumptions for Q3 and full year 2025. Our assumptions factor in everything we know as of today, including net restaurant counts, quarter-to-date trends, our expectations for the weeks ahead and anticipated impacts associated with holiday shifts. Specifically, for Q3, we anticipate total revenues to be between $905 million and $915 million. Next, at this time, we expect effective commodity inflation of low single digits for Q3. We are modeling net total labor inflation of low to mid-single digits when factoring in the latest trends in wage rates and minimum wage increases as well as other components of labor.

G&A is estimated to be about $61 million. Depreciation is estimated to be approximately $28 million. We are estimating preopening expenses to be approximately $7 million to $8 million to support the 2 planned openings in the quarter and early Q4 openings. Based on these assumptions, we would anticipate adjusted net income margin to be about 3.25% at the midpoint of the sales range provided. For modeling purposes, we are assuming a tax rate of approximately 10% and weighted average shares outstanding of $48.5 million. Now for the full year. Based on similar assumptions, and no material operating or consumer disruptions, we anticipate total revenues for fiscal 2025 to be approximately $3.76 billion at the midpoint of our estimates.

We currently estimate total inflation across our commodity basket, labor and other operating expenses to be in the low to mid-single-digit range inclusive of the currently proposed tariff levels. We are estimating G&A to be about flat year-over-year as a percent of sales and depreciation to be about $109 million for the year. And given our unit growth expectations, we are estimating preopening expenses to be approximately $34 million. Based on these assumptions, we now expect full year adjusted net income margin to be approximately 4.9% of the sales estimate provided. For modeling purposes, we are assuming an 11.5% tax rate and a weighted average share count of approximately 50 basis points lower than 2024.

To help with modeling, this implies a Q4 tax rate of 11% to 12% and WASO of $49 million. With regard to development, as David stated earlier, we expect to open as many as 25 new restaurants in 2025. This includes as many as 4 Cheesecake Factories, 6 North Italias, 6 Flower Childs and 9 FRC restaurants. And we would anticipate approximately $190 million to $200 million in cash CapEx to support unit development as well as required maintenance on our restaurants. In closing, we delivered another quarter of strong financial and operational performance with record revenue continued margin expansion and earnings growth.

Our restaurant teams continue to execute at a high level and our differentiated experiential concepts remain well positioned to consistently deliver the delicious, memorable dining experiences our guests expect. As always, we remain focused on making steady progress toward our long-term value creation priorities: growing comparable restaurant sales, expanding operating margins and accelerating accretive unit development. With a stable foundation, a resilient business model and a clear strategic focus, we believe we are well positioned to continue generating consistent results and driving meaningful long-term shareholder value. With that said, we'll take your questions.

Operator: [Operator Instructions] Your first question comes from the line of Brian Bittner with Oppenheimer.

Brian John Bittner: As it relates to the increase in the net income margin for 2025 from 4.75 to 4.9, is this primarily operationally driven at the store level? Do you basically do you have a different assumption for the 4-wall margin expansion in 2025 versus I think 15 to 25 basis points of increase is what you had previously assumed?

Matthew Eliot Clark: Ryan, it's Matt. Thanks for the question. That's true. I think the 4-wall, our expectations now or that it will be better than we had originally expected. I mean clearly demonstrated by our Q2 results being above our expectations. And so I think we are committed to continuing to take it 1 quarter at a time, but our outlook has definitely increased based on operational excellence and overall sales trends. .

Brian John Bittner: And just lastly, as it relates to the third quarter, the revenue outlook you provided, there's a lot of moving pieces within the model these days. Does it basically assume a base case for Cheesecake Factory same-store sales that's relatively similar to the second quarter?

Matthew Eliot Clark: At the high end, that's right. So I would say we really didn't, we've seen very, very stable sales. And so we continue to have that stable outlook. But I still think there's no reason to get out ahead of our skis and try to forecast something greater until we see it happen. .

Operator: Your next question comes from Drew North with Baird.

Andrew D. North: I wanted to follow up on the topic of labor. And my question is focused on labor retention, which has continued to be a good topic and positive for your business in the broader industry. But I was wondering if you could provide some perspective on where retention levels or turnover levels are maybe relative to pre-pandemic or prior peaks to help us understand how much further improvement could be made? Or I guess, higher level, how you're thinking about the opportunity to continue to leverage labor across in the back half of the year here?

David M. Gordon: Drew, this is David Gordon. We continue to be very pleased with our progress around staff and management retention. Our staff level retention today is as good as it's been historically in the company. So even exceeding pre-pandemic levels and the same thing for management retention, and best-in-class across the industry. And we continue to believe that's because of the culture, the enduring culture of Cheesecake Factory and how we care for our staff and managers, the opportunities for them to continue to promote within the concept, whether that's to be more productive as an hourly staff member and learn new stations, which improves productivity in the long run for us over time.

We think we'll continue to see the benefits of this ongoing retention, whether that's in lower overtime, lower training costs. We don't see why that's going to change in the near term. based on the current environment. Certainly, if things change in the macro environment that we don't have control of, we'll see what happens. And on the management side, I think we continue to offer terrific career opportunities for people. for them to progress their career to work in a company that has really leading unit growth today and giving them lots of opportunities to grow in each level of management to go as high as they potentially want to go.

And we continue to be an employer of choice on the selection side because of the stability of the restaurants, the stability of the sales are really staff members know they're going to ours. The tip staff members know they're going to get good consistent tips that we have best-in-class benefits. So our challenge to the operators is to keep this up and to ensure that we make it through the second half of the year, maintaining the type of retention that we've seen thus far.

Andrew D. North: Very helpful. And then 1 on the comp, if I could. On Cheesecake Factory, can you share the Q2 breakdown related to price and mix and the implied traffic, I guess? And then how we should think about the cadence of pricing as we think about the second half?

Matthew Eliot Clark: Sure. Drew, this is Matt. The net effective pricing in Q2 is about 4% for Cheesecake. Traffic was a negative 1.1%, and then mix was the balance and effectively, that's what's encompassed in the guidance for the back half. We do anticipate with the value that we're putting on the menu that we might continue to see that level of mix continue, but we're really focused on getting that traffic back to the positive side of the ledger. So very, very stable sales throughout the quarter and predictable. And I think that's helped our operators deliver on the margins. And so that's what we're forecasting at the back half right now.

Operator: Your next question comes from Jeff Farmer with Gordon Haskett.

Jeffrey Daniel Farmer: You guys touched on it, but with that February menu update, you did shine a brighter marketing light on the new menu items. So I guess the question would be, did you guys see a customer response to that in terms of just in terms of the innovation aspect of the new menu?

David M. Gordon: Jeff, this is David again. Well, certainly, our approach with this next menu is very similar to the last menu change. We are taking all of the new menu items and putting them on a separate card to ensure that guests see them and they don't get lost in the menu early on in their life. We feel good about the stickiness of the menu items that we put on that the previous menu change that you mentioned in February. And as Matt touched on, we think that this new menu from a price point value perspective and also from a flavor profile perspective, should be as successful, if not more successful than the rollout that we had in February.

Jeffrey Daniel Farmer: Okay. And then just as a follow-up to that, as it relates to some of the lower price point menu items you put out there, do you think, 2 things that the consumer is aware of the lower prices or the lower price points? And are they responding to those lower price points?

David M. Gordon: Sure. Well, certainly, again, the fact that they're outside of the menu, if you're a guest that's already coming into the restaurant, you're going to see that lower price point right away. And we can see the order rates from the previous new menu that guests are responding to that. And as Matt touched on the mix, we're anticipating that there'll be some impact to the mix that we're planning on. So we do think that it will continue to resonate and it's the right strategy. and people want to come in and add a bite to their meal, right, just like they did when we rolled out small plates and snacks, right?

We had guests who were actually introduced to a new category and instead of even cannibalizing from previous sales, they were just adding something that perhaps they weren't planning on ordering. And we think this will happen with the bites perhaps as well. And somebody will add something like chicken and biscuits along with an appetizer and an entree whereas before perhaps they were just going to get an appetizer and an entree. So it will be interesting to study here in the next few months.

Operator: Your next question comes from Sara Senatore with Bank of America.

Unidentified Analyst: A quick follow-up and then a question on Flower Child. So just on the follow-up. I just wanted to make sure I understood. I know at the beginning of -- or the end of -- when you reported last quarter, you would you did some caution just given the operating environment. And sort of seems like that didn't materialize. I just want to make sure, is that the right read that the operating environment perhaps is a little bit healthier than you might have initially thought given some of the headlines. So that's a clarification. And then on Flower Child, is there any kind of color you can give on profitability or unit economics?

That certainly seems to be a very successful concept. The comps are very strong, and I think you're adding units at a nice clip. So as you think about kind of the return profile of the company as a whole, anything you can say about how that might shift it in 1 direction or another.

Matthew Eliot Clark: Sure, Sara. This is Matt. Just to start with on the environment. I mean I think certainly for Cheesecake Factory, Flower child, all of our concepts, the environment has been very, very steady for us. I don't know that it's better or they're certainly not true for everybody, but I feel like we were weathering this environment in a very strong way. And I think it's a testament to our execution and as well as the brands that we have. So I think it's prudent just to continue to take a little bit of a cautious approach. We feel really good about where we're sitting today.

With regards to Flower Child and sort of the unit economics, as David Gordon mentioned in the prepared remarks, we're seeing exceptional performance. The mature unit margins cresting over 20% at 20.4% is a high mark for our company at the moment. And the AUV is getting up to in the quarter of 4.8%. So we're looking down at $5 million up there, maybe in the near-term future. So certainly, the returns that we're getting today are in the mid-30s, and we feel really positive about that and look forward to continuing to grow the concept and it seems to be working everywhere that we've been opening.

Unidentified Analyst: Okay. I apologize I missed the prepared remarks on that. But just as you think about it as potentially a driver, do you see like an inflection point in terms of is moving the needle on your results just because you haven't broken it out yet and yet it seems very, very attractive.

Matthew Eliot Clark: Yes. It's a little small from an accounting perspective in terms of segment reporting for sure. But you know our intention when we started this journey about 6 months ago was to continue to pret more information every quarter. So we're continuing to add data to the ability for people to see the progress. And certainly, we would continue to expect to provide even more information. And certainly, the performance has inflected over the past 18 months with all of the work that the team has done, whether it's with a KDS system or the operational dashboards or the catering, right, has all come to fruition and really it is on a very strong trajectory.

And I would suspect that it will play a bigger and bigger role as we go forward.

Operator: Your next question comes from Jim Salera with Stephens.

James Ronald Salera: To ask a couple on North Italia, if I could. First, just some housekeeping, if you could give us the comp breakdown there, price volume in mixfor North tie for the quarter? And then if I recall correctly, in there were some headwinds from the fires in L.A. and some regional weather. And so I believe the comp was similar, if not maybe down or up a little bit, but just any comments on kind of continuing to contribute to softness there for North?

Etienne Marcus: Jim, this is Etienne. I'll just give you the breakdown here. So price was 4% in the second quarter. Mix was negative 1, traffic was negative 4%.

Matthew Eliot Clark: So let me just give some extra color there, Jim, because I think it's important for everybody to understand the performance at North is actually very, very strong. If you look at the AUVs of $8 million, actually outpacing the comps, that's because the new units are coming on that much stronger. And we delivered 18.2% on the mature margins, right? And so the higher sales and the higher margins are making for great returns. But what we are seeing is there is a little bit of sales transfer in some markets. And then that's really what's weighing on it.

So if you take Charlotte as a good example, and it talks to our ability to penetrate markets at the pace that we expected, so we have 2 Cheesecake factories in Charlotte that are doing $25 million, $26 million, right, near the system average. We just opened our third north in that market. And the first full quarter was Q2, and it did on an annualized basis, $10 million, right? And so as the third 1 there, in total, the 3 of them are averaging around $8 million. And the mature margins there are in the low 20%. And so they're great investments.

But when you open up that strong, you're just moving a little bit of sales from 1 existing to another. And that's really the major drive towards the comp there. If we net that out, it's performing pretty much in line with Cheesecake Factory. Like when we net out the sales transfer, it's probably a 1% comp with a negative on traffic. And so we're actually really, really pleased. They're just opening faster and bigger than we expected.

James Ronald Salera: Got it. That's super helpful. And maybe if I could just have 1 quick follow-up there. Just any color that you guys have on North in terms of trends by income bracket, if there's anything that you've noticed in some locations with lower end consumer to the extent that like an aspirational consumer would go to North as kind of an elevated experience.

Matthew Eliot Clark: Yes. I mean, I think it's similar to Cheesecake factory, but maybe it's a little more narrow. It's probably slightly higher income on average, but certainly, aspirational guest can still go to north and use the menu however they see fit, right? I mean they can get it in pizza and pasta and salads, all in the low 20s. And so I think that there's opportunity there. And every market that we're going into now, we're seeing really strong demand. We noted opening in Boise being 40% above the system average, right? And so that's telling us that guests of all walks of life of all income brackets of all demographics are going to north.

You don't open up doing $10 million and 6,500 square feet, if that's not the case.

Operator: Your next question comes from Brian Vaccaro with Raymond James.

Brian Michael Vaccaro: I wanted to ask about menu pricing at Cheesecake Factory. I think you've been running, you said around 4%, maybe the low 4s. Margins have obviously exceeded your expectations it still seems to be a pretty intense value environment, just broadly thinking about the consumer. So I guess how does that feed into your current thinking on your fall menu rollout, and I guess, why not let year-on-year pricing roll off a bit, given the tailwinds that you're seeing?

Matthew Eliot Clark: Yes, Brian, this is Matt. So in fact, it will we are taking less pricing going into the back half of the year. But also, we're introducing some items that have some inherently lower prices. So the effective pricing that we're taking is actually going down quite a bit more. And David Gordon mentioned bowls and the bite. The bites are predominantly items that are understands and the bowls are in the $15 to $16 range with Cheesecake Factory portions. So when we look at what we're doing from a value perspective, on -- really on an effective pricing, I think it's going to be well below where the industry is at, and we're driving significant value for the consumer.

Brian Michael Vaccaro: Okay. Sorry, I might have misunderstood previous comments on the pricing. But what type of year-on-year pricing at Cheesecake would be reasonable for the second half?

Matthew Eliot Clark: Probably on a headline basis. But again, I would just reiterate that with the new menu items, there's probably another 100 basis points of negative mix inherently built into that. So right, so the real pricing is probably going to be more like 2% to 2.5% in terms of what the consumer feels.

Brian Michael Vaccaro: Okay. That's super helpful. I wanted to ask about margins as well and maybe dial in on the North Italia margins. Certainly encouraging improvement. I think our segment margin was nearly 15% if I did the rough math quickly. I guess can you just elaborate a little bit on what drove that improvement in a slightly negative comp environment? And I told the other OpEx line in particular, maybe 100, 130 basis points year-on-year. Maybe just some broader comments on those margin dynamics you're seeing at North.

Matthew Eliot Clark: Sure, Brian, this is Matt. I think generally, it's the stability of the business and operational execution. We did , if you remember, kind of catch up on pricing equivalently to Cheesecake at the end of last year. So some of that is flowing through at this point in time. But we've also seen some of the favorable commodities that we've had for the entire company. And really, if you think about the total sales, I mean, $8 million AUV, we're leveraging those sales and driving profitability in the 4 walls. So we're super encouraged by that as well.

The teams continue to stay intently focused on driving the sales because we know we can deliver the profitability when we get the sales.

Brian Michael Vaccaro: Great. And then just last quick clarification on North Italia comps, you mentioned the negative impact on the L.A. unit. Is it possible to quantify that and kind of what the comp would have been ex the L.A?

Matthew Eliot Clark: It would have been flat without the L.A.

Operator: Your next question comes from Andy Barish with Jefferies.

Andrew Marc Barish: More of a high-level question and thought, I'd love to hear your perspective on it. I mean casual dining seems to be kind of having a moment right now, especially experiential. What do you guys kind of think and see as going on and obviously helping the success of your business?

David M. Gordon: Sure, Andy. This is David. I think that people want their dollars spent in the most productive way possible, you mentioned experiential dining. We believe that we will continue to be leaders in experiential dining and people want to go out to eat for great, wonderful, delicious food, but also as an experience. They want to be in an environment that has a lot of energy. We think we provide that at all of our concepts from Cheesecake Factory to a higher-end fast casual Flower Child, which very much is an experience, not just a transaction. So as people maybe move away from -- especially younger people, move away from transactional purchases.

I want to spend time together, our restaurants, highly designed, high-touch hospitality, today's consumer appreciates that, I think more than ever, they are more sophisticated than they've ever been about food. And we're making all of our food from scratch every single day in every single concept. And we believe we can take market share and have been taking market share because of that sustained quality I think the sustained level of great operations and all the way leading back to the retention numbers that we see at Cheesecake that have led to all-time high NPS numbers, which show consistency and people appreciate that consistency as well.

Andrew Marc Barish: Got it. And then just if you're willing to share, I guess, an early look at the '26 development pipeline, at least directionally, I'm assuming you're going to open more units? Is that something that you're honing in on as we sit here with only 4 or 5 months to go in 2025?

David M. Gordon: Yes. We certainly anticipate opening more units in the '25 that will open this year. We feel good about the pipeline. We feel good about the cadence of openings. So I think you can anticipate that, that number of percentage unit growth that we've shared in the past is 1 that we're going to continue to be able to hit moving forward.

Operator: Your next question comes from Sharon Zackfia with William Blair.

Sharon Zackfia: Sorry, we have new phones. Can you hear me now? Okay. I have to learn to unmute. it's 2025. Sorry if you mentioned this. I was on another call and then hopped on here, but I wanted to ask about the rewards program for Cheesecake. I think you mentioned it, but I was hoping to get some more kind of meat on the bone in terms of kind of what you're seeing there, kind of in terms of percent of transactions that are involving rewards or incremental lift on spend for rewards members versus nonrewards.

And if you have any data on frequency, kind of how that customer is visiting Cheesecake kind of before they joined rewards versus now or just versus the overall nonrewards population?

David M. Gordon: Sure, Sharon. This is David. I think we're going to still continue to keep things at a pretty high level. What I will share is that we continue to see month-over-month acquisition exceeding our internal expectations. So that's good to see. People are still enthused about the program and continuing to sign up at a higher level than we anticipate. Members continue to have higher frequency, higher check average, higher NPS scores than nonmembers. So all very, very positive signs. And as we move from the more broad approach that we took in 2024, a which had about a 1% redemption rate across very large swath of audiences, very broad, reaching everybody with the same type of offer.

As you know, this year, we've moved to more personalized offers that are more behavior-based on the data we have about rewards members and timing based. We're seeing those redemption rates of about 4% or higher. So significantly better than the broad-based approach that we were taking before. We now have our internal team fully intact. We brought on board a Director of Rewards, who's leading our team to continue to do analysis to make sure we have the right type of data to ensure that the redemption rates moving forward are positive, accretive and very much in line with the margin profile around what we want to spend on the program overall.

Sharon Zackfia: Can I ask a follow-up? When you have the rewards with Flower Child as well, kind of are there similarities or differences that you would point out between how the customer kind of interacts with the Flower Child rewards versus Cheesecake?

David M. Gordon: Flower Child is much more of a traditional rewards program. It's an app-based program that has points for visitation and for spend. So we're really not comparing them because they are so different. We're very happy with the program at Flower Child and believe it is driving behavior for guests that are in the program. You can order within the app, you can order ahead all the typical things that you'd be able to do in a fast casual. And thus far, it's had a pretty positive response from guests, but completely different than the Cheesecake program, which is more of that published unpublished non-points program.

Operator: Your next question comes from Jim Sanderson with Northcoast Research.

James Jon Sanderson: I wanted to follow up a little bit more on Flower Child. I was wondering if you could give us a sense of where you think the store capacity could end up given your success on average weekly sales growth, I think you've more or less doubled sales volume over the past 7 years. But wondering where you think this brand can actually end up given the opportunity for catering and for off-premises?

Matthew Eliot Clark: Jim, it's Matt. It's a really interesting question. I don't think we know 100%. And then the reason I say that is because the operating team just keeps getting better and they're able to drive more throughput. And you mentioned 1 of those reasons, which is definitely catering they figured out a way to squeeze those sales in early before the store opens sometimes and maximize the total throughput. I can tell you, we have locations doing between $6.5 million and $7 million. And so we know that there's a pretty good runway still for the overall brand to continue to grow. It's AUV on an organic basis, right, from traffic and transactions that's not from pricing.

That's just from volume. So hopefully, we'll continue to increase that capacity, but we know we've got a long runway in the overall footprint here to go.

James Jon Sanderson: You mentioned those locations doing $6.5 million to $7 million. Are those the most mature locations or anything specific about those sites that might be.

Matthew Eliot Clark: Yes. They are some of the more mature locations. And so they've been building business for a longer period of time. Sometimes it can just be the idiosyncratic nature of the site just works particularly well. But in general, the business keeps growing. And so yes, the longer that the sites have been around, typically, the more traffic they have.

James Jon Sanderson: All right. And just a couple of questions on traffic trends. I think in the past, you'd mentioned sometimes your patio capacity is at risk when you have heat waves, things like that. Is there any change in traffic trends you noticed in the second quarter or in July to date related to weather or something unexpected?

Matthew Eliot Clark: No, it's been very steady across our company. Certainly, we do watch the weather. And you could have some pockets where it can impact it for a period of time, a week here or there. But really, if you take the bigger picture, it's been very steady and predictable.

Operator: Your final question comes from Jon Tower with Citigroup.

Jon Michael Tower: Just curious, I know it sounds like new menus coming now or are hitting now and it does sound like the bowls and the bites, lower price points, $10, $15 or so -- it sounds like those kind of would work well, particularly around the launch. So are you doing any sort of social marketing or just marketing in general to kind of hit that daypart, particularly during the weekdays when maybe your volumes aren't as robust as your bigger weekends.

David M. Gordon: Sure, Jim. This is David. I think as I mentioned earlier on the rewards program, that's the perfect opportunity for us to use the data that we have today to drive behavior to a specific day part, so we've been doing that throughout the first half of this year. We're going to continue to do that. And certainly, as we message the new menu, we actually let members know about the new menu earlier than the rest of the population.

And if we knew that you were a guest, maybe they hadn't come for lunch, maybe we sent that to you at a particular time, talked about a lunch promotion that made you aware of those new items all at the same time. So having the data really makes it more impactful for us to be able to do the right type of targeted messaging to drive specific daypart. And so we're going to be excited to do that through the rest of the year.

Matthew Eliot Clark: And it's really, Jon, 1 of the things, too, it's at lunch, but it's also channels right? We think that the bowl category will work really well for delivery. And as you know, we really don't take incremental pricing. So we have a $15 or $16 Cheesecake portion bowl. We think that stacks up pretty well in this environment to be delivered.

Jon Michael Tower: Yes. No, that's great. Maybe just pivoting just back to the Flower Child brand, obviously, you guys are -- the brand itself sounds like it's hitting on all cylinders today. and you're opening in a fairly healthy, I think mid-20s percent growth clip in terms of new stores. And the returns sound like they're justifying this but is there a threshold at which you won't bump up against in terms of new store opening cadence? Are you guys not going above 30% a year, given human capital constraints or anything like that?

David M. Gordon: Sure, Jon. That's a great question. You've probably heard us talk about that before. And right today, we're comfortable with that 20% number. We could probably be a little bit higher than that. That team is very focused today on manager development and ensuring that we have the right general managers and executive chefs to open those restaurants and open them well, especially because so many of them are opening at such high volumes, and we want to make sure that, that guest experience is perfect from the get-go. So management development is a key focus for the team. We're comfortable with where we are today at 20% or a little bit higher as we continue to build that pipeline.

We certainly have the capacity from a company standpoint to build more and to do it faster, but we're going to be cautious and careful and make sure we can execute as well as we want to.

Operator: We have a question from Rahul Kro with JPMorgan.

Rahul Krotthapalli: Can you help understand the dynamics around the $500 million converts. It looks like we are not far off from the conversion price here. And should we see this elected ahead? What kind of dilution would you anticipate after like expecting to pay a portion through cash? And also remind us how much of this is also hedged through call options?

Matthew Eliot Clark: Yes. So this is Matt. It's a great question. So the price -- the strike prices are 70, 71 sort of right in that zone. Certainly, with the Stub, the $69 million we would watch and sort of decide to do something on that based on economics. And it would have to be around $80 for the sort of cost of carry to net out for us to decide to extinguish those. And on the other is really what I can remember on the $575 million is at, say, $8, a $10 increase over the strike price there you're talking about 1.5% dilution. It's not that meaningful in the bigger picture for us.

And so certainly, that would be a high-cost problem. I think all investors would be happy if we were at $80 and there was a 1.5% dilution at that point in time.

Operator: There are no further questions at this time. Ladies and gentlemen, this concludes today's call. We thank you all for joining. You may now disconnect.

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DATE

• Wednesday, July 30, 2025, at 10:30 a.m. EDT

CALL PARTICIPANTS

• President and Chief Executive Officer — Cliff Pemble
• Chief Financial Officer and Treasurer — Doug Boessen
• Director, Investor Relations — Teri Seck

Need a quote from one of our analysts? Email [email protected]

TAKEAWAYS

• Consolidated Revenue: $1.815 billion in revenue for Q2 2025, up 20% year over year, achieving double-digit sales growth in every business segment.
• Gross Margin: 58.8% gross margin for Q2 2025, expanding by 150 basis points from the prior quarter due to favorable product mix.
• Operating Margin: 26%, up 330 basis points year over year, resulting in operating income of $472 million, a 38% year-over-year increase.
• Pro Forma EPS: Pro forma EPS was $2.17, up 37% year over year. GAAP EPS at $2.00 for the second quarter of 2025; Pro forma EPS set a new second quarter record.
• Fitness Segment Revenue: $605 million, up 41%, driven by advanced wearables; segment operating income at $198 million on 33% operating margin.
• Outdoor Segment Revenue: $490 million, up 11%, with operating income of $158 million at 32% operating margin.
• Aviation Segment Revenue: $249 million, up 14%, operating income of $63 million at 25% margin; recognized by Embraer as top electrical/electronic supplier for 10th straight year.
• Marine Segment Revenue: $299 million, up 10%, with operating income of $63 million at 21% operating margin.
• Auto OEM Segment Revenue: $170 million, up 16% in the second quarter, operating loss narrowed to $10 million; milestone of one million BMW domain controllers shipped.
• Geographic Revenue Growth: EMEA revenue increased 25%, Americas revenue increased 19%, APAC revenue increased 16%.
• Inventory: Increased year over year and sequentially to $1.82 billion, reflecting efforts to meet demand and mitigate tariff impacts.
• Free Cash Flow: $127 million in free cash flow, down $91 million year over year, attributed to higher inventory levels.
• Acquisition of MyLaps: Closed during the quarter; MyLaps is a global leader in timing and performance analysis for athletic, motorsports, and equestrian competitions.
• Full-Year Guidance Raised: Revenue now expected at $7.1 billion (prior $6.85 billion) for full-year 2025; pro forma EPS guidance increased to $8.00 (prior $7.80).
• Segment Growth Guidance Updates: Fitness raised to 25%, Outdoor maintained at 10%, Aviation raised to 7%, Marine raised to 5%, Auto OEM raised to 10%.
• Operating Expense: Second quarter operating expense increased $74 million, driven by higher R&D and SG&A spending largely from personnel costs.
• Share Repurchases: $67 million in shares bought back with $143 million remaining under authorization.
• Dividend Payments: Dividend payments of $173 million paid.
• Tax Rate: Effective tax rate (GAAP) reported at 16.5%, impacted by release of tax reserves.
• Tariff and FX Impacts: Tariff costs are lower than previous estimates for the full year and largely offset by unfavorable currency movement (notably the Taiwan dollar) on gross margin.

SUMMARY

Garmin (NYSE:GRMN) delivered record financial performance in Q2 2025, led by broad-based double-digit growth across all segments and regions. The company highlighted exceptional growth in the fitness segment, underscored by robust demand for advanced wearables and the launch of multiple new product lines. Global expansion continued, particularly in EMEA where year-over-year revenue growth reached 25%, supported by favorable foreign exchange rates. Management emphasized the strategic acquisition of MyLaps, which brings integrated timing and race management technology into Garmin Ltd.'s ecosystem. Full-year 2025 financial guidance was raised for both revenue and pro forma EPS following the strong first half, accompanied by increases in segment-level revenue growth outlooks for fitness (25%), aviation (7%), marine (5%), and auto OEM (10%).

• Cliff Pemble stated, "We are very pleased with our results so far in 2025, which have exceeded our expectations."
• New product launches in fitness, outdoor, aviation, and marine segments were credited with driving segment-level revenue increases.
• The MyLaps acquisition, described as a means to merge training and official event timing, was explicitly included in revised financial guidance.
• Doug Boessen explained that inventory and accounts receivable increases align with strategies to hedge against tariff risk and support rising demand.
• Management noted that channel fill was minimal and stated there is no evidence of significant inventory stockpiling at retailers.
• Subscription and service revenue continues to expand across all segments, but has not yet reached the disclosure threshold of 10% of revenue.
• Cliff Pemble classified current fitness segment growth as being driven by new customer acquisitions instead of just repeat buyers.

INDUSTRY GLOSSARY

• Domain Controller: An automotive electronic system responsible for managing and integrating critical vehicle functions, such as infotainment or advanced driver assistance systems, often used in modern vehicle architectures.
• Chartplotter: A marine navigation device that integrates GPS positioning with electronic navigational charts, used to aid navigation and situational awareness on vessels.
• Part 25 Aircraft: Aircraft certified under Federal Aviation Administration regulations for large transport airplanes, often used in commercial or corporate aviation.
• AMOLED: Active-Matrix Organic Light-Emitting Diode, a display technology providing vivid color and high contrast, commonly used in advanced wearable and mobile devices.
• InReach System: Garmin Ltd.'s satellite communication platform used primarily in the outdoor segment, enabling two-way messaging, tracking, and safety SOS functionality from remote locations.

Full Conference Call Transcript

Cliff Pemble: Thank you, Teri, and good morning, everyone. As announced earlier today, Garmin Ltd. delivered another quarter of outstanding financial results, with strong growth in consolidated revenue, operating profit, and earnings. Consolidated revenue increased 20%, exceeding $1.8 billion, which is a new second-quarter record, and we experienced double-digit sales growth in every business segment. Gross and operating margins expanded to 58% and 26%, respectively, resulting in record second-quarter operating income of $472 million, up 38% year over year, and pro forma EPS of $2.17, up 37% year over year. Yesterday, we announced the acquisition of MyLaps, a global market leader in timing and performance analysis for athletic, motorsports, and equestrian competition.

MyLaps supports an impressive customer base, including the Boston Marathon, Ironman, and Formula One racing, to name just a few. We believe that the combination of Garmin devices with MyLaps' timing and race management technology will provide a comprehensive experience for our passionate customers from training to race day, while also expanding our addressable market. We are very excited to welcome the MyLaps team to Garmin Ltd. and look forward to all that we can accomplish together. We are very pleased with our results so far in 2025, which have exceeded our expectations. From our vantage point, consumers have been resilient, and demand for our highly differentiated products has been robust.

Given our strong performance, we are updating our full-year guidance. We now anticipate revenue of approximately $7.1 billion and pro forma EPS of $8 per share. Doug will discuss our financial results and outlook in greater detail in a few minutes. But first, I'll provide a few remarks on the performance of each business segment. Starting with fitness, revenue increased 41% to $605 million, with growth led by strong demand for advanced wearables. Gross and operating margins expanded to 60% and 33%, respectively, resulting in operating income of $198 million. During the quarter, we launched the Forerunner 570 and Forerunner 970 with new training features and personalized training plans from Garmin Coach for running and triathlons.

These new devices have been enthusiastically embraced by the market and helped drive the remarkable second-quarter financial performance of the segment. We also launched the new Venu X1, an ultrathin case and class-leading two-inch display, resulting in a sleek, lightweight design that is easy to read and packed with our most popular features. Also during the quarter, we launched several new category-defining products, including the Index Sleep Monitor, the Tacx Alpine Gradient Simulator, and the VariaView Bike Headlight with an integrated 4K camera. Given the first half performance of the fitness segment and the continued demand we are expecting for our advanced wearables, we are raising our revenue growth estimate to 25% for the year.

Moving to Outdoor, revenue increased 11% to $490 million, with growth driven primarily by adventure watches. Gross and operating margins expanded to 66% and 32%, respectively, resulting in operating income of $158 million. During the quarter, we launched the Instinct 3 Edition with a bright AMOLED display, a metal-reinforced bezel, a built-in LED flashlight, and support for popular new activities such as rucking. Also during the quarter, we launched new Tread all-terrain navigators that offer larger touch screens and additional mapping options to enrich off-road adventures. We are pleased with the performance of the outdoor segment so far this year. Looking forward, we expect growth to moderate as we pass the one-year anniversary.

With this in mind, we are maintaining our revenue growth estimate of 10% for the year. Looking next at aviation, revenue increased 14% in the second quarter to $249 million, with growth contributions from both OEM and aftermarket product categories. Gross and operating margins expanded to 74% and 25%, respectively, resulting in operating income of $63 million. During the quarter, Embraer recognized Garmin Ltd. as the top supplier in the electrical and electronic systems category for the tenth consecutive year, validating the long-term investments we have made in creating innovative products and building strong relationships with our customers.

We're also preparing for the future with game-changing new products and features such as the recently announced G5000 Prime integrated flight deck for Part 25 aircraft and the addition of FAA Datacom to the GTN 750Xi Navigator, which expands the availability of modern digital communications to the aftermarket. We also launched SmartCharts, which has the potential to be one of the most disruptive new products for aviation in quite some time. Using SmartCharts, pilots can see their position on context-specific georeferenced charts, making instrument approaches much more intuitive and easier to fly. Also during the quarter, we announced that Garmin Autoland was certified for the Cirrus SRG7+ series, becoming the first piston-powered aircraft equipped with this award-winning safety system.

Given the first half performance of the aviation segment, we are raising our revenue growth estimate to 7% for the year. Turning to the marine segment, revenue increased 10% to $299 million, with growth across multiple categories led primarily by chartplotters. Gross and operating margins were 55% and 21%, respectively, resulting in operating income of $63 million. During the quarter, we launched the GPSMAP 15x3 chartplotters, with an ultra-wide display that offers as much display area as two separate nine-inch chartplotters, making information easier to read while maximizing the use of space in the instrument panel. Also during the quarter, we launched the Quatix 8, our most advanced purpose-built smartwatch for mariners.

The marine market has easily surpassed our lowered expectations, demonstrating resilience and stability in an otherwise dynamic macroeconomic environment. Given our first-half performance and the current trends in the market, we are raising our revenue growth estimate to 5% for the year. And moving finally to the auto OEM segment, revenue increased 16% to $170 million, with growth driven primarily by increased shipments of domain controllers to BMW. Gross margin was 17%, and the operating loss narrowed from the prior year to $10 million. We recently shipped our one millionth BMW domain controller from our US manufacturing facility, demonstrating our capability as a respected tier-one supplier to the North American automotive market.

We also continue to make progress on the launch of our next significant auto OEM program, the 2026. Given the first half performance of the auto OEM segment, we are raising our revenue growth estimate to 10% for the year. That concludes my remarks. Next, Doug will walk you through additional details on our financial results. Doug?

Doug Boessen: Thanks, Cliff. Good morning, everyone. I'd begin by reviewing our second-quarter financial results. Provide comments on the balance sheet, cash flow statement, taxes, and updated guidance. We posted revenue of $1.815 billion for the second quarter, representing a 20% increase year over year. Gross margin was 58.8%, a 150 basis point increase from the prior quarter. The increase was primarily due to product mix. During the quarter, the cost impact from tariffs was not significant. It was more than offset by higher revenue associated with the weakness of the US dollar relative to other major currencies. Operating expense as a percentage of sales was 32.8%, a 180 basis point decrease. Operating income was $472 million, a 38% increase.

Operating margin was 26%, a 330 basis point increase from the prior year quarter. Our GAAP EPS was $2.00. Pro forma EPS was $2.17. Next, we'll look at second-quarter revenue by segment and geography. In the second quarter, we achieved double-digit growth in all five of our segments, led by the fitness segment with outstanding growth of 41%. By geography, we achieved double-digit growth in all three of our regions, led by 25% growth in EMEA, followed by 19% growth in the Americas, and 16% growth in APAC. Looking next at operating expenses, second-quarter operating expense increased by $74 million or 14%.

Research and development increased approximately $34 million, SG&A increased approximately $40 million compared to the prior year quarter. Both increases were primarily due to personnel-related expenses. A few highlights on the balance sheet, cash flow statement, and taxes. We ended the quarter with cash and marketable securities of approximately $3.9 billion. Accounts receivable increased both year over year and sequentially to approximately $1 billion following the seasonally strong sales in the second quarter. Inventory increased year over year and sequentially to approximately $1.8 billion. We are executing our strategy to increase inventory of certain product lines to support strong customer demand, as well as mitigate the effects of potential increases in tariffs.

During the second quarter of 2025, we generated free cash flow of $127 million, a $91 million decrease from the prior year quarter, primarily due to an increase in inventory. Capital expenditures for 2025 were approximately $46 million, approximately $9 million higher than the prior year quarter. We expect full-year 2025 free cash flow to be approximately $1.2 billion with capital expenditures of approximately $350 million. During 2025, we paid dividends of approximately $173 million and purchased $67 million of company stock. At quarter-end, we had approximately $143 million remaining in the share purchase program, which is authorized through December 2026. We reported an effective tax rate of 16.5% compared to 17.9% in the prior year quarter.

The increase in the effective tax rate is primarily due to the release of tax reserves. Turning next to our full-year guidance, we estimate revenue of approximately $7.1 billion compared to our previous guidance of $6.85 billion. We expect gross margin to be approximately 58.5%, consistent with our previous guidance. We expect the impact from tariffs to be lower than we previously estimated. However, this favorable impact will be offset by unfavorable foreign currency impacts of the Taiwan dollar. We expect our operating margin to be approximately 24.8%, consistent with our previous guidance.

Also, we expect a pro forma effective tax rate of 17.5% compared to our previous guidance of 16.5%, which incorporates the impact from the new US tax bill. We expect the new tax bill to result in a decrease in US tax deductions to credits in 2025, primarily due to changes in capitalization requirements of certain R&D costs. Expected pro forma earnings per share is approximately $8, up from our previous guidance of $7.80. That concludes our formal remarks. Rob, can you please open the line for Q&A?

Operator: Thank you. We will now begin the question and answer session. If you would like to ask a question, please press 1 on your telephone keypad. Your first question comes from the line of Joseph Cardoso from JPMorgan. Your line is open.

Joseph Cardoso: Hey, thank you and good morning everyone. Maybe just for my first question, obviously, you had another strong fitness performance this quarter. I'm trying to get a sense of the outperformance though, particularly as it relates to any potential influences from channel fill. You obviously talked about a lot of new products in the quarter. And then potentially any pull forward that you might have visibility into and whether that is having any impact on the back half outlook? And then I have a quick follow-up. Thank you.

Cliff Pemble: Good morning, Joe. In terms of channel fill, there's always some channel fill impact when a new product comes out. But we have a broad product line, so it was not a significant factor in driving outperformance. And in terms of pulling forward of demand, we really don't see any of that happening. Retailers aren't willing to take big bets on inventory. And they also have credit limits that are in place that prevent them from exceeding limits that we set. So we feel like the channel is well managed. We also track the registration of our products, and we can compare our sell-in versus sell-out, and we really don't see any signs of stockpiling.

Joseph Cardoso: Got it. No. Appreciate the color there, Cliff. And then maybe for the second question, just relative to the full-year outlook, the implied second-half growth for revenue and gross profit is roughly in the 10% range plus or minus, depending on revenue or gross profit you're looking at there. But you're guiding operating profit dollars to be flat. Can you maybe just flesh that out a bit, what are the drivers that's kind of leading to this like, a little bit atypical leverage that we're used to seeing from Garmin Ltd.? And then just maybe to back on to that question, can you guys size what you're now embedding for tariffs and then FX relative to the full-year guide?

Thank you.

Doug Boessen: Sure. So I'll give you a little bit of background on the operating expense assumptions. And these are for the full year as a percentage of sales. Now we are expecting that to increase about 30 basis points, maybe about 10 basis points in R&D and 20 basis points in SG&A. And that R&D increase is primarily due to headcount increases as well as normal merit. That's primarily, you know, to develop new features, innovation, and new products. Then, as it relates to SG&A, that's going up primarily to build in the infrastructure for that growth. A few additional items are driving operating expense, primarily in the back half here, one of which is foreign currency impacts.

We talked about the foreign currency impacts on the top-line revenue, but also, there will be increases in expenses due to those foreign currency impacts. Also, you know, we recently announced the acquisition of MyLaps. So we'll have the additional expenses relating to MyLaps in the back half. And also, you know, given our strong performance, we have increased performance-based compensation in there. Another one due to the increased revenue is due to co-op advertising that we do have. You know, as it relates to tariffs, we're currently assuming basically the current rates that are effective for that.

Our tariff estimate is lower now today than it was in April, primarily because of changes in some of those tariffs as well as not having a tariff on wearables. From that standpoint. And that's really offset, you know, on the gross margin line item by unfavorable impact on our gross margin due to the strength in the Taiwan dollar, which will increase our product costs that we have. In that standpoint. And then as it relates to FX overall, you know, the FX has moved since the start of the year. So right now, we're expecting FX on a top-line revenue to be a favorable item as it was here in Q2 for us.

Joseph Cardoso: Nope. Very clear, Doug. Thank you for all that color there. Really appreciate it.

Operator: Absolutely. Your next question comes from the line of Erik Woodring from Morgan Stanley. Your line is open.

Erik Woodring: Great. Thanks so much for taking my question, guys. I have two. Maybe, Cliff, I'll start with you and just taking a very big step back. Looking at your growth CAGR over the last ten years, revenue growth has been in and around 7% to 8%. EPS has been, call it, 11% or 12%. Clear leverage in the model. You know, what's interesting about this year is that, you know, both last year and this year, you're clearly outperforming that growth rate. But there is some deleverage in the model, which you just kind of explained.

But I guess my big picture question is, do you believe that Garmin Ltd. is entering kind of this new higher revenue growth paradigm, especially as auto OEM is not the headwind that it once was, but in fact, a tailwind to growth? Can you maybe just unpack how you're thinking about Garmin Ltd.'s growth algorithm relative to history? And if there is kind of a true structural change in that growth rate today relative to history? And then a quick follow-up, please. Thanks.

Cliff Pemble: Yeah. I think, you know, we've made a lot of progress and evolution in our company over the past ten years. In the past ten years, the wearable market has emerged and blossomed. And while we're a smaller market share player, we're gaining share and the market is relatively stable. So that's been a really good opportunity for us. We entered that market because we believed that we had something to offer there, and we have high levels of innovation and differentiation in our product lines that we believe would drive growth. We continue to see that as an opportunity. All over the company and in our segments, we see opportunities in every one of them.

And so, consequently, we're simply running as fast as we can towards those opportunities, especially when it involves creating unique products that either our competitors aren't interested in or haven't thought of. And we try to be a class leader when it comes to both existing product categories and creating new product categories. So, you know, we're excited and optimistic about the future. We believe that there's more work to be done. And we'll continue investing and working hard to achieve it.

Erik Woodring: Okay. Alright. No. That's super helpful. Maybe as a follow-up, you know, because we've seen Garmin Ltd. make some relatively significant price hikes across a number of different kind of smart wearable products over the last, let's call it year, year plus. What have you learned about the elasticity of demand of your customer base? And how does that inform your or Garmin Ltd.'s ability to maybe take more price in the future? How should we think about the relative pricing power of the consumer wearables business, please? Thank you.

Cliff Pemble: Well, I probably take exception to significant price hikes in the past year. What we've done is we've introduced new product lines with new features that can command a higher price point because they do more for the customer. So we aren't necessarily, you know, moving prices on existing categories, products, and existing SKUs. We're doing innovation. We're unique products, innovation is something that customers always love. And we've been successful in doing that. In terms of elasticity, you know, I think when we introduce a product at the higher end, our strategy is to continue to push and promote the products that it overlaps with and ultimately replaces.

So we have a one-two strategy where we can promote products that have been in the market a while and play on the value side while at the same time offering new products with innovation and at higher price points.

Erik Woodring: Okay. Super. And then maybe, Doug, just one clarification question, which just confirming that within the calendar 2025 guide, both overall and at the segment level, the acquisition that you announced over MyLaps is fully included in that guide. That would not be incremental. Just wanted to get that one clarification.

Doug Boessen: Yeah. MyLaps is actually factored into guidance from the top line as well as the expenses.

Erik Woodring: Correct.

Doug Boessen: Okay. Super. Thanks so much, guys. I appreciate it.

Operator: Thank you. Your next question comes from the line of Jordan Lyonnais from Bank of America. Your line is open.

Jordan Lyonnais: Hey, good morning. Thank you for taking the question. Could you guys talk a little bit more about MyLaps? What you're seeing the opportunity is? Where you're expecting synergies just across the segments?

Cliff Pemble: Yeah. MyLaps is a company that specializes in timing of competitive events, whether they're running events, triathlons, auto racing, or even horse racing. And so, you know, their equipment and their services are very critical, especially to some of those high-visibility events that are out there. Market interest and our interest in terms of particularly the running and triathlon, cycling, racing, events. Today, users of Garmin Ltd. devices use them for training. And then when they go to race day, they use our devices, but the official timing is somewhat separate and disconnected from the devices that they're using during the race.

So we see an opportunity to merge the experiences from the training that takes place leading up to an event through the actual participation in the event itself, and we can do it in a dynamic and integrated way because we now have access to both the on-risk information as well as the official timing information.

Jordan Lyonnais: Got it. Thank you so much.

Operator: Your next question comes from the line of Ivan Feinseth from Tigris Financial Partners. Your line is open.

Ivan Feinseth: Hi. Thanks for taking my question, and congratulations on another great quarter. I have two questions. Recently, health secretary RFK has been, you know, very outspoken talking about his vision for smart wearables as an integral part of helping people manage their health. And what are your thoughts? And you know, the opportunities you see for Garmin Ltd. because we have a diverse line of wearables with a lot of proprietary measurements as well as, you know, the add the connect app and the Garmin Health platform.

Cliff Pemble: Well, our thoughts are one of excitement. You know, we have always believed in the utility of wearable devices to help people observe and manage their health. You can't change what you can't measure, so wearables play an integral part of that. And we're really excited about the fact that we have a very diverse product line, so there's not one size fits all for every customer. Instead, we offer a range of things that appeal to somebody's lifestyle and their goals. So I think it presents a significant opportunity for us.

And, of course, we're at the forefront in terms of sensor measurements and creating health metrics for people that are useful and actionable, and so we believe there's a lot of opportunity going forward.

Ivan Feinseth: Thanks. My second question is, you know, the next big thing in smart wearables is glasses that a lot of people believe they will be as ubiquitous as cell phones and watches. And what do you see as your opportunity in there, especially for a lot of the ones that are on the market right now don't have screens in the display that is being talked about coming to integrate your data from your watch into that for, let's say, when you're running. And, also, a while back, you did make a device that clipped onto glasses kind of created a heads-up display into a pair of glasses. So what are your thoughts on opportunities in that area?

Cliff Pemble: Well, I think it remains to be seen. You know, glasses have come and gone once, and the utility and the concerns around the use of those in public have always come up in the context. So I'd say it's a wait-and-see thing. I think people want choices when it comes to things they wear, including watches and glasses. And so there may be some special use cases for those, but in general, we believe that the utility of a wearable is still very strong.

Ivan Feinseth: Alright. Thanks, and congratulations again.

Cliff Pemble: Thank you.

Operator: Your next question comes from the line of Tim Long from Barclays. Your line is open.

Tim Long: Thank you. Two also, if I could. First, maybe if you could touch a little bit on the fitness category. Any color you have on the strength there, how it's looking from kind of repeat users or new install base for Garmin Ltd., if you have any color there. And then secondly, if you could just dig into Europe as you highlighted pretty strong growth there. It's been several quarters of outperformance. Maybe dig into what's driving that and how sustainable that growth can be there. Thank you.

Cliff Pemble: Okay. Yeah. In terms of fitness categories, all the categories were strong. I would say that advanced wearables, as we mentioned in our comments, was the biggest driver. And we did call out running, specifically Forerunner 570 and 970, although running was not really the only driver, we saw strength across all of our products, including what we call our advanced wearables, which is our Venu and Vivoactive Line. So those were very, very strong. In terms of repeat users versus new users, we're seeing stronger growth in the new user category, so new people coming to Garmin Ltd. for the first time, and so we're excited by that.

It means that people are recognizing that we offer something different and are coming to us for a solution. In terms of Europe performance, I think if you normalize for FX, you'd probably see that Europe was pretty much in line with the other geographies. So I think FX had part of the responsibility for the outperformance in Europe.

Tim Long: Okay. Thank you.

Cliff Pemble: Thank you.

Operator: Your next question comes from the line of David MacGregor from Longbow Research. Your line is open.

Joe Nolan: Hey. Good morning. This is Joe Nolan on for David. The marine market remains relatively soft, but you guys continue to deliver growth there. Can you just talk about some of the factors driving that growth and just what's giving you confidence in raising the guide there?

Cliff Pemble: I think growth in marine, you know, for sure, the market has been a little bit towards the downside. We feel like it's been stabilizing. It has faced, you know, a lot more uncertainty as people try to process, especially boat builders, the issues of tariffs that affect them as well as consumer sentiment. But in general, we've seen stable demand for our products, and especially where we're providing products with unique innovation and differentiation, we're seeing people come to Garmin Ltd. and taking share in those categories as well.

Joe Nolan: Got it. Okay.

Cliff Pemble: Well, as I said, we're making good progress on that. We're in the process of validating our production lines globally to be able to support the new device and the new design and to prove that we can run at scale and deliver the quality. So it's a very involved process working with the carmaker and quite a few test runs, pilot runs, evaluations, and feedback that goes into making sure we're ready towards the 2026.

Joe Nolan: Got it. Thanks. I'll pass it on.

Operator: Your next question comes from the line of Ben Bollin from Cleveland Research. Your line is open.

Ben Bollin: Good morning, everyone. Thanks for taking the question. Chris, I was hoping we could start. Could you talk a little bit about how you're thinking about subscription momentum, the materiality, the progress, and what's the right way for us to assess your progress? Is it as simple as looking at the deferred? Is there something else you think we should look at? Curious your thoughts there. Then I have a follow-up for Doug.

Cliff Pemble: Yeah. I think subscriptions are a growing part of our business. We, of course, haven't triggered the 10% threshold to disclose that yet. So we aren't providing specifics on it, but I would tell you that in every segment, we're looking for opportunities to build subscription and service revenues. Outdoor has been a big driver of that with our inReach system. Fitness has been increasing a lot, both with our kids' Bounce wearable as well as Garmin Connect Plus. And then aviation is another one where we offer subscription services for content for the cockpit that is in growth mode. So we're growing across the whole business, and, of course, we're driving towards as much as we can grow there.

But until it triggers that 10%, we won't disclose it.

Ben Bollin: Okay. Doug, just thoughts on working capital management. Both in 2Q and the balance of the year. Receivables and inventory up. Decent amount year over year in sequential. Talked a little bit about the trend there. What do you see? How's it going to plan? And any thoughts for the balance of the year? That's it for me. Thank you.

Doug Boessen: Yeah. You know, as it relates to our working capital, it's really going as planned. You know, as it relates to inventory, our strategy is to have inventory for our increased customer demand, but also we've increased inventory to mitigate potential increases in tariffs. You know, there's currently no tariff on wearables and any potential increase in that. So that was a strategy of ours to increase the inventory. As it relates to receivables, that's primarily related to the growth in our sales, which is a function of that, maybe a little timing depending upon how the sales came in during the month. But, you know, everything from working capital is pretty well on plan.

You know, from our free cash flow estimate for the year, we're expecting, you know, $1.2 billion, which is very similar to what it was last year. We're, you know, expecting, you know, to have increased operating earnings there. That will probably be offset, you know, by an increase in inventory, but things are going as planned, and we're reacting to the current environment that we're in.

Teri Seck: Thank you all for joining us today. As always, Doug and I are available for callbacks.

Operator: You may now disconnect.

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DATE

Monday, July 28, 2025 at 8 p.m. ET

CALL PARTICIPANTS

Chairman and Chief Executive Officer — Dirk Van de Put

Chief Financial Officer — Luca Zaramella

Need a quote from one of our analysts? Email [email protected]

RISKS

Chief Financial Officer Zaramella indicated, "North America, the pure fact is that the major market category wise is, at this point, down, volume wise, minus three percent," and does not expect an immediate recovery, highlighting continued volume pressure in the United States.

Chief Executive Officer Van de Put stated, "chocolate volumes around the world to be down so far. We see it down six, seven percent," referencing the latest cocoa grindings data. referencing global softness following significant price increases.

The call cited retail destocking in North America, described as ongoing through the quarter, with Chief Executive Officer Van de Put noting, "We were a bit surprised to still see some of that in q two,"

Zaramella referenced the need for prudence in the outlook due to unpredictable events, stating, "we really want to be on the prudent side, I would say. I'm not suggesting that the guidance is a slam dunk at this point in time."

TAKEAWAYS

Volume Trend — North America: Biscuits category volume is down about 3% in the first half, with management projecting a similar decline in the second half.

Global Chocolate Volumes: Global chocolate volumes are down 6%-7% to date. Chocolate prices have risen 30%-50% over the past two years.

Emerging Markets Performance: Emerging markets reported double-digit growth this quarter, with sustained volume expansion and notable share gains in Brazil, India, and Mexico in Q2 2025, despite consumer confidence softness.

Pricing Actions: Incremental pricing will be implemented in North America "in few weeks" to counter higher input costs, notably cocoa.

European Chocolate Volumes: Chocolate volumes in Europe were impacted by an unprecedented heat wave, which reduced demand in June and July; recovery was observed after temperatures normalized.

Revenue Outlook — Biscuits ex-North America: Year-to-date revenue outside North America is up more than 7% for the biscuits segment.

Cocoa and Cocoa Butter Costs: Cocoa prices are expected to come down as supply improves.

Full-Year Guidance: Management reaffirmed its full-year outlook, explicitly stating, "there is no material improvement of the U.S. general sentiment" assumed in the full-year outlook guidance.

Channel Shift and Share Gains: Strong share gains continue in club, dollar, and value channels, which management sees as key offset mechanisms for U.S. retail softness.

Share Repurchase Program: The company is actively repurchasing shares, with prior buybacks at an average price below $60 per share, and maintains a $9 billion share repurchase authorization over three years.

SUMMARY

Management directly addressed soft North American biscuit demand and continued retailer destocking, providing detailed context on current challenges. Yet management cited rapid revenue recovery opportunities if cocoa input costs continue to retreat. Emerging markets, especially Brazil, India, and Mexico, were highlighted as the principal sources of volume and share growth. Retailers’ inventory normalization was described as largely complete by the end of Q2 2025, which may reduce future volatility from destocking. Management expects to increase media spend in both chocolate and U.S. brands next year to support category volumes.

Chief Executive Officer Van de Put stated that, "there is currently no real impact on our volumes coming from GLP-one." minimizing concerns about weight loss treatments as a driver of sales weakness.

Zaramella explained that future pricing will be "quite surgical." protecting value pack and competitive price points while limiting increases to select sub-brands.

Net investment hedges were referenced as mitigating currency-related debt volatility, which management sees as key in balancing ongoing capital allocation, including buybacks and dividends.

The company is monitoring elasticity closely across categories and markets, emphasizing caution in assuming demand rebounds until clearer signals emerge.

INDUSTRY GLOSSARY

RGM (Revenue Growth Management): Strategic tactic blending pricing, pack architecture, and promotional actions to maximize profitable revenue growth.

Compound: A chocolate alternative using vegetable fats in place of some or all of the cocoa butter, referenced in the context of adjacent categories reformulating to manage input costs.

Net Investment Hedge: Foreign exchange risk management strategy that offsets translation exposure from investments in foreign subsidiaries via financial instruments or debt denominated in the same currency.

GLP-one: Reference to glucagon-like peptide-1 weight-loss drugs, discussed in the call as a potential consumer demand variable for snacking categories.

Working Media: Direct expenditures on paid media activities actively reaching target consumers, distinguished from non-working media, such as agency fees or production costs.

Retailer Destocking: Reduction of inventory levels by retailer customers, which can dampen manufacturer shipment and reported sales in the short term.

Full Conference Call Transcript

Andrew Lazar: Great. Thanks very much, and thanks also for putting out the prepared remarks. This time around. Very helpful. Derek, it'd be great if maybe you could do a brief walk through of the key geographies and how you see it all playing out in the second half. And then, Luca, given the additional weakness in North America, what incremental actions can the company take, whether they be on the cost side maybe more importantly on the demand driving side to accelerate growth there even in the context of a weaker category. Thanks so much. Thanks, Andrew.

Dirk Vandaput: Yeah. Yeah. Maybe quickly, overall, we think the q two results are quite good. We had some good pricing. If you discount for the downsizing, we're flattish as it relates to volume mix. And our bottom line is slightly better than expected. I think what also is clear is that we have very good global balance in the sense that we see a continued weakness in North America but we had a strong quarter the rest of the world. And since our sales are well balanced between the different continents, that really helps us.

The other one that's important for us is that chocolate and the significant pricing increases and RGM actions that we've done are playing out in line with expectations. So that's good. Our categories are showing continued strength. And we are maintaining our full year outlook. So overall, we feel good about the quarter. If I go a little bit around the world, maybe start in Europe, a good quarter in Europe, with good numbers, strong share gains, Clearly, the business is very resilient. The consumer is more confident in Europe still quite fragile. And frugal spending snacking continues to outpace food. And overall, I would say, we feel pretty good about our European business.

Consumers are not exactly bullish, but and they're focused on essentials, but they keep they keep on buying our category even despite the significant price increases that we had to do in chocolate. If I go to the US, a little bit more of a difficult situation there. There's a lot of consumer anxiety. They look at quite uncertain outlook as it relates to their personal finances, job expectations, inflation. So they tend to focus more on essential on essential items size of the basket is getting very important. Absolute price point the channel shifting going on, There's more promotions and some back shifting too. So overall, we see a pretty soft disc kits category.

Probably performing a little bit better than other snacking categories with holding share, but overall, the volume is declining. Switching to the emerging markets, we feel very good, double digit growth. We have a sustained volume and volume growth. We have very good share gains in Brazil, in India and Mexico. Consumer confidence is softer in these markets. They are worried about their personal finances, job security, inflation. So we see the same channel shifts mainly into bulk and discount in places like China. We also see the fact shift But emerging markets continue to be an attractive growth engine for us. And if you look at our four major markets, we feel good about China, India, Brazil.

Mexico has been softer. But overall, I would say clearly a strength this quarter in emerging markets. Okay. Thank you for your question, Andrew. So as far as North America goes, first of all, there is clearly a consumer sentiment that is impacting consumption across the board. We have not planned for a material rebound of the category in the rest of the year. So I want to reassure you that in the guidance we have given, we have reaffirmed, there is no material improvement of the U. S. General sentiment.

In terms of blasting the plan up, what we have done is, first of all, we have announced incremental pricing that is going to take effect in few weeks in North America. I won't elaborate much, but we are clearly at the point in time where we see inflation going up. Our cost base is higher, particularly because of cocoa, but not only. And I think that will boost revenue and top line. We have done quite a bit of work in terms of being patient active instead of picking the items, for instance, that were most impacted by cocoa, we went pretty much across the board with more limited price increases.

We had protected certain points where we see consumers going. We also had protected specific formats that consumers favor in doing their buying habits. We have a plan that aims at boosting productivities in the second part of the year, and the team has done a very good job in terms of ensuring cost control. And I think you are going to see a rebound of North American profitability particularly in Q3. The team continues to pursue incremental opportunities, particularly in alternate channels.

We mentioned a few times that our share gains in channels like club and dollar in dollar and value, they are clearly outstanding, and we have again the opportunity to get to our fair share or closer to our fair share in those alternate channels. So quite a bit of actions that are planned for the second half. But again, we are not putting out wishful thinking in terms of category rebounds, etcetera, I think it is a fair assumption and safe one.

Andrew Lazar: Thank you.

Operator: We'll go next to Peter Galbo with Bank of America. Hey. Good afternoon, Jerk and Luca. Thanks.

Peter Galbo: For the question. I wanted maybe to put a finer point on the prior previous question, particularly around the lack of change in guidance for the second half. Clearly, you had a, you know, a strong delivery on the first half. So there maybe you can just put a bit of a finer point on the puts and takes in the second half It seems like, you know, maybe the US is a bit weaker than you thought, but then there's other pieces that are holding it up. Any other considerations that we should really think about as we as we contemplate that?

Dirk Vandaput: Yes. So yes, we're trying to be vigilant and make sure that we can execute against our agenda. I think that we have accounted in our outlook for the tougher areas as Luca was pointing out. So the ones that we are keeping an eye on, first one would be chocolate What we've seen in the chocolate in Europe is a very good Easter. We executed well in our RGM and pricing strategy that in the market. Then in June and July, there was quite a heat wave in Europe. And so volumes were lower than expected. In the last two weeks. The temperature have gone down, and we see the volumes come back.

So we are quite vigilant on chocolate elasticity for the second half of the year. But it's difficult to read at this stage with this heat wave in Europe. As it relates to the U. S, we really don't see an immediate change. If anything, I think the consumer will see the full effect of the tariffs in the second half. And so we will see where the consumer confidence and the consumer spending will go. And so we have to be careful of that.

And I would say those are the two big factors that make us keep our current outlook They're like Luca said, we've included I think, a realistic view on what is going to happen in those two. And that seems at this stage for me the best stance that we can take.

Peter Galbo: Okay. Thanks. As a follow-up, there's obviously been a lot of discussion around you know, the move in cocoa and cocoa butter in particular. Which I think has moved in a pretty favorable direction. Maybe you could just talk about how we should extrapolate that, how you're thinking about it as you begin to contemplate hedging for twenty six. Thanks very much.

Luca Zaramella: I think when you look at the cocoa market fundamentals, they are going in the right direction There has been clearly a pressure point in terms of demand. I think you saw the grinding numbers being down seven, eight percent. And that drove a couple of weeks ago a low level of cocoa price below you know, the five thousand GBP per ton mark. Clearly, we took advantage of that. And it is what we said to you many times, which is many adjacent categories are reformulating out of real chocolate and moving into what we call compound? The pop count in West Africa is very promising. The weather has been cooperating.

And, look, now we're spending the fact that there is still a long way to go. Today, with the fifty percent confidence level, we can say that the season is going to be good in terms of the crop. And so potentially, there is a material and meaningful upside between supply and demand into the twenty six season. The level of the industry stock is still low. So many are on the watch out still. And so I believe the sentiment the overall sentiment is that sooner or later, cocoa prices will have to come down. On the cocoa butter which is the most noble part of cocoa, and it is the one we use the most around the world.

And that is what allows you to call chocolate, for instance, in places like Europe. It has come down dramatically, I would say, versus last year. It is usually traded as a ratio to the overall cocoa prices. Last year, it was most likely at a certain point in time even higher than three. And it went almost to four. And today, it I think we can strike contract with supplier for most likely half of that of that price and ratio.

And so there is a material benefit coming, which obviously is affecting you know, the cost we have seen as of as of late But in general, we feel like cocoa prices will have will have to come down.

Dirk Vandaput: Alright. Next question.

Operator: We'll go next to Megan Clap with Morgan Stanley. Hi. Good evening. Thanks so much. Maybe another follow-up on the second half outlook. There was a comment in the prepared remarks just about some of these headwinds reducing your flex

Megan Clapp: And I guess if I were to look at what's implied in the second half, in terms of organic sales growth, it's it's roughly similar to what you reported in the second quarter. And just wondered if we could talk a little bit more about the regions and how to bridge from the second quarter to the second half does seem like you have good momentum in emerging markets. You'll have more pricing coming through in Europe. Understand maybe elasticity is a bit higher. North America is weak, but, Luca, if I if I understood you correctly, maybe North American could get a little bit better.

So are kind of the offsets that I'm missing that, you know, reduce the flexibility in your minds as it relates to the second half. Thank you.

Luca Zaramella: Thank you, Megan. So as far as outlook goes, in the prepared remarks, we make a comment about a little bit less unprecedented heat wave that impacted chocolate in Europe is clearly something we couldn't predict as well as the impact we had particularly in the U. S. Because of the trade destocking. So that's what we really mean by a little bit less flexibility. You might imagine, we try to keep always a little bit of a buffer, particularly as we give guidance because things can happen. I think what we see in the last couple of weeks in Europe is the weather being more collaborative with us. And we see chocolate consumption coming up.

And you might imagine it is a little bit hard to distinguish between elasticities and weather consumption. But the latest indication is that the volume impact on chocolate is more benign than we have seen in the last I would say, couple of months. Now you know, that has implications in terms of shipment in Europe in Q3. And so we are a little bit prudent in terms of projecting Europe, particularly in Q3. North America, the pure fact is that the major market category wise is, at this point, down, volume wise, minus three percent The category started going south in Q4 and even in Q3 last year.

So we are lapping but we are projecting our category volume wise to be down still three percent. Now there is pricing, so revenue should go up from the what you have seen particularly this quarter on the positive side and clearly top bottom line should go up as well from what we have seen this quarter. In emerging markets, we have implemented multiple waves of pricing. We are out with a new price both in India and Brazil that are the main we have in emerging markets.

And so again, we need to stay quite prudent and see what happens to elastase We don't have reasons to believe that elasticity is going to be worse than what we planned for at this point in time. But again, we want to be on the cautious side. Our biscuits business continues to do well, excluding North America actually year to date revenue is up a little bit more than seven percent. And, again, we project a combination of that. So we really want to be on the prudent side, I would say. I'm not suggesting that the guidance is a slam dunk at this point in time.

You know that in the US, most likely, there is a wave of inflation coming up. And so we have to be we have to stay prudent and execute with excellence as I think we have done in most of the cases in the first half.

Megan Clapp: Okay. Great. Super thorough and helpful. Thank you. Then maybe just a follow-up on Coco. You know, when we came into the year, you said there's essentially two scenarios in terms of twenty six. One is COKO comes down and you have higher earnings upside potential. Two is elevated. You have to take a bit more pricing. And, you know, you mentioned you took advantage of the recent drop in cocoa prices, but how are you thinking about you know, whether or not you might have to do a little bit more pricing, some more r g m and I guess, how are you thinking about that into the back half of this year?

Luca Zaramella: So I think, look, this is one of the unknowns of the plan. I think but I might be proven wrong. I believe that with the new crop data, we will know which direction Coco is gonna take particularly for twenty six. And I think there are possibly two scenarios. One, it is if stays elevated, but the other one is it might go down quite rapidly because if there is a surplus, I between supply and demand, I think there will be material cost availability that will drive prices down. In the first case, I think we might need or not additional pricing based on where Coco is.

If it stays where it is, I think all the actions that we are about to take from now to the end of the year in some of the markets, I think will put us in a good spot. I said many times that when I look at the underlying per kilo of cocoa, or the chocolate business gross profit dollars, I see a number that I like as we exit the year. Remember that pricing as a carryover as well into next year. So if Coco stays elevated, there might be additional pricing But I think in all we know, we should be in a good spot at the end of the year.

If COCO comes down, the question becomes what do we do to protect demand? What do we do to face potentially some competitive actions, etcetera. But in the end, I think the P and L will try because if I apply the elasticity, yes, seen on the way up, to the way down, there is either material price upside or there is a potential volume rebound. Also remember one critical thing which we said many times The GIS chose model of this company has been in the last few years to protect gross profit dollar growth, as opposed to percentages, but it has also been investing for which and in route to market.

And we will continue to do so and potentially in twenty six we'll step it up depending on the level of Coco to the point where we really reestablish a virtuous cycle, which is volume growth share growth, generation of GP dollars and again good cash for the company.

Megan Clapp: Great. Thank you.

Operator: And just a reminder, it was We will go next to Robert Moskow with TD Cowen.

Andrew Lazar: Maybe just a couple of things to clarify, Luca.

Robert Moskow: The comment that you need to invest in working media in twenty six you know, a lot of other companies do that when they reduced media in a given year. So it doesn't sound like that's what you're doing. So maybe you could you could explain whether that's like a catch up in twenty six or not. And then I'll ask a quick follow-up.

Dirk Vandaput: Yes, Rob. I'll take that. So the way I would describe it is that we will have a chocolate category whereby the price will have gone up thirty percent to fifty percent in the last two years. And what we see is consumers are staying in the category but they're diminishing their frequency and they're diminishing bought. So we expect that after all the price increases and even if cocoa comes down, I'm not expecting they will come down enough for us to see significant price reductions in chocolate. We will have to support our brands and make sure that the volume in the category remains or goes back to where it historically has been.

I don't know where we will end the year, but you could expect chocolate volumes around the world to be down so far. We see it down six, seven percent. That's the latest news on grindings for cocoa. So that's the main reason why we think we will have to reinvest On top of that, as it relates to biscuits, particularly the U. S, we see a very anxious and weak consumer situation. I'm not expecting that immediately will be better next year. So I'm expecting that we will have to increase our investment in our brands also in North America next year.

Those are the two main reasons why we believe that it is appropriate to increase our media investment next year.

Luca Zaramella: And you're right. We have protected working media This year, what we have got is the non working bar. And so I wouldn't say the baseline is favorable. But this year, unlike other years, we haven't increased book in media much.

Robert Moskow: Okay. And my follow-up is, I noticed, Luca, that you said you know, category volume down about three percent in biscuits in first half. You expect it to be similar in the second half. But then you're also raising prices in the US, and you've mentioned that the consumer's under a lot of pressure. Is this one of the know, the flex points that might go the wrong way? You know? And how much pricing do you think you'll you'll raise in the US?

Luca Zaramella: Look, I'm not gonna comment specifically on the amount of pricing yet But as I said, the price increase that we are about to take has been quite surgical. We mentioned to you a few times that beeping three dollars and four dollars per pack, it is the magic of being there and attracting consumers And that's what really we are about to not to touch. We will protect those price points. I we mentioned to you that there are specific pack sizes that are very relevant to consumers like the multipacks. We are keeping those price points.

There are brands that are not our top brands necessarily where we are going to go with higher prices and that over time has proven to us that elasticity is not material. And then there is a whole host of ideas as to what we have to do to boost consumption in the second half, particularly as it boils down to RGM and promotions. I think the team has says late of actions that hopefully will lead to much better revenue results.

So you're right in saying how do you reconcile the fact that consumers are price sensitive to a price increase But we have done our homework and we believe there is not going to be a material volume repercussion on consumption in our case.

Robert Moskow: Got it. Thank you.

Operator: We'll go next to Alexia Howard with Bernstein.

Alexia Howard: Good evening, everyone.

Dirk Vandaput: Hi, Alicia. Hi. Hi.

Alexia Howard: Can I start with a question on use of the cash? It seems as though you are taking on a bit more debt in order to repurchase shares. I think you put a nine billion dollar share repurchase approval over the next three years out at the end of last year. Should we expect that dynamic to continue? How are you thinking about the trade off between taking on debt and continuing to repurchase our shares at this point.

Luca Zaramella: Look. The number one ticket item between the balance of cash flow and share repurchase and dividend, is actually the forex impact on our debt. Our debt composition is made up of obviously a dollarized base, but importantly of the euro, of the GBP, of what you call it. We have diversified the currency nature of our debt over time. And we believe that this is the right action to take. The second thing which is not capturing that is we have meaningful net investment hedges that hedge the composition of the balance sheet and the variety of currencies that we have functionally around the world.

So looking at the debt that is impacted by ForEx, and not looking at the overall balance sheet and the gains, the material gains we are making on the net investment hedges is a little bit misleading. But to your point about share, I speak to what I said in the Q1 call. We have been buying back quite a bit of shares at a very compelling price which was below sixty dollars per share on average. We are gonna be very pragmatic shoot the stock for any reasons.

And quite frankly, I have to say, when I fast forward and I see COVID coming down, when I see Mondelez in a context where many companies are challenged printing a number on top line, which is quite good. As I look at the plans around the world, I believe we are setting ourselves up for a decent twenty six I don't believe necessarily the stock price is gonna go down much I hope, from here. But in case it does, we are going to be pragmatic and buyback more stock. And I think in hindsight, as COCA normalizes and we look at our normalized earnings, this will be one of the best deployment of capital decisions we have made.

Great. Thank you. And just a follow-up,

Alexia Howard: weakness in North American volumes, I know you've attributed it to weakness, value seeking behavior on the part of consumers. How are you thinking about the GLP one impact on these indulgent snacking categories, particularly as we think about pill versions coming out next year, is there a danger that North America sees continued pressure? Obviously, your other regions are doing fine, which is great. But I'm just thinking about how you prepare for that eventuality next year. Thank you, and I'll pass it on.

Dirk Vandaput: Yes. Well, I mean, from our perspective, there is currently no real impact on our volumes coming from GLP-one. We did an in-depth analysis in North America and most of the negative volume that we're seeing and the changing in consumer buying is all driven economically. The anxiety about the future the frustration with the inflation and so on. We look at the numbers, at this stage, the penetration of the drug in the adult population is about four percent. The reduction in calorie intake at this stage is about eleven percent, and consumers are staying about nine months on the drug. The penetration is not going up at this stage.

And so you think about it, four percent of the population reducing their calorie intake by eleven percent, that is a zero point four percent effect on the total population. Of the total calorie intake, sorry, And so that is an almost invisible effect for us. Even if we extrapolate that for twenty six we do not see a major increase in the penetration of GLP once happening. And so think even in twenty sixteen, to be honest, when we even extrapolate it for ten years, we do not think that the effect will be significant. Don't think that the current weakness that we see in the snacking category is driven by GLP ones.

Nor will it be in twenty six.

Alexia Howard: Helpful. Thank you so much. I'll pass it on.

Operator: We will now move to our final question from Max Gunport with BNP Paribas.

Max Gumport: Hey. Thanks for the question. Just sticking on North America, I wanted to get a better sense for the retailer destocking that you saw. I'm I'm hoping to get more color on what drove it and how you think it plays out or recoveries from here. Thank you. Yes.

Dirk Vandaput: I mean, it's sometimes difficult for us to put ourselves in the place of the retailer. But we believe that this is driven by a number of things. But in the first place, probably the retailers wanting to manage their cash flow you think about it, there's an overall slowdown in consumption. Tariffs were coming. They probably wanted to import more from the countries that were going to be affected. So they increased the imports and increased their inventories in certain items and wanted to offset that by reducing other items. The second reason I think is there's an overall slowdown in food consumption and also in snacking.

So there's a need for them to have less inventory at this at this stage. For me, those are the two main reasons. As we said, we still have significant opportunity in other channels. So one of our strategies is to shift more of our pressure into channels like the value channels or ecommerce or the discounters. And that is giving us an opportunity to offset some of that destocking that we've seen in the retailers. But overall, I think those were the factors that drove it.

We were a bit surprised to still see some of that in q two, but I think we now have that behind us and q Q3 should be clean as it relates to in retailer inventory.

Max Gumport: Great. Thanks very much. I'll leave it there.

Dirk Vandaput: Okay. Thank you.

Operator: That will conclude the question and answer session. I will now turn the program back over Dirk Vandepak for any additional or closing remarks.

Dirk Vandaput: Well, I want to thank everybody for their interest for their attendance to the call. And you can always follow-up on more questions with our IR group And I'll see you for the call the quarter from now. Thank you. Thank you, everyone.

Operator: Thank you. This does conclude today's call. We thank you for your participation. You may disconnect at any time.

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This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. Parts of this article were created using Large Language Models (LLMs) based on The Motley Fool's insights and investing approach. It has been reviewed by our AI quality control systems. Since LLMs cannot (currently) own stocks, it has no positions in any of the stocks mentioned. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

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DATE

• Wednesday, July 30, 2025, at 2:00 p.m. EDT

CALL PARTICIPANTS

• Chief Executive Officer — Gernot Ruppelt
• Chief Financial Officer — Bart Kelleher

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TAKEAWAYS

• Adjusted Earnings: Adjusted earnings were $9 million, or $0.22 per share, for the second quarter.
• TCE Rates — MR Tankers: MR tankers achieved $23,500 per day during Q2 2025. Booked $25,500 per day so far in the third quarter, with 50% of available days secured.
• TCE Rates — Chemical Tankers: Chemical tankers earned $20,400 per day, and $21,700 per day so far in the third quarter, with 65% of available days secured.
• MR Tanker Acquisitions: Agreement to acquire three secondhand Korean-built MR tankers with deliveries expected this quarter; described as "attractive relative to applicable benchmarks" by CEO Ruppelt.
• Debt Refinancing: Closed a €350 million fully revolving credit facility with a 1.8% margin and a six-year tenor; all existing debt consolidated, providing enhanced financial flexibility.
• Fixed Rate Coverage: Secured a three-year time charter on one 25,000-ton chemical tanker at $19,250 per day, and added fixed rate charters on two MR tankers, bringing MR fixed rate coverage to four vessels at $22,500 per day on average for six to twelve months.
• Dividend: Eleventh consecutive dividend declared since policy reinitiation in 2022.
• EBITDAR: Reported EBITDAR was $22.4 million for Q2 2025, serving as a key comparable metric.
• Dry Docking Capex: Projected at $35 million to $38 million for 2025, with approximately 50% of the 2025 capital outlay is allocated to coatings and efficiency upgrades.
• On-hire Availability: The fleet achieved 99% on-hire availability during Q2 2025.
• Fleet Improvement: Five out of six chemical tanker recoatings finished, with access to premium cargoes and improved asset utilization already noted.
• MR Fleet Order Book: The order book stands at 14% of the MR fleet as of Q2 2025. Half the fleet is expected to be over 20 years old by the end of the decade.

SUMMARY

Ardmore Shipping Corp. (NYSE:ASC) reported $9 million in adjusted earnings for Q2 2025, supported by rising TCE rates for both MR and chemical tanker segments and the execution of strategic vessel acquisitions. The company consolidated its debt under a €350 million revolving facility with favorable terms to maintain low cash breakeven and improve operational flexibility. Capital allocation included sustained dividend distributions, targeted acquisitions, and continued investment in fleet enhancements. Management indicated that drydocking and related capex will moderate in future periods, creating the potential for increased revenue days and earnings power.

• Bart Kelleher highlighted the aging MR fleet with the decreasing order book, emphasizing limited newbuild supply as a favorable dynamic.
• Management stated that market dynamics remain favorable, driven by stronger refining margins, OPEC+ production increases, and heightened geopolitical factors.
• The company noted progress on digitalization and AI investments contributing to operational efficiencies across fleet and shoreside operations.
• Refinery relocations and closures, particularly in the West, are driving longer ton-miles and increased transportation demand, which management believes could accelerate over the next year.

INDUSTRY GLOSSARY

• MR Tanker: Medium Range product tanker, typically 45,000–55,000 deadweight tons, used to transport refined petroleum products.
• EBITDAR: Earnings Before Interest, Taxes, Depreciation, Amortization, and Vessel Rentals; metric for comparing operating performance, including ship charter costs.
• Time Charter Equivalent (TCE) Rate: Standardized revenue per day, allowing performance comparison across types of charters and spot voyages in shipping.
• Ton-Mile: Volume of cargo multiplied by distance moved; a key demand metric in shipping reflecting transport workload.
• Aframax: Crude or product tanker with capacity between 80,000–120,000 deadweight tons, a relevant benchmark in tanker market supply dynamics.

Full Conference Call Transcript

Gernot Ruppelt: Please allow me to outline the format of today's call, which you can see here on Slide three. First, give you the usual snapshot of second quarter highlights, and then we will call out some transactions we executed since our last call. I will then hand over the call to Bart Kelleher, who will cover the market outlook and provide an update on our financial operating performance. Thereafter, I will conclude the presentation before opening up the call for questions. Turning first to Slide four. We are pleased to report adjusted earnings for the second quarter of $9 million or $0.22 per share. TCE rates have been increasing over the course of the year.

And in the third quarter, typically a softer period, we are seeing continued momentum with even higher bookings today. Our MRs earned $23,500 per day for the second quarter and $25,500 so far in the third quarter with 50% booked. Meanwhile, our chemical tankers earned $20,400 per day for the second quarter and $21,700 for the third quarter with 65% booked. Overall, these rates reflect levels that are about double our cash breakeven. Market dynamics remain favorable driven by stronger refining margins, OPEC+ production increases, and heightened geopolitical factors. In addition, long-term industry fundamentals remain robust, which we will cover in more detail later. Moving to slide five.

Since our last earnings call, that enhance our strong performance while opportunistically cementing earnings quality. We agreed to acquire three high-quality MR tankers in the second-hand market. All vessels were built in Korea, and we expect to take delivery this quarter. We achieved prices that are attractive relative to applicable benchmarks, reflecting Ardmore Shipping Corporation's disciplined and deliberate approach to fleet growth. We also closed on a comprehensive refinancing with leading banks at favorable terms. Through this refinancing, we consolidated our existing debt into a single fully revolving credit facility. Euros $350 million in total. This enhances our financial flexibility while supporting low cash breakeven.

In addition, while our predominant trading strategy remains focused on the spot market, we dynamically executed on selected quality fixed-rate opportunities. For one of our 25,000-ton chemical tankers, we secured a three-year time charter at $19,250 per day. The counterparty is a top-tier chemical producer. And to give you a bit of context, we achieved essentially what is a three-year MR rate which goes without saying as a vessel twice the size. On a more tactical level, we opportunistically increased our short-term coverage adding fixed-rate charters on two additional MR tankers. This brings our MR fixed rate coverage to four vessels, at an average rate of $22,500 per day over varying durations between six and twelve months.

Turning to Slide six. Where we highlight our capital allocation policy and how we are delivering across all strategic priorities. We continue to balance growth, reinvestments in our fleet, and capital return to shareholders while maintaining low debt levels. We declared our eleventh consecutive dividend since the reinitiation of our dividend policy in 2022. We just mentioned our acquisition of three modern MR tankers, and we are almost done with our chemical tanker recoating project, which we discussed previously. Five of the six recoatings are completed, with the final vessel scheduled for completion this quarter. We are already seeing results for the ships on the water, accessing premium cargoes and boosting earnings power.

With that, I would like to hand it over to Bart Kelleher.

Bart Kelleher: Thanks, Gernot Ruppelt. Turning to Slide eight and the market outlook. Starting with industry fundamentals. With OPEC+ ramping up supply, an additional 2.5 million barrels of oil per day are forecast to hit the water by September. And at present, low diesel inventories, particularly in Europe, have already driven up crack spreads. Boosting trading activity and incentivizing increased refinery production. In addition, the EU has further ramped up sanctions. Creating market inefficiencies and effectively reducing vessel supply. Furthermore, fresh Chinese export quotas for refined products are anticipated to be announced in the near term. Following a significant ramp-up in exports in July, the current quotas are expected to be fully utilized earlier than normal. Turning to slide nine.

Where we examine the ongoing evolution of the global refinery landscape and its positive impact on product tanker demand. The refinery base continues to shift, Refining and petrochemical capacity is increasingly concentrated in the East. While closures persist in the West. Driving ton mile growth. As shown in the table on the upper right, new capacity additions in Asia, The Middle East, and Africa. Sharply contrasted with recent closures in The U.S. and Europe. A clear example is playing out in California. Local refinery shutdowns are leading to record-high imports. The chart on the lower right emphasizes the ton mile component.

Refined product that would have been produced and consumed locally on the West Coast must now be imported on lengthy transpacific voyages. This trend is anticipated to accelerate in the near term with additional refinery closures planned for the U.S. West Coast over the next twelve months. On slide 10, we contrast the aging MR fleet with the decreasing order book. Highlighting the favorable supply dynamics. Starting with our favorite chart on the left, the evolution of the MR fleet over time. As we have discussed on previous calls, the MR fleet is the oldest it has been this century.

And with the lack of new build orders this year, the order book is now declining and currently represents just 14% of the overall MR fleet. Moving to the chart on the right, the aging fleet is three times larger than the current order book. Half the fleet will be older than twenty years by the end of the decade. Now moving to slide 11. Looking at the broader product tanker sector, it is important to highlight the positive impact of the low Aframax order book. LR2s have been exiting the product trade shifting into the crude trade, as the Aframax fleet continues to shrink. This is not a temporary shift.

More than 50% of the Aframax fleet is now over fifteen years old, and there are essentially no new orders for uncoated Aframaxes. The trend is already very evident today, Looking at the chart on the right, the percentage of LR2s in the clean trade has declined over the last several years. Now moving to slide 13. Turning our attention to Ardmore Shipping Corporation's financial performance. We continue to maintain our strong financial position. We successfully refinanced our existing debt facilities into a single fully revolving credit facility enhancing our financial flexibility and supporting our low cash breakeven. As highlighted in the table on the left, the terms are quite attractive.

Including a margin of 1.8% and tenor of six years. We are showing quarter-ending figures as well as pro forma that include the three vessel acquisitions. As you will see, given the notably lower margin and modest leverage level, we continued to maintain our low cash breakeven. Turning to Slide 14, for financial highlights. For the second quarter, we reported EBITDAR of $22.4 million and as mentioned earlier, earnings per share of $0.22. We continue to frame EBITDAR as an important comparable valuation metric against our IFRS reporting peers. Full reconciliation details can be found in the appendix on slide 24. As noted in the chart on the bottom left, we continue our downward trajectory on cash breakeven.

Achieving this in an elevated interest rate environment and when accounting for the recent vessel acquisitions. This cost discipline in tandem with our significant operating leverage, strongly positions Ardmore Shipping Corporation to take advantage of market volatility. Also, please refer to slide 25 in the appendix for our third-quarter guidance numbers. Moving to slide 15, for fleet operations. The majority of this year's drydocking work is now behind us. And we have limited dockings in the years ahead. The company stands to benefit from increased revenue days and enhanced earnings power. Dry docking and the related capital expenditures for 2025 are now projected to be $35 million to $38 million.

As a reminder, approximately half of this capital outlay is related to tank coatings and efficiency upgrade projects. This also includes the first special we are acquiring this quarter. In addition, we are continuing to invest in digitalization tools and AI and are seeing benefits across our fleet and shore-side operations. Finally, our on hire availability was a strong 99% in the second quarter. Moving to slide 16, Here we bring our nearly completed MarineLine project to life. As you can see in the shiny pictures on the bottom left, we have got some really fresh high spec tank coatings that are enhancing our trading flexibility attracting premium cargoes.

These vessels have not been out of the yard for very long and we have already secured some really exciting voyages. Achieving strong TCE premiums. In fact, with our new coatings, our vessels are practically behaving close to stainless steel tankers but at a lower capital cost based on current market values. In addition to this, we are benefiting from shorter tank cleaning times improving asset utilization and reducing fuel consumption. With that, I am happy to hand the call back to Gernot Ruppelt and look forward to answering any questions at the end.

Gernot Ruppelt: Great. Thank you, Bart Kelleher. Moving to Slide 18. Allow me to summarize three key points. Earnings have continued to strengthen through 2025, and into the third quarter, reflecting favorable market conditions. Executed a range of well-timed transactions and initiatives that further enhanced our strong performance and earnings power. While maintaining our financial strength. And guided by our strong governance, and consistent approach to capital allocation Ardmore Shipping Corporation continues to deliver on its strategy to create long-term value through market cycles. And with that, we now welcome your questions.

Operator: Thank you, gentlemen. Ladies and gentlemen, we will now begin the question-and-answer session. Should you have a question, please press the star followed by the one on your touch-tone phone. You will hear a prompt that your hand has been raised. Should you wish to decline from the polling process, please press the star followed by the two. If you are using a speakerphone, please lift the handset. Before pressing any keys. One moment for your first question. Our first question comes from Omar Nokta from Jefferies. Please go ahead.

Omar Nokta: Okay. Thank you. Hi, Gernot Ruppelt and Bart Kelleher. Good afternoon. You know, clearly, the company has been in a net cash position for the past several quarters. You are buying these MRs. And it is not really going to stress your, stress your balance sheet. Obviously, you need to take your ships in transition them in, and get them going. But in general, is there a target leverage you want to get to in a perfect world given you know, in this environment, assuming nothing changes from here, is there a certain net leverage ratio you would like to get to?

Gernot Ruppelt: I will let Bart Kelleher comment on that in a second. Omar Nokta, good morning, and thanks for joining. But I think we are really focusing on value and being opportunistic all the avenues of capital allocation. We saw great value in these three ships. Quality built, top yard, attractive prices. And we have demonstrated that we were able to be patient as we as we felt the market were going through a notable correction over the past year. And now certainly at an opportune time, we were able to be very decisive ultimately, that is what we are looking for. For us, of course, you know, having the financial flexibility to do so is important.

We are not trying to optimize for a specific growth target. We are under no rush. We have an organization that is performing to a very high standard. Is very scalable, but at the same time, you know, it is ultimately value that we are looking for. And that will determine our future capital allocation choices. Debt through the cycle. I would say it is situational in terms of the market conditions and our view of forward market conditions. But maintaining some dry powder to be opportunistic and build value all while maintaining the low breakeven are things that are really important that are in focus. Thank you. Now

Omar Nokta: That is helpful, perspective. And maybe perhaps Gernot Ruppelt just a bit more kind of like a market related question and you know, obviously, a lot of moving parts to this. But, you know, recently, we have been seeing the U.S. stepping up pressure on Russia and using tariffs perhaps as a bit of a deterrent for, say, Chinese or Indian refiners to buy those barrels. And refine it. How would you as you see this, things are still to develop, but how do you see this kind of affecting the product market, if things really start to take shape on that front.

Gernot Ruppelt: Yeah. I think there is a there is a few different things in play. Think markets are definitely getting a stronger sense of direction. We have gone through a period of risk aversion at the earlier part of the year. And think that is now overcome by sort of a snapback in activity. Inventories need to be rebuilt. There is this catch up phase in trading activity. That is playing out now in the third quarter. And of course, we are not far from sort of a structurally stronger winter.

I would say that, without kind of trying to unpack, you know, the many layers of the geopolitical landscape, we continue to of course, monitor very closely as long as we continue to see reshift in trade, reshift in regulation, you know, that creates constant reshift in trade flows as well. That sort of volatility is something that benefits the overall product tanker market. And the way we operate the business, I believe we are perfectly geared for that because it is always the question, you know, about how can we best position ourselves in those shifting trade flows.

Omar Nokta: Thank you, Gernot Ruppelt, for that. And then, Bart Kelleher, thank you. I will I will turn it over.

Operator: There are no further questions at this time. I will now turn the call over to management for closing remarks. Please continue.

Gernot Ruppelt: Thank you, operator. We understand it is a busy reporting day for shipping in the broader general transportation sector. So look forward to further Q and A in follow-up meetings. Thank you. All set for now on the call.

Bart Kelleher: Thank you.

Operator: Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.

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DATE

Tuesday, July 29, 2025 at 8 p.m. ET

CALL PARTICIPANTS

President and Chief Executive Officer — Jugal Vijayvargiya

Vice President and Chief Financial Officer — Shelly Chadwick

Director, Investor Relations and Corporate FP&A — Kyle Kelleher

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RISKS

CEO Vijayvargiya said, "there is a lot of uncertainty that's still out there," referencing ongoing tariff environment risks affecting business predictability.

Chadwick indicated, "uncertainty remains around our semiconductor sales to customers in China," due to market and policy volatility.

TAKEAWAYS

Adjusted EBITDA— $55.8 million, representing a 20.8% margin on value-added sales, a second-quarter record but down 3% year-over-year due to lower volume and unfavorable mix.

Value-Added Sales— $269 million, down 2% organically year-over-year, but up 4% sequentially, primarily affected by lower precision clad strip and China semiconductor demand.

Adjusted Earnings Per Share— $1.37, down 4% year-over-year, but up 21% sequentially (adjusted, non-GAAP).

Free Cash Flow— $36 million, with year-to-date free cash flow conversion over 70% of adjusted net income, reflecting disciplined capital allocation.

Electronic Materials Segment EBITDA Margin— 23.4% of value-added sales, an all-time high, with the segment up 6% outside China year-over-year and margin up 230 basis points year-over-year.

Performance Materials Segment Value-Added Sales— $168.5 million, down 3% year-over-year and up 5% sequentially; sales excluding precision clad strip rose 3% year-over-year, led by energy and aerospace and defense demand.

Precision Optics Segment— Value-added sales of $24.4 million, down 5% year-over-year, up 14% sequentially, with EBITDA of $2.2 million or 9% of value-added sales, reflecting a 950 basis point sequential margin improvement.

Defense Market Performance— Record bookings of $75 million, over $100 million in requests for quotation, and a 60% year-over-year increase in non-US defense sales.

Energy End Market— Sales up 28% year-over-year for 2025; first-half 2025 new energy sales exceeded full-year 2024 totals.

Conasol Tantalum Assets Acquisition— Facility in Korea acquired and integrated, expanding semiconductor footprint in Asia; sample production for customer qualifications has begun.

Full-Year EPS Guidance Affirmed— $5.3-$5.7 adjusted earnings per share range for 2025, supported by order growth and backlog diversification.

Capital Deployment— $26 million of debt repaid and 100,000 shares repurchased at an average price of $78 per share.

SUMMARY

Materion Corporation(NYSE:MTRN) reported a record second-quarter adjusted EBITDA margin and sequential improvements in adjusted earnings per share and free cash flow conversion. Management attributed margin expansion in the Electronic Materials segment to operational performance and cost discipline, while the acquisition of Conasol's tantalum assets broadened the company's semiconductor presence in Asia. Affirmed full-year adjusted EPS guidance reflects confidence in sustained margins, increasing defense and new energy business, and improving semiconductor order rates.

CEO Vijayvargiya stated, "Our order backlog has more than doubled in the last year," specifically for space-related projects.

Chadwick said Precision Optics achieved a 950 basis point sequential margin improvement (excluding special items), underlining the positive impact of restructuring and cost initiatives.

Vijayvargiya emphasized, "Increased level of spending that's happening in Europe," across defense markets, broadening the company’s global reach.

Share repurchases and debt reduction indicate continued focus on capital allocation optimization.

INDUSTRY GLOSSARY

Value-Added Sales: Sales excluding the impact of pass-through precious metal costs, providing clearer insight into operating performance for engineered materials companies.

EBITDA Margin: Percentage of earnings before interest, taxes, depreciation, and amortization relative to value-added sales, used to assess segment profitability in materials manufacturing.

Precision Clad Strip: A composite engineered metal strip used in electronic, automotive, and specialty applications, produced through layering and bonding distinct metal materials for performance tailoring.

Tantalum Solutions: Business focused on manufacturing deposition materials, notably tantalum targets, for semiconductor and adjacent technology markets.

Full Conference Call Transcript

Kyle Kelleher: Greetings. Welcome to the Materion Second Quarter 2025 Earnings Conference Call. At this time, participants have been placed on a listen-only mode. Please note this conference is being recorded. I will now turn the conference over to your host, Kyle Kelleher, Director of Investor Relations and Corporate FP&A. You may begin. Good morning. Thank you for joining us on our second quarter 2025 earnings conference call. This is Kyle Kelleher, Director, Investor Relations and Corporate FP&A. Before we begin our remarks this morning, I would like to point out that we have posted materials on the company's website that we will reference as part of today's review of the quarterly results.

You can also access materials from the download feature on the earnings call webcast link. With me today is Jugal Vijayvargiya, President and Chief Executive Officer, and Shelly Chadwick, Vice President and Chief Financial Officer. Our format for today's conference call is as follows. Jugal will provide opening comments on the quarter. Following Jugal, Shelly will review the detailed financial results for the quarter in addition to discussing expectations for the remainder of 2025. We will then open up the call for questions. Let me remind investors that any forward-looking statements made in the presentation, including those in the outlook section and during the question and answer portion, are based on current expectations.

The company's actual performance may materially differ from that contemplated by those factors listed in the earnings call press release issued this morning. Additionally, comments regarding earnings before interest, taxes, depreciation, depletion, and amortization, net income, and earnings per share reflect the adjusted GAAP numbers shown in Attachments four through nine in this morning's press release. The adjustments are made in the prior year period for comparative purposes and remove special items, non-cash charges, and certain discrete income tax adjustments. And now I'll turn over the call to Jugal for his comments.

Jugal Vijayvargiya: Thank you, Kyle, and welcome, everyone. It's a pleasure to be with you today to discuss our second quarter results and provide an update on our outlook for the remainder of 2025. Our business performed very well in the quarter, delivering record second quarter margins and strong free cash flow. Although sales were down 2% organically, we experienced solid growth in aerospace and defense, energy, as well as in semiconductor outside of China. EBITDA was strong, at $56 million, and we continue to deliver margins above 20% despite some pockets of softness still moving through our top line.

I am particularly proud of our electronic materials team as they delivered an all-time high EBITDA margin of 23.4%, demonstrating the power of the work that has been done to optimize the cost and improve operational efficiencies in that segment. We have reached a new level of performance with EM, and I expect the business to deliver very good margin expansion for the full year. Precision Optics also showed a significant improvement in the second quarter as the transformation continues. Sales improved 14% sequentially, and EBITDA increased more than $2 million, marking the second consecutive quarter of improvement.

Beyond the cost structure improvements that have been implemented, the business is making excellent progress on new business initiatives that should begin contributing by the end of the year. As we have discussed over the last few quarters, cash flow generation remains a key focus for us. As evidenced by our Q2 results, we generated $36 million in free cash flow, the strongest we've seen in any second quarter. Our disciplined approach to managing working capital and pacing capital investments is driving the performance. Earlier this month, we acquired the manufacturing assets for Tantalum Solutions from Conasol, a Korean manufacturer serving the semiconductor and adjacent markets.

This acquisition expands our semiconductor footprint in Asia, allowing us to better serve the large tier-one chip manufacturers in that region and insource more of the target manufacturing value chain. This move expands our position as a leading global supplier of deposition materials. The integration is progressing well, and we have begun producing samples for customer qualifications. While the results for the quarter were very strong, there are many positive signs we're seeing in order rates, signaling promising momentum as we move through '25 and into '26. As the broader semiconductor market is showing signs of improvement, with wafer starts up and customer inventories coming in line, our order rates are improving, especially within data storage, power, and communication devices.

Sequentially, our order rates improved double-digit excluding China. Defense is an area that is getting a significant amount of attention globally, and this is leading to many new opportunities for Materion. With over $100 million of requests for quotation received in the second quarter alone, we saw record bookings of $75 million. And our initiative to grow our defense business outside the US has resulted in a 60% year-on-year sales increase. I expect the pace of defense-related activity will continue picking up. In space, we continue to win new applications and expand our reach.

Our order backlog has more than doubled in the last year, and we recently won a new application for ground station equipment with a leading US-based customer. Leveraging our larger space propulsion systems win in the US, we also secured an order for the same application for the customer in Europe. I also want to highlight our business activity in the energy end market. Our sales are up 28% year-on-year for '25. As we are growing new and existing business to meet the world's increasing energy demands, we have a particular focus on initiatives in new energy, where our first-half sales have exceeded the full-year sales of 2024.

As our business is well aligned to this global megatrend, we expect this area to be a growth driver for the company for the foreseeable future. When we released our first-quarter earnings in late April, there was considerable uncertainty surrounding the tariff environment, which we noted as a qualifier to our guidance. While much remains to be finalized, we are more confident affirming our initial full-year earnings guide despite the risk that remains. Thanks to our strong year-to-date performance, new business wins, and the increased order activity we are seeing. I would like to thank our global team for their unwavering commitment to driving our business forward while navigating the current environment.

Now let me turn the call over to Shelly to cover more details on the financials.

Shelly Chadwick: Thanks, Jugal, and good morning, everyone. During my comments, I will reference the slides posted on our website this morning starting on slide 10. In the second quarter, value-added sales, which exclude the impact of pass-through precious metal costs, were $269 million, down 2% organically from the prior year and up 4% sequentially. This year-over-year slight decrease was largely driven by lower precision clad strip shipments and semiconductor demand from China. Excluding the impact of these items, value-added sales would have been up 2% versus the prior year. Strength in aerospace and defense, energy, and semiconductor sales outside of China are driving the year-over-year sales increase.

When looking at earnings per share, we delivered quarterly adjusted earnings of $1.37, down 4% from the prior year, but up 21% sequentially. Moving to Slide 11, Adjusted EBITDA was $55.8 million or a second-quarter record of 20.8% of value-added sales, down 3% year-over-year with 10 basis points of margin expansion despite the lower volume. This decrease was driven by lower volume, partially offset by strong operational performance and structural cost improvements, offsetting unfavorable mix from hydroxide shipment timing. Moving to Slide 12, let me review second-quarter performance by business segment. Starting with Performance Materials, value-added sales were $168.5 million, down 3% year-over-year, but up 5% sequentially.

The year-over-year decrease was driven primarily by lower precision strip shipments as the expected inventory correction continues. Excluding Precision Clad strip, sales were up 3% driven by strength in energy and aerospace and defense. Adjusted EBITDA was $41.5 million or 24.6% of value-added sales, down 4% compared to the prior year period. This decrease was driven by lower volume and unfavorable mix, partially offset by strong operational performance. Looking out to 2025, we expect to see continued strength across the aerospace and defense, and energy end markets. In addition to higher volume, we expect to see continued strong operational performance and cost management. Now turning to Electronic Materials on Slide 13.

Value-added sales were $76.1 million, down 6% from the prior year, driven by lower semiconductor sales to China. Excluding this impact, the remainder of the semiconductor market was up 6% from the prior year, signaling market strength with improving demand across many subsectors. EBITDA, excluding special items, was $17.8 million or a record 23.4% of value-added sales in the quarter, up 4% from the prior year with 230 basis points of margin expansion. This record margin and year-over-year increase was driven by continued operational performance including the impact of our cost improvement initiatives, and strong price mix, despite lower volume.

As we look out to the remainder of the year, we expect the semiconductor market to improve in the second half and continue the momentum seen during the quarter. While some uncertainty remains around our semiconductor sales to customers in China, we are confident that our balanced and global semi portfolio will help offset some softness there. And as demonstrated so far this year, we expect to deliver considerable margin expansion as demand increases and the impact of our improved cost structure takes hold. Turning to the Precision Optics segment on Slide 14. Value-added sales were $24.4 million, down 5% compared to the prior year and up 14% sequentially.

The year-over-year decrease was driven largely by order timing in the defense market. EBITDA, excluding special items, was $2.2 million or 9% of value-added sales in the quarter. Approaching double-digit margin with 950 basis points of sequential improvement. The increase was driven by improving performance and the impact of the structural cost changes. This quarter brings the second consecutive quarter of improved results. We expect to continue this trend as new business initiatives advance and we continue to improve our business performance. Moving now to cash, debt, and liquidity on Slide 15. We ended the quarter with a net debt position of approximately $413 million and approximately $257 million of available capacity on the company's existing credit facility.

Our leverage remains below two times as cash flow generation is an important focus. We delivered approximately $36 million of free cash flow during the quarter, bringing our year-to-date conversion to more than 70% of adjusted net income. While continuing to invest organically, we also repaid $26 million of debt and repurchased 100,000 shares at an average of $78 per share. Further demonstrating our balanced and disciplined approach to capital allocation. As we look out to the remainder of the year, we are well on our way to deliver free cash flow that exceeds 70% of adjusted net income. With strong first-half cash generation, lastly, let me transition to Slide 16 and address the full year 2025.

We are pleased with our business performance in the first half of the year, having delivered strong results despite a volatile macro environment. And we are encouraged by improving market dynamics and new business opportunities won as we look to the second half of the year. With that, we expect Q3 will be similar to slightly better than Q2 and we are on track to deliver a strong Q4. With improving demand and the timing of defense shipments. As a result, we are affirming our initial guide of $5.3 to $5.7 adjusted earnings per share for the full year. This concludes our prepared remarks. We will now open the line for questions.

Kyle Kelleher: At this time, we will be conducting a question and answer session. You may press 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we pull for questions. First question today is coming from Phil Gibbs from KeyBanc Capital.

Phil Gibbs: Hey. Good morning.

Jugal Vijayvargiya: Morning, Phil.

Shelly Chadwick: Hi, Phil.

Phil Gibbs: So really strong performance in Electronic Materials in terms of their margins. Jugal, you mentioned a new level of performance and you expected for the full year. How sustainable do we think the recent quarters, you know, EM margins are? And then I also noticed there was a pretty solid sequential pickup in consumer electronics. I know that at times can have a nice, mix impact for you because I don't I wouldn't think intuitively it would've been a pickup in clad because I know that's in that in that piece. But you know, maybe talk about that holistically.

Jugal Vijayvargiya: Yeah. So, Phil, electronic materials, as you know, we've been talking about that for the last year, year and a half. You know, as the market has been down, our team has done a really nice job of driving operational performance, adjusting the cost structure, at the levels that we had. What that has done now, of course, is that as the volumes are starting to pick up, we are starting to see the benefit of that. And, we started with, you know, volumes picking up in the logic and memory section, but now volumes are starting to pick up in power. They're starting to pick up in our, our, data storage.

And I think that's giving us a Certainly, you know, 23 and a half percent type margins confidence, and it's leading to these improved margins that, you that we saw here in Q2. are not necessarily the type of margins that we think we can deliver every quarter. But it's very, very encouraging for us to see this. And I think the improvement, is gonna continue. I believe that we're gonna have a good year-over-year performance and margin expansion in this business. Especially as the as the market, you know, continues to improve. So we're very encouraged by where, electronic materials is and very encouraged with, I think, where it can go. The rest of the year.

But I think also, importantly, in June as we would expect the market to continue to rebound. I think with consumer electronics, you know, what the one of the reasons that the uptick took place is a little bit more shipments for our PMI business. We have, you know, as we've indicated that our full year is in line with what the customer has communicated to us in the past, there's no real changes on a full-year basis, but there certainly is always timing issues that happen between quarter to quarter. So nothing, nothing abnormal, I would say, there, but, you know, we'll continue to drive performance, of course, across all of our markets.

Phil Gibbs: Thank you, Jugal. Appreciate that. And then on energy, you talked a bit about that in your prepared remarks. It looks up a decent bit half on half. Versus last year. And I know that there's a couple, excuse me, of subsegments within your energy business, and maybe talk a little bit about talk a little bit more about what you're what you're seeing there and what has you excited. Thanks.

Jugal Vijayvargiya: Yeah. So as you know, we've had traditional energy. You know, we're we're an impactful player in the in the oil and gas market. Our content per rig has continued to improve. We provide, in fact, more content, you know, as the new drilling technologies come on board. And more and more electronics and more and more AI is implemented on the on the on the traditional energy side. So that feel makes us feel good, I think, in terms of that side of it. But last couple years, we've talked a lot about alternate energy, new sources of energy, in particular, clean nuclear energy. We've talked about our partnership with Kairos.

But in addition to that, we have a number of initiatives that we're involved in that, you know, we're not able to talk about the customer names, but we are involved in those. Here in the US as well as globally. And we're excited about You know, we're excited about where that can take us over the next three, five, seven years because as we know, the trend and the world's expectations of energy is increasing. The demand is increasing at a at a rapid rate, and the world has to be able to, conform to that demand. And I think we're a key player with our, materials in the energy, sector.

So not only are we excited about our content on the on the traditional energy side, I think we're even more excited about the role that we can play on the new sources of energy that I think, I think are coming forward. With the number of different projects that we have.

Phil Gibbs: Thank you. And then lastly for me, clearly, clearly outlined the tariff risks or potential tariffs tariff risks associated with China last quarter. Looks like you've essentially believe you've you fully mitigated that in the existing you know, Outlook and just curious from your perspective holistically, what has changed and what has, what has given you confidence in the landscape other than just the no, the pickup the cyclical pickup in the semis business overall? Thank you. Good luck.

Jugal Vijayvargiya: Yeah. Well, as you know, at the time that we did our Q1 earnings, you know, there were some substantial tariff rates both for material coming into the US and material going from the US into China. Changes happened, during the quarter, where those rates were reduced, significantly. As a result, we were able to get some product out still in Q2 that, you know, initially, had forecasted that we may not be able to get out. We never really stopped producing. We wanted to make sure that we were prepared in case there were changes to the tariff environment, and certainly there were, and we were able to take advantage of those.

Now we still had some level of impact in Q2, not to the level that we had initially expected. And we expect that there will still be some level of impact in the back half of the year as well. However, I think I'm really, really proud of our team for driving operational improvements, commercial improvements to our business. So that we can make sure that whatever impact that we think we may still have in the second half of the year we're gonna be able to offset that impact and deliver our original guide. You know, our incoming order rates are up, 4% from, second quarter to the, the first quarter to the second quarter.

Non-China semis up 15% sequentially. We have record defense bookings of $75 million. Our space backlog is double what it was at the same time last year. New energy sales, which I just talked about, you know, are up. We've had more new energy sales in the first half of this year than we had all of last year. So all those types of things, I think, give us encouraging signs of where things are headed in the second half of the year, and I think where we could be positioned, you know, for '26. So certainly, a lot of hard work by our team.

We're in no way out of the woods because, you know, there is a lot of uncertainty that's still out there. But certainly encouraging to see the results for the second quarter. And what it may do for us then, you know, in the back half of the year.

Phil Gibbs: Thank you.

Kyle Kelleher: Thank you. The next question will be from Daniel Moore from CJS Securities. Daniel, your line is live.

Daniel Moore: Good morning, Jugal. Good morning, Shelly. Congrats on the strong results. Thanks for taking the questions.

Shelly Chadwick: Thanks, Dan. Good morning.

Daniel Moore: Maybe just talk a little bit more about Conasol. Us a little bit more about the facility and the capabilities you're acquiring to your deposition capabilities here in the US? And how do we kind of think about, you know, either current revenue EBITDAs or the scope of the opportunity set over time?

Jugal Vijayvargiya: Yeah. I think this is a great move that our team has been able to make. As you know, we've been talking, Dan, for the last few years about continuing to gain more capacity and capability outside the US. Particularly in our semiconductor business. You know, the largest semiconductor suppliers, you know, tend to be in Asia. We wanna be make sure we're local, and we're providing the local support to those to those customers. Conasol fits right in for that. It's a facility in Korea. We're able to support not only the Korean, chip manufacturers, but also chip manufacturers in Taiwan, in China, in Japan, etcetera.

And, you know, it really gives us a full value stream for our tantalum business. It also gives us a facility that we can build on for our other semiconductor business as well, you know, down the road. So we were able to close on that, here in the in the second quarter. Now we're really, really excited and busy about making samples and qualification products, that we can give to those many customers in the Asia region. As you know, in this in this space, of course, it takes a little time to get the qualifications done. So perhaps, in some cases, it's six months. Other cases, it may be twelve months.

We would expect to see some level of sales starting in the twenty-six time frame and the associated EBITDA with that, but it positions us very well for, I think, the general growth that we see that we always talk about for the semispace over the next three to five to, you know, to seven years.

Daniel Moore: Very helpful. And just sticking with semi, obviously, you described very well some of the green shoots and improvements you're seeing here. Or at non-China. Maybe talk about what you're seeing or hearing in China specifically and any confidence in a return to growth as we think about '26 and beyond?

Jugal Vijayvargiya: Yeah. Well, you know, first of all, to your point about the green shoots, yeah, we, you know, we started to see the green shoots in the and memory side maybe a couple quarters back. But what's really encouraging to us I think, is the is the growth and sort of the green shoots that we're starting to see on our data storage business, on our power semiconductor business, our communications devices business because, you know, that's a that's at the heart of our heart of our business in the electronic materials business. It contributes, you know, good, obviously, on the top line, but also very good on the bottom line.

So we're very, very encouraged with where things are starting to develop. I mean, we really think that trend can continue here in the back half of the year. With regard to China, you know, China, as you know, has been developing a their own semi supply chain for a number of years now. They've put a lot of effort into it, and I think they've made great progress, along with, of course, the full manufacturing or final manufacturing for the semi side. They're also doing a great job of putting their own supply chain in place.

So, certainly, we wanna be, involved in that China semi main many manufacturing over the long term, but we also recognize that, you know, there will be a competition from the local players, you know, and as they gain, as they gain speed. So I think for us, we're looking at the global market, the investments that are going on in the US, investments that are going on in Europe, and, of course, the investments that are going on in Korea, Taiwan, etcetera. And in general, we believe that semi will continue to be, you know, mid-single digits to high single digits growth market for the foreseeable future.

Daniel Moore: Super helpful. Last for me, and I'll I'll jump back. It just kinda it sounds like Philip Morris or PMI, no changes to the kind of full-year outlook. Any update on potential timing around phase two of, you know, precision cloud strip project and what you're hearing, in terms of from the FDA, etcetera? Thanks again.

Jugal Vijayvargiya: Yeah. So the full year, I mean, we like we indicated, you know, we year to be in line with what we have communicated before. We're on track with that. Typically, we sit with the with them in Q3, sometimes maybe early Q4 start talking about the following year. So we'll do that, in our meetings with them and start to have an understanding of what their expectations are for the next year. Yeah. They announced last week, I mean, in the earnings call, that they are continuing to work with the FDA to gain approval.

Whether they're able to get that this year or next year is obviously, you know, discussion that they're having, you know, with the FDA and what they can do regards to that. But certainly, we are very well prepared so that once they do get the approval, then, you we're able to support them as needed.

Daniel Moore: Very good. Appreciate the color. Thanks again.

Shelly Chadwick: Thanks, Tim.

Kyle Kelleher: Thank you. The next question is coming from Mike Harrison from Seaport Research Partners. Mike, your line is live.

Mike Harrison: Hi. Good morning. Congrats on a nice quarter.

Shelly Chadwick: Thanks, Mike.

Jugal Vijayvargiya: Thanks, Mike.

Mike Harrison: I wanted to go back to the margin performance in the Electronic Materials business. It kind of sounds like while you're expecting some improvement, maybe Q2 is kind of a high watermark. And I guess I just wanted to understand you know, what kind of temporary or unusual factors could be playing into the margin performance? And specifically, I was curious is the strength outside of China something that is a positive for mix meaning that, you know, some of your inside China business is actually lower margin business than outside?

Shelly Chadwick: Yeah, Mike. Let me start with that one. So you're, you know, you're hitting on some good points there with let's Materials, the performance has definitely been improving. But as you know, it's not really consistent quarter to quarter with a within a very small band as to what those margins are. And there's different factors, but mix certainly is one of the larger ones. You know, as you know, sometimes we talk about our precious metals business versus our non-precious metals business as those carry different margin profiles. But regionally as well, China is does tend to be a lower mix item.

So when our strongs are when our sales are stronger on the other items, that would be a positive mix. Positive mix item.

Mike Harrison: Alright. That's helpful. And then within the Performance Materials business and that precision clad strip business, I think we just kinda touched on it, but I was hoping to get an update on that new precision clad strip facility and kinda where we are in terms of phase two being fully up and running and kinda what that looks like in terms of capacity and utilization. And then the other piece of that is the old precision clad strip facility. Is that still producing anything for PMI? Or maybe just give us an update on where you are in the process of filling that old facility with maybe some new, clad strip business?

Jugal Vijayvargiya: Yeah. So first of let me just talk about the old, facility, the legacy facility. As you know, that facility produces some level of material for PMI. But it also, in fact, majority of the facility is non-PMI. We produce material and products there for automotive customers, consumer electronics customers, various other type of markets, and we've been doing that for years. So we are still producing material there. And it just and the reason for that is there's little different nuances on the type of material, and that facility is better equipped to produce know, one type of material versus another type of material. And so we are still doing that.

Then with regard to, I think, the new facility, like I indicated, I mean, our discussions with PMI will take place over the next, three to six months in terms of what they're looking, from us for next year. We will be prepared at whatever level that they want. Certainly, if they are able to enter the US or if they're able to enter other markets and they have an increased set of volume, we will be fully prepared to do that. You know? If they want the same level of product from us for some other reason, we'll be prepared to do that. I think, you know, our position with them is, you know, we have the facility.

We have the capacity. We have the people. And, we'll be prepared to support them as they would like. Know, once we have the discussions with them over the next, you know, three to six months.

Mike Harrison: But just to clarify, is the equipment associated with the phase two of that new precision class strip facility, is that equipment in place already, or is that are there some pieces of equipment or lines that you would need to add if in fact the orders from PMI were expanding in conjunction with, an FDA approval.

Jugal Vijayvargiya: No. The facility is fully ready. We have the equipment. It's qualified, and we would be prepared to produce, you know, as we got orders.

Mike Harrison: Perfect. And then last question for me is just on the, Precision Optics business. You have really nice sequential earnings improvement there and kind of some recovery there. Just curious, do you expect that better performance to continue? And can you maybe give us a little bit more color on how you've engineered a turnaround what seems to be relatively quickly.

Jugal Vijayvargiya: Yeah. It we're really pleased with, I think, the progress that this business has made. As you know, we've had some challenges in this business. We acknowledge that. And I think we've taken strong action, including leadership change along with, I think, a number of different other you know, structural cost changes, portfolio adjustments, and so on. And we're very, very pleased with the progress that this business has made over the last few quarters. Reaching almost double-digit EBITDA margins here in Q2. We've indicated that we continue to expect sequential improvement. And so that's what we're, you know, gonna strive for here in the back half. And, of course, you know, into next year.

I would I just of the year is to drive, continuous improvement in Q3 and then in Q4. wanna remind you, Mike, and I know we've talked about this is that, you know, just a few years back, you know, this business was 20% plus EBITDA margins for us. And our goal has not changed. You know, our goal is to return the business to the that level of EBITDA margins. Certainly, it'll take some time. But we're very, very pleased with the level of turnaround that this business has, has given to us.

Mike Harrison: Alright. Thanks very much.

Kyle Kelleher: Thank you. The next question is coming from Dave Storms from Stonegate.

Dave Storms: Morning. Thank you for taking my questions.

Shelly Chadwick: Hi, Dave.

Jugal Vijayvargiya: Good morning, Dave.

Dave Storms: I just want morning. Just wanted to dig into a couple of that markets here. It's noted that seeing some continued market softness. Just would love to get your thoughts on what your outlook is for that market for the rest of the year. Should we continue to see, maybe sequential growth? Or is this maybe a plateau before the next leg up?

Jugal Vijayvargiya: Yeah. Auto, I think, as a market, you know, for us has been quite challenging. The last couple of years. And, certainly, you know, Q1 was encouraging signs here in Q2, sequentially up 15%. We would expect that in the back half of the year, we would be somewhere in the flat to probably slight increases, in the back half of the year. I think this market continues to be a bit choppy. There is still some headwinds, I would say, in the European market and certainly in the US, and changes have happened between EV and hybrid and traditional ICE. And so I think the choppiness in the auto market could continue for us.

But at the same time, it's a it's it's become a smaller market, for us. So I think the impact to our company, from the choppiness is much less. You know, we're very encouraged with what we are seeing on defense and on space, on commercial aerospace, the semiconductor market, the energy market. I think we are very, very impressed and pleased with where those markets can go over the next three to five years. And automotive, we'll just monitor and, support, you know, as, as needed.

Dave Storms: Oh, that's perfect. And that actually brings me to my next question around the defense backlog. Just hoping you could give us a little more maybe texture, timeline and burn rate around that, maybe what the margins look like compared to current margins. Anything like that would be very helpful.

Jugal Vijayvargiya: Well, the defense market, you know, is a very positive mix market for us. So we enjoy, you know, improved performance, I think, on a margin of a level on the from the defense market than perhaps some of the other markets. Like we indicated, we have $75 million of bookings, 30% on a year-over-year basis. For defense. So and then and then we see a tremendous number of new inquiries much more than what we have seen in the time that I have been here, in the company, for defense. There's increased level of activity, from US defense.

Increased level of spending that's happening in Europe, and that's resulting in, I think, a higher activity and certainly increased activity from some of the countries in Asia as well. Our non-US portion of the defense business, continues to grow, based on all these, initiatives. So I think the level of activity we expect to continue to increase in the back half of the year, and our expectation is to be able to make sure we're capturing as much of this business as possible. And you know, supporting our supporting our customers.

Dave Storms: Understood. Thank you for the commentary.

Shelly Chadwick: Thanks, Stacy.

Kyle Kelleher: Thank you. And the next question will be a follow-up from Phil Gibbs from KeyBanc Capital. Phil, your line is live.

Phil Gibbs: Thank you. Just curious in terms of the big beautiful bill, if you've got any tax saving cash tax savings associated with that, either year or next year?

Shelly Chadwick: Yes. Good question. So we've been going through that. As you can imagine, in some detail and taking a look initially at where we think the benefits are and maybe where we won't have as much benefits. You know, we get a lot of questions around the bonus depreciation. On the bonus depreciation itself, it possible that could give us some benefit. But it's intertwined with our FITI deductions, our foreign intangible income deductions. So we've got to model that out and really decide where we may want to take the 100% bonus versus a lower amount, but that could be beneficial, as you said, from a cash tax perspective.

But there's other areas around interest, you know, the deductions we can take there that are beneficial. And then, you know, as you know, the production tax credit that we have that we enjoy is currently now scheduled to wind down by 2031. You know, that item could change. Administration. But right now, you know, before it had no end in sight, and now it's showing that it would wind down by 2031.

Phil Gibbs: Thank you. And then you've talked a lot about the strength in defense. Obviously, it's a it's a critical imperative for this administration. Has there been any discussion around repletion of the strategic stockpiles of beryllium in the country? By the government. I don't I don't know where those inventory levels stand, but I would imagine given the activity we've seen globally last few years, they probably have not gone up. So just anything you have there in terms of, your commentary or views. Thanks.

Jugal Vijayvargiya: Yeah. Bill, as you know, you know, a large part of our defense business does rely on our Beryllium capability and, you know, what we're able to do. And so I can tell you that we are actively involved, in discussions with the defense department, but really all parts of the defense area, in the country, as well as, I think, you know, with the primes and, you know, beryllium's supply, and, and overall stockpiles, and other types of, let's say, things that are related to this without going into a lot of detail that I can't get into, but we're involved in a in really all the discussions that are that are there on defense.

Phil Gibbs: Thank you.

Kyle Kelleher: Thank you. And we have reached the end of the question and answer session. I will now turn the call over to Kyle Kelleher for closing remarks.

Kyle Kelleher: Thank you. This concludes our second quarter 2025 earnings call. Recorded playback of this call will be available on the company's website, materion.com. I'd like to thank you for participating on this call and your interest in Materion. I will be available for any follow-up questions. My number is (216) 383-4931. Thank you again.

Operator: Thank you. This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.

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DATE

Tuesday, July 29, 2025 at 12:00 a.m. ET

CALL PARTICIPANTS

Chief Executive Officer — Fred Thiel

Chief Financial Officer — Salman Khan

Investor Relations — Robert Samuels

Need a quote from one of our analysts? Email [email protected]

TAKEAWAYS

Revenue: $238.5 million in revenue for Q2 2025, up 64% versus Q2 2024, marking the highest quarterly revenue in company history.

Net Income: Net income (GAAP) was $808.2 million for Q2 2025, reversing a net loss of $199.7 million (GAAP) a year earlier.

Earnings Per Share: $1.84 per diluted share for Q2 2025, compared to a prior-year GAAP net loss of $0.72 per diluted share.

Bitcoin Holdings: Increased by over 170% to nearly 50,000 BTC as of the end of Q2 2025, making the company the second largest corporate Bitcoin holder globally.

Market Value of Bitcoin Holdings: The market value of Bitcoin holdings increased by more than $4.2 billion, or 362% year over year, between Q2 2024 and Q2 2025.

Energized Hash Rate: Rose 82% to 57.4 exahash per second, from 31.5 exahash per second a year ago.

Bitcoin Production: Average of 25.9 BTC produced daily in Q2 2025, up from 22.9 BTC a year earlier, resulting in 300 more BTC mined compared to the prior year.

Blocks Won: Number of blocks mined increased by 52% compared to the prior year.

Purchased Energy Cost per Bitcoin: $33,735 per coin, described as among the sector's lowest.

Daily Cost per Petahash: Daily cost per petahash improved by 24% year over year.

Fleet Ownership: Approximately 70% of hash rate now comes from owned and operated mining sites.

Convertible Notes: $950 million zero percent convertible senior notes issued after the quarter, providing flexibility for strategic purposes.

Liquid Assets: Exceeded $5 billion in liquid assets as of June 30, 2025, plus ~$1 billion raised since quarter end.

Active Bitcoin Management: Nearly one-third of Bitcoin holdings were actively managed for yield, including through SMA with Two Prime.

Wind-Powered Data Center: Construction completed in Hanford County, Texas, expanding access to low-cost power.

Record Month: May 2025 was the company's highest single production month.

Three-Gigawatt Global Pipeline: Infrastructure expansion pipeline now exceeds three gigawatts worldwide.

75 Exahash Target: All miners are secured and funded except for $150 million expected to be paid in the second half of 2025.

SUMMARY

Management signaled a strategic focus on leveraging digital energy and compute infrastructure beyond Bitcoin mining, including grid-responsive load balancing and sovereign AI compute. The balance sheet was significantly strengthened through the convertible notes issuance and the scaling of actively managed digital asset strategies. New international initiatives were highlighted, with groundwork laid for operations in Saudi Arabia and France to capture demand for sovereign, energy-aligned compute platforms. Partnerships with entities such as TAE Power Solutions and Pado.ai were cited as key to entering adjacent high-growth markets. Management explicitly differentiated the company's approach from passive Bitcoin treasury peers by treating digital assets as productive, risk-managed resources that generate yield and support operational expansion.

Salman Khan said, "We produced an average of 25.9 BTC each day during Q2," directly linking increased output to operational improvements.

Fred Thiel emphasized, "We're actively managing our Bitcoin holdings to create long-term value for shareholders." underscoring an active asset management philosophy.

The company’s behind-the-meter wind facility enables direct access to near-zero marginal cost electricity, supporting margin expansion and future cost reductions.

Strategic investments in infrastructure are positioned to support both Bitcoin mining and AI inference workloads as AI becomes a dominant factor in compute economics.

INDUSTRY GLOSSARY

Energized Hash Rate: The actual computational power committed and powered up for cryptocurrency mining, expressed in exahash per second.

Behind-the-Meter: On-site generation or consumption of electricity that bypasses the utility grid, typically yielding lower energy costs.

Sovereign Edge Infrastructure: Compute or data platforms located within a particular jurisdiction to address regulatory, latency, or security requirements for sensitive workloads.

SMA (Separately Managed Account): A professionally managed investment account offering tailored asset management, in this context, for digital assets.

Exahash: A measure of computing power equal to one quintillion (1018) hashes per second, referencing mining capacity.

Full Conference Call Transcript

Fred Thiel: Good afternoon, everyone, and thank you for joining us. No matter how you look at it, Q2 was a record-breaking quarter for Marathon Digital Holdings, Inc. Setting new highs in revenues, adjusted EBITDA, net income, energized hash rate, lead efficiency, and blocks produced in a single month in May. Beyond performance, we continued to invest in the infrastructure that underpins our business. From scaling low-cost flexible load data centers to exploring international opportunities in regions with abundant energy and growing demand for sovereign compute. This quarter, in support of our strategy to support the load balancing needs of AIHPC data centers, we announced strategic partnerships with TAE Power Solutions backed by Google and Pado.ai backed by LG.

Together, we're co-developing grid-responsive load balancing platforms that support the next generation of AI infrastructure, enabling us to monetize our energy and compute capabilities across broader markets. As part of our low-cost energy strategy, we completed construction of a new behind-the-meter data center at our wind-powered site in Hanford County, Texas. This gives us access to low-cost power directly at the source, improving our margin structure and boosting energy efficiency. And subsequent to quarter end, our holdings surpassed 50,000 Bitcoin. This milestone solidifies Marathon Digital Holdings, Inc. as the second largest Bitcoin holder globally. More importantly, this is a treasury we built through disciplined infrastructure development, scaled operations, and focused execution.

Now, while some people may see us as a Bitcoin treasury company given the size of our Bitcoin hold, we don't consider ourselves as one. We're innovators, builders, and operators. We're actively managing our Bitcoin holdings to create long-term value for shareholders. Bitcoin remains our reserve asset, and we will continue to build on our holdings, whether through production or opportunistic purchases depending on market conditions. To that end, we made a minority investment in Two Prime, a digital asset management firm specializing in risk-optimized yield strategies who've been managing a portion of our holdings. We will continue to make prudent decisions around allocation and risk exposure based on broader macro and market conditions.

Regarding the current price of Bitcoin, our view is that things feel a little frothy at the moment. While there is persistent demand for Bitcoin, this is balanced by an ample supply owing to long-term holders taking profits from Bitcoin held in some cases since the earliest years of Bitcoin's infancy. Supply is currently being absorbed relatively well. But if the buying demand were to subside, we could see downward pressure as sellers attempt to lock in gains at these high price points. With our recent convertible notes offering, we have significantly bolstered our balance sheet to have the flexibility to act across a range of strategic priorities, including opportunistic Bitcoin purchases, debt repurchase, M&A, and general corporate purposes.

Whether Bitcoin goes up or Bitcoin goes down, we believe we are positioned to benefit. We're positioning Marathon Digital Holdings, Inc. at the forefront of what's increasingly being recognized as digital energy or the use of technologies and data to make energy systems more efficient, reliable, and sustainable. This strategic focus enables us to capture value at the intersection of compute and energy, a convergence that will define next-generation infrastructure economics. We're exploring ways to design infrastructure for hybrid workloads like AI inference, which is rapidly emerging as the dominant workload in AI infrastructure.

Another area that we believe will drive value is sovereign edge infrastructure, allowing enterprises and public sector customers to have jurisdictional and operational control over data, compute, and AI outputs. We see growing demand for compute infrastructure that is geographically sovereign, energy-aligned, and secure by design. We believe the addressable market is accelerating, particularly in Europe and emerging markets where data sovereignty and energy efficiency are critical factors in purchasing decisions. Our intent is to extend Marathon Digital Holdings, Inc.'s vertically integrated compute platform into edge environments that meet the unique needs of latency-sensitive, compliance-driven, and workload-diverse use cases. In this regard, we are working closely with government officials and major energy partners to extend our reach into global markets.

As part of these efforts, we've been laying the groundwork for a regional headquarters in Saudi Arabia, and we have established an entity in France as a European headquarters. We believe this approach will provide us access to low-cost energy by partnering with energy companies and infrastructure capital providers to lower our capital commitments. Through these efforts, we built a global growth pipeline exceeding three gigawatts, positioning us to scale efficiently across key markets. When you put it all together, as inference increasingly becomes the dominant cost center in AI, control over geography, latency, and energy costs becomes a strategic advantage. We'll continue to invest here to ensure Marathon Digital Holdings, Inc. is well-positioned to meet this demand.

We're excited to host our first-ever investor day this fall. This inaugural event will offer a deep dive into our long-term roadmap with insights into how we are activating our digital energy strategies across mining, infrastructure, and AI. To join us, please reach out to our Investor Relations team. To wrap up, Q2 was a milestone quarter. We grew our treasury, expanded our infrastructure, and proved once again that Marathon Digital Holdings, Inc. is far more than a Bitcoin mining company. We are the category leader in Bitcoin mining, but our value lies in the infrastructure that underpins it. Infrastructure that we're now leveraging to shape the future of compute.

Thank you for your continued support as we build what is next. Now I'll turn it over to Salman for additional insights on the quarter.

Salman Khan: Thank you, Fred. In Q2, we delivered record financial performance driven by strong execution and an improving Bitcoin price environment. Over the past year, we've remained laser-focused on aligning shareholder interests with Bitcoin ownership through disciplined operational execution. Between Q2 of 2024 and Q2 of 2025, our Bitcoin holdings surged by over 170%, going from approximately 18,500 BTC to nearly 50,000 Bitcoin. During the same period, our energized hash rate expanded by 82%, increasing from 31.5 exahash per second to 57.4. And the market value of our Bitcoin holdings increased by more than $4.2 billion or 362% year on year. Let me provide some financial highlights for the quarter. We broke some records.

Revenues increased 64% to $238.5 million from $145.1 million in the second quarter of 2024. This was the highest revenue quarter in the company's history. The increase was primarily driven by a 50% increase in the average price, which contributed $77 million. We produced an average of 25.9 BTC each day during Q2, compared to 22.9 BTC each day in Q2 of 2024, which resulted in 300 more BTC earned. Furthermore, we saw a 52% increase in the number of blocks won in the quarter compared to the second quarter of last year. May 2025 was the highest single month in our history.

We reported net income of $808.2 million or $1.84 per diluted share in the quarter compared to a net loss of $199.7 million or $0.72 per diluted share in the second quarter of last year. We recorded a $1.2 billion gain on digital BTC receivable during the second quarter of 2025. This reflects the impact of Bitcoin holdings on our balance sheet. Let's turn to cost structure. Our purchased energy cost for Bitcoin for the quarter was $33,735 per coin, which we believe is among the lowest in the sector. And our daily cost per petahash per day improved 24% year over year.

This improvement reflects our growing fleet of owned and operated sites, which now account for approximately 70% of our total hash rate. That transition continues to pay dividends both operationally and financially. Now let me talk about our Bitcoin holdings and asset management. Marathon Digital Holdings, Inc. is the second largest corporate public holder of Bitcoin, and we seek to generate returns on our holdings as Bitcoin price appreciates. Our dedicated Bitcoin asset management team, made up of seasoned professionals with decades of experience in hedge funds and crypto asset management, actively pursues risk-adjusted return opportunities to generate cash flows that support our operating expenses.

We deploy Bitcoin across a diversified portfolio of investment strategies, including lending, trading, and other structured arrangements designed to unlock incremental value. Our approach combines the potential for long-term Bitcoin appreciation with disciplined efforts to generate return while managing risk. To a lesser extent, we have also used Bitcoin as collateral to borrow under lines of credit. Let me deep dive a little bit. During the quarter, we entered into a separately managed account or SMA agreement with Two Prime, which is an external full-service registered adviser, and transferred 500 Bitcoin in mid-May of 2025, followed by an additional 1,500 Bitcoin in late June of 2025.

As of June 30, 2025, a total of 2,004 Bitcoin were held and actively managed within that SMA. The 500 Bitcoin transferred in May 2025 generated an additional 4 Bitcoin or an additional $0.4 million in a short period of time. We manage the SMA to generate returns while limiting risk, and it maintains liquidity with short-term notice following an initial one-year lockup. In addition, our Bitcoin asset management team may, from time to time, engage in various Bitcoin-denominated trades, such as options, futures, swaps, covered calls, and spot transactions, to generate additional returns on our Bitcoin holdings. I want to highlight that subsequent to quarter end, we issued $950 million of zero percent convertible senior notes due 2032.

With this upsized convertible notes offering, we have significantly bolstered our balance sheet. This additional liquidity gives us the flexibility to act strategically, whether by acquiring more Bitcoin, funding M&A, or repaying debt. Its purpose is not to fund day-to-day operations. We're under no pressure to deploy capital immediately. Instead, we're positioned to act in response to market conditions in order to maximize long-term shareholder value. We are different from other Bitcoin treasury companies, as Fred mentioned. Our core business is Bitcoin mining and large-scale data center operations. Even as we hold the second largest Bitcoin worldwide amongst public companies. Looking ahead, what sets us apart is our thought leadership, worldwide operational scale, and capital and operational efficiency.

As of June 30, 2025, we held over $5 billion in liquid assets, and with approximately $1 billion raised since, gives us flexibility to fund domestic growth and pursue international expansion. Unlike passive treasury companies, we treat our Bitcoin as a productive risk-managed asset. Through a disciplined asset management strategy, our holdings strengthen the balance sheet and help fund operations, which we believe will enhance long-term shareholder value. We don't just hold Bitcoin; we put it to work. Finally, we remain on track to reach our 75 ExaHash goal by the end of the year with all miners secured and funded except for $150 million that we expect to pay in the second half.

We are laying the groundwork for 2026 and beyond. We're executing on a pipeline of energy infrastructure projects both in the US and internationally. And we expect these investments to expand our capabilities while costs continue to be low. With that, I'll turn over to Christopher Charles Brendler from Rosenblatt Securities to begin our management interview. Chris?

Christopher Charles Brendler: Hey. Thanks, Salman, and thanks so much for inviting me to do this. This is super exciting to be able to dig through the results with you guys. And also to, you know, sort of get an update on the strategy. A lot is going on in Bitcoin and crypto these days. So I guess I wanted to start with the mining business, the core mining business, and maybe for Fred. Just give me an update on the current thinking around mining versus HPC, and we've seen a lot of competitors increasing. We look to move their power assets towards high-performance compute potentially, could sort of see a slowing of Bitcoin mining competition.

But at the same time, we know that the network hash rate is reaching new highs again even though we're in the middle of a pretty hot summer. So, we'd love to hear your sort of ten thousand foot view on the Bitcoin mining business as it stands today.

Fred Thiel: Thank you, Christopher, for joining us today. I think as you look at the marketplace today, there's a shift occurring. You have companies who previously were kind of in the mid-tier of Bitcoin mining, who have been working on a transition to HPC trying to leverage their energy assets. And you've been seeing really a couple of things happen. For one thing, not many of them have been able to secure contracts with hyperscalers, and some of them have moved towards essentially trying to go out and get customers, enterprise customers directly, who will host with them or leverage their capacity.

We personally think that business is, over time, going to be very price competitive and margins are going to compress because, in most cases, Bitcoin miners are really just providing power. And if they are building buildings and making the investments, which according to some analysts, can be as high as, you know, millions and millions of dollars per megawatt, well over ten million dollars a megawatt, it's going to be hard for them to acquire customers. Many enterprise customers want to work with people who have hosted enterprise customers before and understand how to run those types of data centers. And most Bitcoin miners don't.

So you still haven't seen really any large number of these companies transition successfully to HPC outside of a handful. At the same time, you're seeing new entrants come to this market. You know, you have Tether coming in. You have Bitmain, the single largest hardware vendor, effectively taking control of a company called Tango, transferring hash rate to that company, and becoming the number three, four, or five largest Bitcoin miner in direct competition with their customers. Tether themselves have stated a goal that they want to be the largest Bitcoin miner in the world. So you're seeing a whole new entrant of people coming into this marketplace and some people leaving the market.

We remain very focused on being a Bitcoin miner, but we're also very focused on looking at where you have the convergence of inference AI and the needs of enterprises, especially around sovereign data. We believe this is a unique area where we're positioned to be quite successful in the long term, and that's why we've been focused our efforts on developing relationships with sovereigns, with governments, with energy companies in regions where we think there's going to be a huge amount of investment that we can take advantage of to help grow our business along those lines. While at the same time continue to grow our Bitcoin mining business.

As we mentioned on the call, we have a pipeline of three gigawatts plus of power. And we intend to continue to grow at a very fast rate while also growing our business around sovereign data.

Christopher Charles Brendler: That's very helpful. I guess I'm going to drill down a little bit on the sovereign topic. You mentioned in your prepared remarks the potential for a headquarters in Saudi Arabia as well as France. And, you know, sort of mentioning that or highlighting the fact that location was important when it comes to inferencing. Does that suggest that you, you know, potentially will enter this business directly, or it seems more like you would do it through partnerships, so I'm guessing.

Fred Thiel: Exactly. The focus here is through partnerships. Partnerships with energy companies. Some people on this call may recall that four years ago at Mining Disrupt, I did a presentation that most people found a little startling, which basically said that Bitcoin miners will either have to become partners with energy companies or energy companies will take over their businesses. And I believe that unless you, as a Bitcoin miner, own your own energy generation, you have to become a partner with the energy company, not a customer of the energy company.

And so if you look at some of these regions, Europe, the Gulf region, for example, you have very top-down driven energy companies who are typically government-owned or government-run or have a substantial percentage of ownership by the government, and you have to partner with the government, partner companies. And in these regions, there is a big demand for sovereign data and AI because the enterprises in those regions do not want to have their data in clouds that are either owned and operated by the US or the Chinese or people outside of their regions. And so they want that data residing in their countries within their borders in close proximity to their enterprises.

And we believe that partnership of working with government and sovereign-controlled energy companies and operating data centers within their borders to provide them with sovereignty over data and AI is a combination of factors that could make us very successful.

Christopher Charles Brendler: Makes sense. Would this be similar to the experience and the success you've had in the UAE, where it's a joint venture, or are you envisioning a different type of partnership when you go about these kinds of relationships?

Fred Thiel: That's great that you mentioned the UAE. So when we did that transaction, it was very focused on Bitcoin mining and remains one of the most successful Bitcoin mining data centers that we built from a perspective of uptime and operations. It's, you know, an amazing site and is clearly still one of the leading immersion Bitcoin mining data centers in the world. That taught us a lot about working with sovereigns, especially in that region. It taught us what the right type of partnerships are and how to structure those partnerships.

And what you'll see going forward is something a little bit different, where you see the energy companies being more involved in the deal, and also where you see us having a greater degree of control over the terms and the relationships.

Christopher Charles Brendler: Great. Okay. I do remember that presentation you gave four years ago that was pretty prescient for sure, and definitely was surprising to think that energy companies would be directly working in the Bitcoin mining space, but that seems a lot more likely today. For sure. Speaking of Bitcoin mining, I wanted to ask a question. You know, it comes to acquiring power assets, and, you know, it seems like Marathon Digital Holdings, Inc.'s own path has slowed a little bit just in terms of growth. You know, I feel like based on the conversations and your pipeline you disclosed just now, there's a lot going on.

And is that because you're trying to balance, you know, your needs with your investment, or is it increasing competition from hyperscalers that are impacting the queue for power assets?

Fred Thiel: Well, we wouldn't have a pipeline of three gigawatts if we were competing with hyperscalers tooth and nail for power assets. We made a fairly concerted decision to focus on growing with the right types of assets versus just growing at any price. Growth at any price can be dangerous. You know, in a market where Bitcoin price is running high, and where hash rate is remaining relatively stable, because of constraints of either capital or compute or capacity, you can afford to grow in network-attached mode. And, you know, if you recall, we started as an asset-light company.

The reason we were successful in growing to be the largest Bitcoin miner in the world using an asset-light strategy was there were enough constraints in the market that you could grow most rapidly by controlling compute because there was ample capacity and there was ample access to capital, the three C's that constrain our business. Today, it's different. Today, if you are looking at using pre-attached energy at an average price of anywhere from four and a half to five cents a kilowatt hour, you are forced to replace your machines every three years, which is a significant capital cost.

And as you start looking at a halving in 2028, and another one after that in 2032, you really have to look at controlling your energy assets or being a partner with energy companies that can contribute energy and you contribute compute. That's the only way companies will be successful in the long run in this business. And so we've been very focused on executing the strategy of partnerships and controlling energy assets. And, yes, it takes a while to get that started, and we've spent a lot of time this year focused on getting that process started and initiated. And we've built the pipeline now. We built the relationships.

And we're in the phase where we start to begin to execute. And I think this will feed our growth over the next two to three years quite significantly.

Christopher Charles Brendler: That's awesome. And I don't want to get into breaking undisclosed ground here, but is it safe to assume that maybe the majority of that three-gigawatt pipeline is outside the United States?

Fred Thiel: Yeah. That would be undisclosed. So I think you can reference what we've said before that by 2028, about 50% of our revenue would come from international, and we're still focused on that.

Christopher Charles Brendler: Perfect. I'll have to stay tuned. I wanted to ask one more question on the Bitcoin mining business before moving on, actually two more, which was the I don't know where the industry stands from a hydro cooling perspective. I feel like it's relatively new technology for large-scale miners. You know, what are your thoughts on the S23 from Bitmain or similar models and coming into hydrocooling?

Fred Thiel: Yeah. I think the early generations of hydrocooling had lots of challenges. Leaky pipes, large consumption of water, you know, which is a no-no in many places. And a lot of just glitches. I think, you know, Bitmain has most probably figured out how to do this more effectively now. I think the other difference is the form factor for the hydro has changed. They're now doing proper two U rack mount devices, which means you can start using similar infrastructure for Bitcoin mining as AI, which, you know, as we've been talking all along, is what we view the future as being a mix of AI and Bitcoin mining in the same data centers.

You know, we in UAE, for example, chose Immersion Technology because at the time, hydro wasn't significantly developed in a way that was reliable to operate in those regions. Today, I think you can go either way. You can continue to go immersion or hydro. I think what's going to be very interesting in the future, and it's one of the things we've learned with our Tupac technology, is there is this very interesting middle ground around cold plate technology that potentially is the ideal transition, which is slightly different than liquid on chip, which is how the hydro works.

So I think we have yet another evolution to go through in this market before the world moves to the need to go to full immersion on AI. The heat densities in the next couple of generations will start getting to a point where you're going to have to go to full immersion. But today, you can still make it with, you know, liquid on chip and eventually cold plate.

Christopher Charles Brendler: Okay. Makes sense. Would like to talk about the Bitcoin mining in the quarter for a second. You know, one of the things that analysts have to realize is that these things could ebb and flow unless there is some randomness to Bitcoin mining operations. And sometimes you have good months and bad months. And this quarter, in particular, the market share kind of bounced around quite a bit between April and May was fantastic, and then it came back down in June. Was there any, you know, sort of structural uptime or downtime or curtailment that have impacted those numbers significantly, or was it just total randomness?

Fred Thiel: I think, you know, you can look at the year and look at seasonality. We have a large amount of our production in Texas. As you get into June, you start getting into warmer months and curtailment starts happening. There are also things like certain maintenance cycles and other things that can impact any given site from time to time. Definitely, May was an amazing month where we benefited from the randomness very well. But generally, we have found that when we look at what extent luck, as it's called in our industry, impacts us, we have over a long period had a minor degree of quite positive luck.

But that being said, you know, as you get into the summer months, you just have to expect a greater percentage of curtailment if you're operating in states where that's a requirement, which it is in Texas.

Christopher Charles Brendler: Sure. It makes sense. Okay. So that sort of big picture question. I'd love to hear your current thoughts on, and you mentioned that already in your prepared remarks, was the Bitcoin treasury strategy companies and their success and, you know, sort of this frothiness that we're seeing with companies can not only announce the Bitcoin treasury strategy, but other tokens and crypto assets now beginning to get lots of investor attention. You know, I think there's certainly a narrative here that Marathon Digital Holdings, Inc. is different. So it looks like your current thoughts on, you know, the Bitcoin treasuries and how we should see that difference play out in market values over time?

Between Marathon Digital Holdings, Inc. and some of the competitors.

Fred Thiel: I'm not sure who to attribute this quote to, but somebody at a recent event that I was at basically said, Bitcoin treasury companies are the new ICOs. If you go back to kind of 2017, you, as you said, you know, Bitcoin treasury companies, you can basically a whatever coin it is into a Bitcoin treasury company, raise money for it, and get investors. You know, there's even one for BNB coin that was announced recently. So I think there's a lot of money going at these things. I think a number of analysts and reporters have written about the fact that, you know, strategy has done an amazing job of creating this space.

You know, kudos to Michael and his team for what they've done there. But any advantage in any market starts disappearing when you have lots of companies going after it. I think it was earlier this week, somebody published $82 billion has been raised for Bitcoin treasury companies that are going to hit the market or sorry, crypto treasury companies, writ large. Across all the different coins and, you know, they can't all be successful. And what happens to those companies that are holding coins when their mNAV goes to one or worst case, like what happened to grayscale during a period, the mNAV goes negative. Likely will have to sell those coins.

So my concern and I think the concern of many people regarding the frothiness in the market today is you have a lot of people buying Bitcoin with other people's money. And if Bitcoin, especially for the newer treasury companies, sees a decline, they may be challenged. And people may sell the stock to get their money out. Realize, you know, Bitcoin treasury companies are not like an ETF. What people have to do to try and save their money is sell the stock in those companies. And I think, with as many companies doing this as there are, a certain percentage of them will likely fail. And that will negatively impact the price of Bitcoin.

You know, we've had wallets from 2011, I think that's this wallet that Galaxy recently traded. Nine billion dollars, 80,000 coins, I think it was. You know, people are selling at the peak. When the whales that have been holding are selling, it tells you something, you know. Historically, whales always sell leading into the peak. They sell into the top in the market. And every Bitcoin, I mean, 98 point something percent of all Bitcoin are in profit today. And the people who are buying and looking to build treasury companies are buying at the absolute top of the market. And at some point, demand will waver.

And you have to remember that Bitcoin from an institutional perspective still is a risk asset. It typically follows M2 on the asset side, liquidity. It also correlates inversely to the dollar. And to the equity markets, it's quite correlated at times. And so I think if we see a deterioration in the economy, if we see deterioration in the equity markets, and we start seeing an improvement in the dollar, you may have an environment where Bitcoin could see a drop. And, you know, I'm not saying it's going to drop 80%, but it could drop 20%, 30%. Great buying opportunity for many.

But you've again, you've got a lot of people who have been holding on for the right time to sell. And if you see any momentum to the downside, you may see a lot of selling which will just accelerate things. So I think that you have to be prudent. And it's important. You know, these treasury companies are, again, a bit like ICOs. And I think that too much of a good thing ruins the returns for everybody. So I would expect you'd start seeing the mNAV on these things to eventually just hit one. And at that point, you're better off holding spot.

Christopher Charles Brendler: Makes sense. How do you view the Marathon Digital Holdings, Inc. stack differently? I mean, it's gotten very large now. It's, you know, 50,000 coins, over $5 billion. And, you know, I think it's not really, you know, sort of tagged for growth purposes. I think you've been pretty clear this is a longer-term investment. But do you foresee, you know, sort of building forever, or is there a point where you would think about potentially selling some of your Bitcoin? Just given how large it's becoming relative to your market cap?

Fred Thiel: I think there's, unlike some treasury companies, there's always a point at which we would sell some Bitcoin. There may be a point where, for example, the appreciation of Bitcoin and the volatility of Bitcoin decreases to the point where it operates more like gold, for example. At which case the cost of us for the company of holding Bitcoin can be such that our average weight of capital is to run the business by leveraging equity to become too prohibitive, and it would make sense for us to, like we did in 2023, sell Bitcoin from production to pay for operating expenses. That's always an option. You know, we are a Bitcoin company.

We believe in Bitcoin for the long term. And as long as Bitcoin continues to perform, we have to do what's right for our shareholders, which is fiduciaries, is leverage Bitcoin while it continues to perform and if need be, sell Bitcoin.

Christopher Charles Brendler: Makes sense. And so there was good commentary, I think it was more on Salman's side, about actively managing the Bitcoin treasury and yield strategies with Two Prime. Maybe give us an update on the thinking around Two Prime and how large, you know, how much of your Bitcoin stack are you willing to try to monetize? And does the active management include hedging strategies? And I know there was a collar strategy in the past. Is that something that's on the table? If you think that it's a little extended, or are you still more focused on yield than actual hedging?

Salman Khan: Chris, when you think about our Bitcoin treasury, as you mentioned, 50,000 stack, a coin, sitting on our balance sheet. We are looking at not just capital appreciation from a long-term perspective, as a treasury asset, but also we want to create a yield and earn cash flows from that Bitcoin that's sitting on our balance sheet while it continues to appreciate for a longer duration of time. So it's a two-pronged approach and it's a financial decision. As Fred mentioned, we are a Bitcoin mining company. And we produce Bitcoin on a day-to-day basis, unlike treasury companies where they have to go and buy Bitcoin from the open market. We don't have to do that.

As we alluded to, we can produce it cheaper than going out and buying Bitcoin from the open market. Having said that, much newer than, you know, this industry is other industries. This is just the beginning. And we have tested multiple investment strategies over the last two years by testing the market, testing different partners, and placing Bitcoin with parties that we trust and we have verified their credibility from a delivery standpoint. And as a result of that evolution, now we have about a little bit shy of one-third of our Bitcoin is activated, as we call it, in the active Bitcoin asset management strategy.

With that, you know, it includes, I would say, hedging is when you say hedging, typically, people think hedge means that we're trying to protect from the price risk. That's not the objective. The objective is to create cash flows that could have covered calls, that could have multiple trading strategies where we either in-house or through our investment and partnership at Two Prime, we go out and we squeeze value out of the Bitcoin. As I've mentioned in the prepared remarks, within a very short period of one and a half months, from 500 Bitcoin, we were able to produce 4 Bitcoin. And look, it's in its infancy stage, newer industry, but we're testing these different strategies successfully.

And the plan would be as we test the waters, we continue to expand from here on a step-by-step basis, while keeping in mind the fiduciary responsibility that we have the stack on our balance sheet that our stock owners own by being a stockholder in this company.

Christopher Charles Brendler: Excellent. That's fantastic, Salman. Thank you. I want to go back to the higher bigger picture stuff and think about diversification beyond Bitcoin mining. I think there was a push at one time to try to diversify the top line and be less reliant on the ebbs and flows of the mining business. Where do you stand today on diversifying the business, and is the Bitcoin treasury yield strategy part of that diversification?

Fred Thiel: I mean, Bitcoin treasury yield is a way to generate yield off of an asset that we have. It's kind of like you think of old money. You know? What does old money do? They buy real estate, and then they live off the yield off the real estate. If we have enough Bitcoin, you can generate a yield off of it that it covers a good portion of our operating expenses, and that takes pressure off of the other businesses. So that we can continue to invest in diversifying revenue. So we are focused on investing significantly in growing our business around sovereign data and Inference AI.

As we come to a point where we're launching things and announcing things, it'll become quite clear. But for the moment, you know, I'll just leave it to say that we're very focused on building the next leg of Marathon Digital Holdings, Inc. So that for the future, we can leverage these great assets that we have, continue to grow them, and gain synergies from them as we also add additional revenue streams that let us leverage some of the benefits of those assets going forward well beyond the period we're having. Reduced Bitcoin rewards to much lower levels.

Christopher Charles Brendler: I'd imagine that would include, you know, sort of along with your international expansion goals as well as you sort of expand beyond the core US mining business.

Fred Thiel: Yeah. Absolutely.

Salman Khan: Chris, just to add to that, Chris, the diversification of revenues, there are two ways of unlocking value. One is diversification of revenues, and the other way is to reduce cost. Just a quick reminder for our listeners today, that Marathon Digital Holdings, Inc. started with an asset-light strategy years ago. And we grew very quickly over the years. And last year, we pivoted towards an asset-heavy strategy where we exited the year with 70% owned and operated. The result of that was that we reduced our electricity cost per coin to one of the lowest in the sector. Now we still have a portion of our business that is tied to an asset-light strategy from our historical contracts.

And there's an opportunity to reduce cost over time as those contracts expire. And as Fred has alluded to last time and we've talked about low-cost strategies, the diversification doesn't stop there. We also went out and bought a wind farm. That we just provided an update on in our prepared remarks a few moments ago. Those wind farms, just to pause on that or double click on it, in a traditional Bitcoin mining operation with grid-connected, compare that to the wind farm intermittent power, but just consumes power when the electricity is close to low-cost electricity. Marginal cost is almost zero.

At that point in time, you're all in cash operating costs of a traditional Bitcoin miner versus a wind farm is about 75% to 85% lower than a traditional Bitcoin mining operation. When we talk about diversification, it's not just diversification of revenues, but also the sources of power and the way we generate Bitcoin and in the future, it could be, yeah, depending on what is the best use of those electrons. So I wanted to highlight that important fact that diversification continues to happen at Marathon Digital Holdings, Inc. And our shareholders will get to see those benefits over a longer duration of time.

The only large-scale miner where we have the opportunity to further reduce cost with these third-party contracts expiring over years.

Christopher Charles Brendler: Yes. That's a great point. The improvement in cost has been phenomenal. And really helped improve the gross margins and for the position from a profitability standpoint. A quick question I had to follow up on, Salman, was from a CapEx perspective. You know, how much of the 75 exahash target has been already funded as of this quarter?

Salman Khan: As we mentioned earlier, almost all of it is funded except for $150 million in minor capital. There will be additional electron-related capital that may be added to it to get to the 75 exahash, but our eyes are laser-focused on the 75 exahash as we had publicly disclosed a few weeks ago. And we're excited about that.

Christopher Charles Brendler: Great. Well, again, thank you so much for all the time and the answers here. Pretty exciting stuff and look forward to hearing the future announcements on your plans. Thanks so much. I'll turn it back over to Robert Samuels.

Robert Samuels: Thanks, Chris. We're now going to take just a few questions from our retail shareholders. And the first one I'm going to address to you, Salman, and it's one that we get asked quite often. Can you talk a little bit more about Marathon Digital Holdings, Inc.'s cost to mine per Bitcoin?

Salman Khan: That's a very important question. And I want to address it point blank. When you think about our financials, you have to think about the evolution of the company. As I had alluded to earlier, we were an asset-light strategy company. We grew very quickly. But as a result of that, our costs were higher compared to some of the other peer group companies. We, as a strategic decision last year, made the decision to move towards an asset-heavy strategy. Or vertically integrated model where we own and operate our own sites. We paid cents to the dollar to acquire those sites compared to the market price and also, the build multiple. Less than 50% than the build multiple.

And now we're operating those sites. As a result of that, our electricity cost per coin is one of the lowest in the sector. And, you know, when you think about Bitcoin mining and Marathon Digital Holdings, Inc., Bitcoin mining is in our DNA, but we are also focused on other initiatives that Fred has alluded to. So we also own a mining pool. We have our own firmware. We are also investing in R&D that is the future of the business and diversification of the revenues that Fred mentioned around AI. And those costs, it's not fair to compare the total cost of the company on a coin basis because that cost is not attributable to the coin.

So if I have to do the math and look at our asset-light and asset-heavy combination of cost of revenue, cash costs, and look at our Bitcoin produced quarter over quarter, it hovers around $50,000 per coin. And that is still more than 50% cheaper than buying in the open market. Now with time, as I had said earlier, we expect these costs to further improve as our third-party mining operations that are more expensive than own and operate mining operations will expire over a period of time. As we exit those contracts and continue to build on the low-cost strategy with the wind farms and the NGON, which we plan to expand further.

The oil and gas operations where we consume natural gas that was being emitted into the air and we reduced the harmful gases by consuming that and put those electrons to use, those costs are tens to the dollar compared to a traditional mining operation. And with a combination of those things, our focus or our expectation would be that over time, our costs are going to continue to be going down from here as we expand.

Robert Samuels: Great. And then the second question is for Fred. How will the signing of the Genius Act affect Marathon Digital Holdings, Inc.'s path to Bitcoin mining?

Fred Thiel: So what the Genius Act does is essentially opens the floodgates to Stablecoins being integrated with the TradFi system. For example, today, we saw Circle announce that Fiserv and FIS are going to integrate Circle into their payment system. And you're seeing the credit card companies developing Stablecoins. You're seeing banks developing stablecoins. What happens when you have stablecoins is you now have liquidity that can flow 24/7, 365. For people today, wanting to buy Bitcoin, they have to move money from a bank account onto an exchange during banking hours, which means the predominant volume of Bitcoin that trades typically happens during banking hours, nine to five.

With Stablecoins, people can hold value in a digital currency the equivalent of a dollar. So it doesn't have the volatility of something like Bitcoin, for example. And they can move on a moment's notice, transfer to an exchange, and trade right away. What that does is likely creates a greater incentive for people to trade 24/7. Now there are many traders who take advantage of the lower volumes of trading that happens during nighttime cycles depending on the market you're in. Because there's lower volume, which means that if you're placing orders at different price points, you can potentially move the market a little easier.

But with stablecoins, I think what's going to happen is more liquidity will flow into Bitcoin. You've also seen things like Ray Dalio now say that you should have 15% of your assets in gold and Bitcoin. So I think with Stablecoins, essentially, liquidity will flow. When liquidity flows, people will move that liquidity into whatever asset they think is the best performing place to hold it. So stablecoins will increase the ability for people and especially institutions to potentially allocate bigger amounts of capital to things like Bitcoin. So I think it only bodes well.

Robert Samuels: Terrific. Well, that's all the time we have for today. Thanks, everyone, for joining us. If you have questions that were not answered during today's call, please feel free to contact our investor relations team at [email protected]. Thanks very much, and enjoy the rest of the day.

Operator: Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.

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DATE

Tuesday, July 29, 2025 at 12:00 a.m. ET

CALL PARTICIPANTS

Chief Executive Officer — Andrew Wilson

Chief Financial Officer — Stuart Canfield

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TAKEAWAYS

Net Revenue: $1.92 billion for Q1 FY2026, up 15% year over year, driven by live services and new game launches

Operating Margin: 24% GAAP and 31% non-GAAP in Q1 fiscal year 2026, attributed to efficiency and the live services business model

Gross Profit: $1.35 billion gross profit for Q1 FY2026, up 18% from the prior year, supported by a continued shift toward higher-margin live services.

Cash Flow from Operations: Cash flow from operations was $750 million for Q1 FY2026, ascribed to operational performance and disciplined working capital management

Fiscal Year Revenue Guidance: Management raised full-year net revenue guidance to $7.8 billion based on current franchise strength.

Live Services Performance: "our live services continue to perform strongly across all our major franchises," Wilson said, highlighting Ultimate Team in FIFA and esports as growth drivers.

Battlefield Franchise: "Battlefield's performance since launch has been exceptional." Wilson said, emphasizing player engagement surpassing internal expectations.

Sims Franchise: The Sims was noted as a key contributor with a growing, highly engaged community supported by frequent content updates.

Margin Drivers: Canfield said margin expansion came from "favorable shift in revenue mix towards live services, as well as improved operational efficiencies across our global operations."

Skate Opportunity: Skate is described as "a new creator-driven platform" with ambitions to become "a meaningful contributor" to engagement and recurring revenue.

FC Strategy: "Our strategy focuses on continuing to deliver unparalleled authenticity and depth in our gameplay," Wilson stated, leveraging partnerships and live services to engage the football community.

Leadership Structure: Organizational changes are positioned as "an evolution rather than a shift in strategy." aiming to enhance agility and focus on major growth areas.

SUMMARY

Electronic Arts Inc. (NASDAQ:EA) reported a 15% year-over-year increase in GAAP net revenue and lifted full-year guidance, attributing gains to high-margin live services and successful new launches. Management stated cash flow from operations reached $750 million due to operational performance and working capital discipline. The company highlighted exceptional engagement in the Battlefield franchise, expanded its Sims and sports communities, and signaled Skate as an upcoming platform for incremental recurring revenue. Strategic emphasis included capital allocation through dividends and repurchases, and leveraging partnerships to boost engagement in its new football franchise. EA reaffirmed its approach to agility and long-term growth while introducing targeted leadership changes.

Wilson called out Ultimate Team and esports as expanding the reach of FIFA's live services franchise to new audiences.

Canfield indicated quarterly operational margin improvement primarily resulted from controlling discretionary expenditures and adopting scalable practices.

Management stated that creating new organizational roles is designed to capture upcoming growth opportunities and reinforce EA's leadership in the industry.

INDUSTRY GLOSSARY

Live Services: Ongoing, revenue-generating digital content and features that extend a game's lifecycle and drive engagement beyond the initial sale.

Ultimate Team: A proprietary mode in FIFA titles where users build teams using virtual cards, driving high recurring monetization and engagement.

Full Conference Call Transcript

Andrew Wilson: The quarter's results were driven by our diverse portfolio and robust execution. Our teams have delivered an outstanding Battlefield experience, with player engagement exceeding our expectations. In EA Sports, live services continue to drive growth, with FIFA and Madden exhibiting strong performance, and NHL showing positive momentum. Our focus on live services, seamless updates, and new content additions have deepened player engagement and extended the life cycle of our franchises. The Sims franchise remains a key contributor to our success, with an active and growing community. This passionate and engaged player base continues to explore and create in new ways, and our commitment to regular content updates keeps the franchise vibrant and fresh.

Moving on to our financials, I'll now turn the call over to Stuart to provide details on our performance and forward outlook.

Stuart Canfield: Thank you, Andrew. As Andrew highlighted, we had a strong start to the fiscal year, and I'm pleased to share our financial results for the first quarter of fiscal year 2026. For the quarter, net revenue was $1.92 billion, up 15% year over year, driven by strong live services performance and the successful launch of innovative titles. Our GAAP operating margin was 24%, and our non-GAAP operating margin was 31%, reflecting our continued focus on delivering efficient operations and the strength of our business model. Our gross profit was $1.35 billion, up 18% from the prior year, driven by the mix shift towards high-margin live services.

Our cash flow from operations in the quarter was $750 million, a significant increase due to strong operational performance and working capital management. Looking ahead, we remain focused on achieving our long-term growth objectives and delivering value to our shareholders. We are raising our full-year net revenue guidance to $7.8 billion, reflecting the strong performance and outlook for our key franchises. Additionally, we remain disciplined in our capital allocation strategy, with a commitment to returning value to our shareholders through dividends and share repurchases. Now, let's move to the Q&A portion of the call.

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Alexia Quadrani from JPMorgan. Please go ahead.

Alexia Quadrani: Thank you. Just a couple of questions from me. First, on the live services, we've seen continuous growth there. Can you provide more color on what's driving that momentum, particularly for FIFA and your other sports franchises? And then secondly, any updates on Battlefield's performance since its launch?

Andrew Wilson: Thank you, Alexia. To address your first question, our live services continue to perform strongly across all our major franchises, driven by our focus on engaging and growing our player community. For FIFA specifically, our Ultimate Team mode continues to be a standout, offering players a dynamic and evolving experience with regular updates and content drops. This keeps engagement high across our global player network. Additionally, our FIFA esports initiatives have been successful, extending the reach of the franchise and bringing in new fans. As for our other sports franchises, Madden and NHL have both seen strong engagement, thanks in part to our updated content and compelling live service offerings that resonate with players.

Moving to your second question, Battlefield's performance since launch has been exceptional. We've seen strong player uptake and engagement, and the game is performing ahead of our expectations. The player community is enthusiastic, and our teams are committed to delivering regular updates and new content to sustain that engagement. Thank you for your questions, Alexia.

Operator: Our next question comes from the line of Matthew Thornton from Truist Securities.

Matthew Thornton: Thanks, good afternoon. From a margin perspective, I wonder if you could talk about the drivers of the expansion both year over year and quarter over quarter? And secondly, when you think about Skate, how should we think about the potential opportunity there relative to your other franchises, particularly in terms of engagement and financial contribution?

Stuart Canfield: Thanks for the question, Matthew. Regarding your first question, our margin expansion reflects both our operational efficiency and the strength of our live services model, which tend to carry higher margins compared to full game sales. Year over year, the expansion is largely driven by the favorable shift in revenue mix towards live services, as well as improved operational efficiencies across our global operations. Quarter over quarter, we saw improvements primarily from the ongoing managing of discretionary spending and continued focus on scalable, efficient operational practices. Your second question on Skate, we're incredibly excited about its potential. Skate represents not just a new game, but a new creator-driven platform that aligns with the current trend towards user-generated content and community-building.

We see the potential for significant engagement given the passionate Skate community and the broad appeal of skateboarding culture. Financially, while it's early, we're aiming for Skate to become a meaningful contributor to EA's overall portfolio, with live services providing opportunities for recurring revenue generation. Overall, our strategy is focused on long-term engagement, and the creative opportunities in Skate align well with that vision. Thanks for the questions, Matthew.

Operator: Our next question comes from the line of Mike Hickey from The Benchmark Company.

Mike Hickey: Hi. Thanks for taking my questions. Just two from me. First, on the upcoming launch of FC, given the soccer/football landscape's competitive dynamics, what can you share about your strategy to solidify and grow your position there? And second, with the changes in leadership at EA and the creation of new roles, how do you see this impacting your strategy, if at all?

Andrew Wilson: Great questions, Mike. On your first question related to FC, we are very optimistic about the future. Football is the world's most popular sport, and our FC title is advantaged by the foundation of FIFA's global fan base. Our strategy focuses on continuing to deliver unparalleled authenticity and depth in our gameplay, underpinned by our unique access to player data, partnerships with clubs, leagues, and the governing bodies of football. Furthermore, our live services will continue to connect and engage our community year-round, capitalizing on key football events and trends. Regarding the second question, as we refine our leadership structure at EA, the changes reflect an evolution rather than a shift in strategy.

The creation of new roles is designed to enhance our agility and focus on major growth opportunities, ensuring we remain at the forefront of the industry. With a deep bench of proven leaders, we're well-positioned to continue our creative and commercial success in the competitive interactive entertainment landscape. Thanks, Mike, for your questions.

Operator: There are no more questions in the queue at this time. I would like to turn the call back over to Andrew Wilson for any closing remarks.

Andrew Wilson: Thank you, operator, and thank you to everyone for joining us today. We appreciate your continued support and interest in Electronic Arts Inc. We are excited about the opportunities ahead and look forward to updating you on our progress in the coming quarters. Have a great afternoon, everyone.

Operator: This concludes today's conference call. Thank you for participating. You may now disconnect.

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DATE

Tuesday, July 29, 2025 at 12:00 a.m. ET

CALL PARTICIPANTS

Chief Executive Officer — Scott C. Sanborn

Chief Financial Officer — Andrew LaBenne

Head of Investor Relations — Artem Nalivayko

Need a quote from one of our analysts? Email [email protected]

TAKEAWAYS

Originations Volume: $2.4 billion in loan originations for Q2 2025, reflecting 32% year-over-year growth and 20% quarter-over-quarter growth from Q1 to Q2 2025, driven by increased marketing initiatives and new product enhancements.

Total Revenue: $248 million total revenue for Q2 2025, up 33% from the prior year’s comparable quarter.

GAAP Net Income: $38 million in GAAP net income for Q2 2025, representing a 156% year-over-year increase.

Return on Tangible Common Equity (ROTCE): Nearly 12% ROTCE for Q2 2025, surpassing the 8% target established at the start of 2025.

Noninterest Income: $94 million in noninterest income for Q2 2025, up 60% versus the comparable quarter last year, primarily driven by increased loan sales through the marketplace and improved pricing.

Net Interest Income: $154 million in net interest income for Q2 2025, a 20% year-over-year increase, reaching an all-time high for the company.

Net Interest Margin: 6.1%, marking continued expansion due to proactive deposit repricing following Federal Reserve actions.

Noninterest Expense: $155 million noninterest expense for Q2 2025, an increase of 17% year-over-year compared to Q2 2024, primarily attributable to a 26% year-over-year rise in marketing spend, supporting 32% year-over-year originations growth.

Pre-Provision Net Revenue (PPNR): $94 million in noninterest income for Q2 2025, a 70% year-over-year increase and exceeding the guidance range of $70 million to $80 million, bolstered by higher originations and an $11 million improvement in fair value marks.

Provision for Credit Losses: $40 million provision for credit losses for Q2 2025, up modestly from $36 million in Q2 2024, with stronger credit performance offsetting higher retention of held-for-investment loans.

Net Charge-Off Ratio: 3% for held-for-investment loans in Q2 2025, down sharply from 6.2% in Q2 2024; management noted that seasonality and recovery timing contributed to the unusually low net charge-off rate.

Guidance for Third Quarter Originations: $2.5 billion to $2.6 billion, projecting 31% to 36% year-over-year growth in originations.

Guidance for Third Quarter PPNR: Pre-Provision Net Revenue (PPNR) guidance for Q3 2025 is $90 million to $100 million, implying 37% to 53% expected year-over-year PPNR growth compared to Q3 2024.

Revised Third Quarter ROTCE Target: Increased to a 10% to 11.5% range for Q3 fiscal 2025, reflecting above-trend financial performance.

LevelUp Savings Deposits: $2.7 billion in LevelUp Savings deposits as of Q2 2025, with nearly 80% of accounts qualifying for the product’s highest interest rate.

LevelUp Checking Adoption: Post-launch, daily checking account openings increased sixfold, with approximately 60% of new accounts opened by borrowers.

Structured Funding Partnerships: Extension of Blue Owl partnership for up to $3.4 billion in new originations over two years, including an initial $600 million to close in the near term as announced in Q2 2025, and an inaugural $100 million transaction closed with BlackRock under the Fitch-rated structured certificate program.

Marketplace Mix and Credit Performance: Management cited a 40% improvement in prime credit performance versus competitors and signaled continued loan investor demand tied to credit results.

Effective Tax Rate: 29%, increased due to a California law change reducing deferred tax assets by $2.3 million; the long-term statutory tax rate is now expected at 25.5%.

Balance Sheet Size: Approaching $11 billion in total assets as of Q2 2025, quadrupled since the bank acquisition in 2021.

SUMMARY

LendingClub Corporation (NYSE:LC) reported 32% year-over-year originations growth and robust revenue growth in Q2 2025, supported by expanded marketplace activity and disciplined balance sheet management. Management described the quarter as an "inflection point" for both strategic execution and financial trajectory, underscored by sustained improvement in credit metrics and increased loan retention. The company advanced key product initiatives, including rollout of LevelUp Checking and partnerships with Blue Owl and BlackRock, which signal diversification in funding sources and innovation in customer engagement. Guidance for Q3 2025 reflects expectations for continued above-average topline expansion and durable returns, with management raising its ROTCE target. In addition to beating prior originations and ROTCE objectives well ahead of schedule, LendingClub highlighted scalability of its technology platform and emphasized growing multiproduct relationships as a foundation for future earnings growth.

CEO Sanborn stated, "We have all of the variety of product and experience constructs and, let's call it, funnel conversion mechanisms that we think pull through the customers that we want." referencing management’s confidence in competing in a dynamic marketplace.

Management indicated attractive incremental returns on recent loan originations.

Results included a $9 million provision benefit for Q2 2025 and $11 million fair value marks improvement tied to credit outperformance, which management cautioned may not recur at the same magnitude in subsequent periods.

The company announced in-progress plans for a corporate rebrand and broader rollout of digital banking products, aligning with its transition to a more integrated financial platform model.

INDUSTRY GLOSSARY

ROTCE (Return on Tangible Common Equity): Annualized net income available to common shareholders divided by average tangible common equity, used to assess profitability relative to shareholder capital at risk.

Pre-Provision Net Revenue (PPNR): Income before provision for credit losses and taxes, measuring core profitability before credit costs.

Net Charge-Off Ratio: Annualized charge-offs of uncollectible loans, net of recoveries, expressed as a percentage of average loans held for investment.

LevelUp Checking/Savings: Proprietary deposit products offered by LendingClub, providing cash back features for checking and tiered interest for savings tied to customer engagement or payment behavior.

Marketplace (in LendingClub context): The capital-light loan sales platform where funded loans are sold to third-party investors, generating fee income for the company.

Full Conference Call Transcript

Scott C. Sanborn: Thank you, Artem. Welcome, everyone. We had a fantastic quarter, delivering 32% year-on-year growth in originations and 33% growth in revenue. We more than doubled our earnings, generating $38 million in GAAP net income compared to $15 million last year. And as a result, we achieved an ROTCE of nearly 12%, well north of the 8% target we set at the beginning of the year and delivered well ahead of schedule. Beyond the strength of our financial performance, we continue to outperform on prime credit, sustaining our 40% improvement versus the competitive set. We extended our forward flow agreement with Blue Owl for up to $3.4 billion of new originations.

We closed our first transaction with BlackRock, enabled by our recently launched Fitch rated structured certificate program, and we introduced LevelUp Checking, a first of its kind checking product offering cash back rewards for on-time loan payments. Let me hit on a few of the highlights of our performance across the business. I'll start with originations volume. We said we were going to drive growth through marketing and product innovation, and we did just that generating meaningful originations growth, both sequentially and year-on-year, while realizing better-than-expected marketing efficiency as we return to channels, including direct mail and online advertising. We also delivered strong credit performance, thanks to our vast data sets, advanced models and decades of experience.

We're not only consistently beating our competition, but we're also beating our own expectations. And while we continue to closely monitor the macro environment, our data is demonstrating the effectiveness of our underwriting and the resilience of our borrower base. Our consistent credit performance and status as a provider of choice continues to generate strong loan investor demand, which over time leads to higher loan sales prices and increased marketplace revenue. We just announced the extension of our funding partnership with Blue Owl for up to $3.4 billion in structured certificate transactions over 2 years with up to $600 million closing within the next several months.

And last quarter, we launched our Fitch rated structured certificate program to enable improved loan sales prices by attracting lower cost pools of capital, including insurance. We successfully closed the first of these transactions with a top global insurance company in Q1, and I'm happy to announce today that we recently completed an inaugural $100 million transaction with funds and accounts managed by BlackRock, and we hope to partner with them on more transactions like this in the future. Now I want to spend some time talking about our innovation efforts built on our mobile-first platform, each designed to more regularly engage our members and build multiproduct relationships.

That's because engaged multiproduct members have better credit outcomes and higher lifetime value. We launched LevelUp Savings last year, offering a higher rate to depositors who make a regular habit of savings. To date, we've reached $2.7 billion in LevelUp Savings deposits with almost 80% of those accounts meeting the threshold to earn the highest rate. It's also driving engagement with these members logging in 30% more often than those with our prior savings product. Now LevelUp Savings was designed specifically for savers who have cash to put to work.

And even so, we're finding that over 10% of new accounts are being opened by our borrowers who are coming to us for loans, which is indicative of their desire to engage more deeply with us. Building on the success of LevelUp Savings, we recently launched LevelUp Checking specifically for our borrowers, along with paying 1% interest on qualifying balances, it has 2 key features. First is 1% unlimited cash back on everyday purchases like gas and groceries. Here, we're rewarding our members for using money that they have versus money that they borrow thereby incenting good financial behavior. Second, and this is unique to us.

We're offering 2% cash back for on-time personal loan payments from a LevelUp Checking account. We're rewarding borrowers for their financial discipline while allowing us to benefit from a stickier relationship. While it's still early, the initial results are encouraging, we're now opening 6x more checking accounts per day than prior to launch with nearly 60% of these accounts being opened by borrowers. Next up on our product road map is an enhanced version of DebtIQ, which will move beyond credit monitoring to include card- linking, in-app payments and automated payment strategies. DebtIQ will give our members transparency and control over their debt in an easy-to-use command center.

We're currently in beta testing in a limited fashion as we work towards a broader rollout later this fall. In closing, this quarter marks an inflection point in both our strategic and our financial trajectory, where the work we've been doing over the past several years is translating into tangible results for both our members and our shareholders. I'm energized by the momentum we have going into the back half of the year and the many opportunities in front of us. I want to close by thanking the LendingClub team for their continued outstanding work and focus. And with that, I'll hand it over to you, Drew.

Andrew LaBenne: Thanks, Scott. This quarter marks my 3-year anniversary at LendingClub, and this has been the most exceptional quarter yet. Let's walk through the details of our results. We originated $2.4 billion in loans in the quarter, which was a 32% increase year-over-year. The increase in originations was driven by the successful execution of our paid marketing initiatives and new product enhancements. If you turn to Page 12 of our earnings presentation, you can see the originations broken down across the 4 funding channels. We increased the dollars retained in both our held for investment and extended seasoning portfolios.

Given the demand for seasoned loans, we expect to direct more volume into the extended seasoning portfolio as we move through the second half of the year. As shown on Page 13, total revenue for the quarter was $248 million, up 33% from the same quarter of the prior year. As a reminder, our business has 2 primary revenue streams. First, we have the capital-light Marketplace business that generates fee-based revenue through loan sales to funding partners. The Marketplace business is highly scalable, capital-efficient and allows us to serve more borrowers across the credit spectrum while generating in-period revenue. The Marketplace business represents the vast majority of our noninterest income.

Second, we have net interest income from loans held on the balance sheet. These loans generate a strong recurring revenue stream funded by customer deposits and our own capital. We generate approximately 3x the earnings over the life of the loans for those held to maturity compared to selling through the marketplace. Since the bank acquisition in 2021, we have quadrupled the size of the balance sheet, which is now almost $11 billion in total assets. Taken together, these 2 revenue streams complement each other.

The highly scalable nature of the marketplace enables rapid growth during periods of strong demand in the capital markets, and the bank balance sheet provides a durable recurring revenue stream to sustain the business through all economic cycles. Now let's dig into these 2 components of revenue. First, noninterest income was $94 million in the quarter, up 60% over the same quarter of the prior year. This increase was driven by more originations sold through the marketplace and improved loan sales pricing. Marketplace investors continue to value our best-in-class credit performance and the resulting attractive asset yields. As Scott discussed, our outlook on credit performance continues to improve and the mark on the held-for-sale portfolio improved by approximately $11 million.

Looking ahead, we are very pleased with the trajectory of the Marketplace business and look forward to building on the momentum as we move through the balance of the year. Now let's move on to net interest income, which was $154 million in the quarter, up 20% over the same quarter last year. This is another all-time high for us as we continue to grow and optimize our balance sheet. In addition to the strong balance sheet and revenue growth, net interest margin improved again to 6.1%. Margin continues to expand as we are repricing our deposit portfolios in response to previous Fed cuts. To date, our repricing beta on deposits has been nearly 100%.

We expect the balance sheet to continue growing and net interest margin to maintain around current levels until the Fed cuts interest rates further. Now please turn to Page 15 of our presentation, which covers noninterest expense. Noninterest expense was $155 million in the quarter, up 17% compared to the prior year. As we foreshadowed last quarter, the largest driver of expense growth was marketing spend, which was up 26% compared to the prior year, enabling a 32% growth in originations. We are harnessing the power of our marketplace bank model to deliver significant operating leverage with revenue growth of 33%, outpacing expense growth by nearly 2:1 over the past year.

Taken together, pre-provision net revenue or revenue less expenses was $94 million for the quarter, up 70% from the same quarter last year and above our guidance range of $70 million to $80 million. To summarize the earlier comments, the large improvement over the high end of our range was driven by stronger-than-forecasted originations and an improvement in fair value marks of approximately $11 million related to credit outperformance, which may not repeat in future quarters. Now let's turn to provision on Page 16. In the quarter, we more than doubled retention of held-for-investment loans versus last year.

Despite that, provision for credit losses was only up modestly to $40 million compared to $36 million in the same quarter of the prior year. The increase in provision from higher retention was largely offset by better-than-expected credit performance. Across all vintages, stronger credit performance resulted in a provision benefit to our pretax income for the quarter of approximately $9 million. You can see evidence of the credit improvement on Slide 17, as the lifetime loss expectation for the 2024 vintage came down. As a reminder, the 2024 vintage carries higher qualitative reserves compared to the previous vintages, given its longer remaining life. Excluding those qualitative reserves, the 2024 vintage is expected to have lower losses than the previous vintages.

It's also worth noting, we did not make any material adjustments to our qualitative reserves in our allowance this quarter. The net charge-off ratio for our held-for-investment loan portfolio improved further to 3% in the quarter, down from 6.2% in the same quarter last year. The net charge-off rate for the quarter is unusually low as it benefited not only from improving credit performance but also from dynamics around the timing of recoveries and the age of the portfolio. We, therefore, expect net charge-off rates to move modestly upward from these low levels as the more recent vintages season. All of these dynamics have already been provisioned for on a discounted basis and are reflected in our allowance.

Now let's move to taxes. Taxes in the quarter were $15.8 million or 29% of pretax income. The higher effective tax rate this quarter was due to a change in California tax law, which will lead to a lower statutory rate in the future, but had the impact of reducing our deferred tax assets by $2.3 million. The good news is while we will have some variability in our effective tax rate from quarter-to-quarter, our long-term statutory tax rate expectation is now reduced to 25.5% from 27%. The combination of originations growth, credit outperformance, strong marketplace demand and margin expansion drove an exceptional quarter. Net income came in at $38 million, up 156% compared to the same quarter last year.

This translated to a diluted EPS of $0.33 per share and tangible book value per share of $11.53. This quarter represents a step function improvement in our financial performance that we expect to continue. We are executing well and are coming into the second half of the year with significant momentum. For the third quarter, we anticipate growing originations to $2.5 billion to $2.6 billion, up 31% to 36% compared to the same period last year. We are continuing our push in the paid marketing acquisition, and we have seen early success, and we'll look to build further on the growth coming out of the second quarter.

We expect PPNR in the range of $90 million to $100 million, up 37% to 53% compared to the same period last year. The growth was driven by higher marketplace volumes, stable loan pricing and growing net interest income. This also factors in expenses arising from investments in our product road map and marketing channel expansion to support continued growth. We are pleased to have already exceeded the $2.3 billion originations target and the 8% ROTCE Q4 exit rate target we set at the beginning of the year. To that point, we are increasing our ROTCE target to a range of 10% to 11.5% for the third quarter, reflecting top line momentum translating to bottom line earnings for our shareholders.

In the fourth quarter, we typically have some seasonal headwinds to origination volumes. Despite that, we expect overall results to be similar to our third quarter guidance. With that, we'd like to open it up for Q&A.

Operator: [Operator Instructions] The first question comes from Bill Ryan with Seaport Research Partners.

William Haraway Ryan: I normally obviously don't say congratulations, but you guys have really held the line on credit the last couple of years, and it's obviously paying dividends right now. First question I have is about competition, it's coming up a little bit more frequently given you've seen very high volumes come out of the private or the personal lenders, a lot of capital being allocated to the sector. There are some new products being introduced, one of your competitors talked about an interest-only product, at least for a few months when they take out the loan.

Personally, I've gotten offers from Bread Financial for a personal loan, and more recently, one name, which I have to say, I kind of picked that one a little bit personal. But if you could kind of maybe give us some idea of what you're seeing on the competitive front, any obstacles into the future, any risk that you're seeing out there?

Scott C. Sanborn: Yes. First, thanks, Bill, for the shout-out on credit. That's something that you don't really get credit for short term. It plays out over the long term. And I think we're seeing that in the results now, both what's coming off the balance sheet, but also the partners that we're bringing on board and the price that we are selling at. On the competitive front, I think, again, you can see in our results, we grew volume 32% year-on-year, 20% quarter-on-quarter, and we actually maintained marketing efficiency, even though we were going back into channels for which we do not have optimized efforts, response models, creative, anything else.

So I would say we feel -- that was a long-winded way of saying, we feel very good about our ability to compete. We know how to compete in this space. We have all of the variety of product and experience constructs and, let's call it, funnel conversion mechanisms that we think pull through the customers that we want. And we've got an infrastructure that allows us to make sure we're getting who we want. So we had anticipated, I think we signaled that we were expecting a competitive environment. We have -- this space has always been competitive, and there are always new entrants coming in on a very regular basis.

They routinely come in strong and then end up pulling back over time as they see that it's very hard to build a bureau inference model and kind of step into the space and get the returns you were expecting because there's a lot going on under the cover. So I'd say we are not seeing at this point anything that has us concerned about our ability to compete and our ability to maintain the kind of growth that we're demonstrating.

William Haraway Ryan: Okay. And just a follow-up question on the marketing efficiency. Obviously, everybody has been building higher marketing costs into their models, came in a bit better than I think what a lot of people had expected this quarter when you measure marketing as a percentage of marketplace originations and even total originations. But could you give us some sense of what -- how we should think about modeling that going forward from current levels?

Andrew LaBenne: Yes. I mean it's -- you should expect it still to go up as we've been signaling it, obviously, did go up a bit this quarter. But what else you should expect to go up are originations. So I think our marketing efficiency probably won't be quite at these levels as we go forward and grow volumes. But I think we've had a good initial start to our expansion here and looking forward to doing more of it.

Scott C. Sanborn: Yes. A little color is we leaned more heavily into reaching current members through some of the new channels and got really strong response there as we ramp up the prospecting efforts. We are maintaining our roughly 50-50 new versus repeat. So about half of our business comes from prior customers. We're maintaining that as we lean into the new channels, but we're seeing strong response from those new channels from our prior customers.

Operator: The next question comes from Crispin Love from Piper Sandler.

Crispin Elliot Love: First, on credit quality, definitely a very strong quarter, improving metrics, a lower provision following the qualitative adjustment last quarter. So can you share your thoughts as you sit today? Are you seeing similar trends versus 3 months ago on the last call, but just a better macro environment compared to that volatility early in the quarter? And then secondly and relatedly, would you expect any impacts from the end of the student loan moratorium?

Andrew LaBenne: Yes. So thanks for the question, Crispin. The -- I'd say, one -- at the end of last quarter, we were seeing strong credit performance from consumers there as well in terms of the quantitative measures, and that has just continued to improve as we've gone through Q2. Really, the increase in provision at the end of Q1 was what we call the qualitative provision, which was really just looking forward at the economic signals and Liberation Day and reserving more for that. So it really didn't have anything to do with the core performance we are seeing in the consumer portfolio. Obviously, as we've ended this quarter, it feels like things have settled down quite a bit.

We didn't materially change the qualitative reserves. But what we did do is take through the benefits of stronger consumer performance. And then the other question is...

Scott C. Sanborn: Yes. So on the student loan side, I think we've talked about this before Crispin, we proactively reduced our exposure to the student loan population. I think more than a year in advance of student loan repayments resuming and also put a bunch of programs in place to both monitor it and also be able to service the needs of those customers. We're actually not -- we have seen really no change since the resumption of payments. And I think the next step will be the potential for wage garnishment. But we're -- the percent of our population that is paying our loans, that is obligated to pay student loans, but that isn't paying student loans, you're talking like 1%.

And we're not seeing any difference in performance from that population right now at all. So we feel pretty good about that.

Crispin Elliot Love: Perfect. That definitely makes guidance in the credit side. And then just on the guidance and the ROTCE targets guiding to double- digit ROTCE in the third quarter. And then as you said on the call, you were previously expecting a greater than 8% in 4Q. But I don't believe you have any 4Q targets out there. Would -- as we look forward, would you expect to maintain that double-digit ROTCE target in -- from 4Q and beyond? Or just any -- or are there any other puts and takes as you look out a couple of quarters?

Andrew LaBenne: Yes. No, that's our expectation. I sort of softly said it in my remark. So we expect -- when I said the financial momentum to continue, we'd expect to be at similar levels as Q3 in terms of ROTCE in Q4. And we'll obviously give a more official guide as we're entering the fourth quarter.

Operator: The next question comes from Vincent Caintic with BTIG.

Vincent Albert Caintic: First question, kind of the philosophy around your guidance. So you've had really good performance over the past couple of quarters, handily beating your guidance for those past couple of quarters. And I guess, to your point, for instance, beating the fourth quarter guidance for volumes already in the second quarter. I'm sort of wondering maybe first, what's changed where you were able to beat that so handily. And then when you think about your third quarter volume -- origination volume guidance, are you assuming say, a worse macro environment? Just trying to kind of understand if there's any conservatism backed into that?

And then for your PPNR side of the guidance, guidance is basically flat for PPNR in the third quarter versus second quarter. You've highlighted some things, you had the $11 million fair value marks and provision benefit of $9 million. You also talked about in the press release the marketing expense increase, not sure if you can provide what that number would be in terms of PPRN impact. But also wanted to understand any conservatism baked into that.

Scott C. Sanborn: Maybe I'll -- Drew, I'll let you take that. But just a comment up front, Vincent. Just a refresher when we came into the year, what we had telegraphed was that we expected to resume, let's call it, more ambitious growth starting in Q2, because that's when seasonality turns in our favor. And that's when we expected our loan sales prices to afford the kind of unit economics that would allow us to invest in those growth channels.

And so when we gave Q1 guidance, which was more or less in line with Q4, the reason we gave a Q4 number was basically to just say, "Hey, we expect the trajectory to be up from here, while Q4 to Q1 is more in line. We expect throughout the course of the year to be growing volumes and importantly, profitable growth, expanding bottom line, ROTCE. That's why we put a number out there, the number out there that we did, and then the only other piece was, obviously, while it's been great to see things sort of settle down, there's a lot of very dynamic forecasts in the beginning of the year, both around the rate environment, inflation, unemployment.

And so consuming all of those changes, which were fairly dramatic swings quarter-to-quarter, which, as you know, we are -- in our space, we're the only one that sort of absorbs the impact of that in real time. And so we were sort of making sure we could absorb that kind of volatility and the outlook we gave.

Andrew LaBenne: Yes. And just to add to that, I think if you put yourself back at the end of Q1 when we were giving the Q2 guide, Liberation Day just happened, I think all of us speaking broadly were unsure -- more unsure what the future was going to look like. It obviously resolved itself midway through the quarter, I'll call it, and that certainly helped results come in on the upper side. But even if you take the one- timers there, we were a little bit ahead of the PPNR guide. So there's probably always going to be some level of one-timers that we're going to need to adjust for, given the nature of the business.

But this is the first quarter we've actually given a next quarter ROTCE guide. So obviously, I think we're feeling that the visibility into the next quarter is improving versus where we've been over the past 1.5 years. And so hope to provide more of that visibility in the future. [ And then you also had a... ]

Vincent Albert Caintic: [indiscernible] question on the marketing dollars.

Andrew LaBenne: Yes. And I think marketing dollars probably without totally guiding to the number, probably the increase next quarter, similar to slightly higher than the increase you saw this quarter.

Vincent Albert Caintic: Okay. Great. That is super helpful. And thank you for that context. I really appreciate it. And I guess related to the ROTCE comments, so that's super helpful, and it's nice to see that the guide up. And I guess within the context of your CET1 ratio being at 17.5%, I mean it's a pretty high number. And I imagine if you were to normalize that CET1 ratio, your ROTCE guide would be even higher. So I'm just kind of wondering how you're thinking about that 17.5%. And if you were to deploy that capital towards anything like what would you think -- what's your priorities? And what's sort of the time frame around that?

Andrew LaBenne: Yes. If you reflect on the time since we've been a bank, we're about a little over 4 years in. We've [Technical Difficulty] the balance sheet over that 4 years. So it's been pretty substantial growth over that time. We're looking to continue a high level of growth with the balance sheet and with the business, and we want the capital to be able to do that. We're very conscious of the dilution that we create for shareholders, and we've been able to not raise common at all over those 4 years.

And I think we're very proud of how we've grown tangible book value per share for shareholders, and we're going to look to continue to do that and use the capital we have for that growth versus having to go back out and raise more capital in a dilutive fashion.

Vincent Albert Caintic: Okay. Okay. Maybe sneaking in one more. I guess to that point, when you think about the incremental loan that you're putting on and the returns on that, I guess you do have a slide on that, but that's sort of a high teens or 20% ROTCE for every incremental loan you're putting on?

Andrew LaBenne: No, the marginal ROTCEs on our personal loans have been kind of 25% to 30% range for several quarters. And our other businesses perform at similar levels. So we think the marginal returns that we're putting on the balance sheet are very attractive for shareholders.

Operator: The following question comes from Kyle Joseph with Stephens.

Kyle Joseph: Congrats on a good quarter. I just want to get your thoughts on kind of the competitive environment and how you envision that influencing your mix of originations, whether HFI or vice versa. Obviously, there's a lot of capital out there and that makes the marketplace loans attractive, but I think one of the big competitive advantages for you guys is your bank and ability to balance sheet those. So just kind of how you're thinking about the world, how you're thinking about the mix in terms of originations going forward?

Andrew LaBenne: Yes. I mean, listen, we look to be -- the world we are trying to get to is where our originations are growing at a level that we are growing the balance sheet with pace and we are fulfilling the demand in the marketplace where we're getting in-period economics as well. And we think the combination of those 2 together is going to generate a very attractive return for investors off the base balance sheet, the banking business and the marketplace business is going to be what takes those returns to higher levels from an industry comparison standpoint. So we obviously need to keep growing originations to be able to do both.

And I'd say, investor demand is very high right now. And so we're going to look to both feed the balance sheet for growth and feed the investor community that is asking for more loans.

Operator: The next question comes from David Scharf with Citizens Capital Markets.

David Michael Scharf: A question on just the demand side of the marketplace in terms of the consumer. Obviously, originations were outstanding, and it sounds like marketing efficiencies as well. I'm wondering, do you have any sense in maybe some historical context as well, do you have any sense whether prime card borrowers are becoming more willing to engage with you or respond to marketing, the more that there are headlines around rate cuts that are muddled? I'm just curious if historically, if those prime borrowers do not feel like there's any daylight towards getting more conviction on rate cuts, then they're definitely more willing to pull the trigger on refinancing?

Scott C. Sanborn: Yes. I mean -- so I guess hard to connect the direct driver. What I would say most broadly is the need and the TAM is the largest it's ever been. The obstacle to that has generally been awareness, not only awareness of refi as an option, but most importantly, awareness of what their actual credit card bills are. And meaning, right, we've released research that says half of all consumers don't know the APR on their cards and of the half that say they do, half are wrong.

And so people really -- and so what we routinely see is when we present an offer of say, 14% when we reach out to the customer who didn't take it and say, why didn't you take it? They say that was too high. And then we'll say, "Well, what do you think your credit card interest rate is?" And they're like, I don't know, 8% or 9% and then you walk them through how to go find it and they find out it's 21% and you can hear their jaw hitting the desk, right?

So the real obstacle is letting people -- having people really understand and if any of you on the call haven't done this, go try to find your credit card APR, right now and see how easy that is for you. So the obstacles [ letting -- getting that out there. ] And you've got to see which page on your 14-page statement it's on, hint, it's not at the top or the bottom, it's somewhere in the middle.

And so that's, for us -- once we get that first breakthrough with consumers, that's why we see this strong repeat behavior and the fact that we make it much, much easier the second time around and you get a better product construct, you get a better rate. But that's the driver behind DebtIQ, which is the ability for us to show people, you're holding $8,000 on this card, you are paying 21%, this is how much that's going to cost you an interest. If you do this instead, you're going to get a much better deal. So we think overcoming that awareness obstacle is probably the biggest opportunity we've got, and that's the driver behind DebtIQ.

David Michael Scharf: Got it. No, that's helpful, clearly top of funnel is very strong. One quick follow-up on the charge-off rate. I didn't quite catch. I thought you had mentioned 1 or 2 factors that may have kind of artificially depressed it this quarter. I'm not sure if it was the timing of recoveries or the sale of charge-offs. Can you just kind of repeat the factors?

Andrew LaBenne: Yes. It really has to do with the timing of the vintages, both the old ones and the new ones. So right now, we're having a higher level of recoveries coming through from the older vintages that had previously had charge-offs come through. So the recovery line this quarter is -- and I think for the past couple of quarters has been higher than we might expect going forward. But on top of that, we've been putting more loans in HFI, which means our HFI portfolio is a bit younger, and the younger your portfolio in total, the lower your charge-off rate is going to be. And as it ages, it will go back up.

So it's sort of the natural dynamics of the personal loan portfolio. Something very important to look at as you're kind of comparing charge-off rates across the industry.

Scott C. Sanborn: Yes. And I think the other piece there, those are the artificial things. Obviously, the organic trend is positive. So those are on top of it. And that's one of the reasons we put those annual vintage disclosures out there, so you can see what have we reserved for and what has happened, right? And so you'll see most notably, our most recent 2024 vintage, you'll see our reserve coming down because of the observed performance.

Operator: The next question comes from Reggie Smith with JPMorgan.

Reginald Lawrence Smith: I'm curious, I know you mentioned last quarter that you were going to lean into direct mail and online ads. I was curious if you can frame how your mix of applicants have changed? Like what proportion of your incoming applications are coming from these channels now? It sounds like you haven't optimized it fully. But kind of where can that go? And then how should we think about those channels changing your conversion, your quality of borrower, APRs? Any way to kind of frame out or directionally point us in the direction of how that will play out on the income statement and in your approvals?

Scott C. Sanborn: Yes. So, I guess, starting with the -- it was a significant driver of the quarter-on-quarter growth in addition to just continued product experience, innovation. We are still early innings because we'll be optimizing response models, targeting, creative, pricing, all of that in the channel. And our growth there is deliberate for the reasons you just indicated. We have an understanding of the performance differentials by channel and how to price and underwrite for that. But that data is always evolving. So we're deliberate as we book.

In terms of the impact to the P&L, I mean, I guess, the way to think about it is we run on average, 50-50 new versus repeat as we ramp up new, we'll tend to ramp up repeat. I think we had a slightly higher percentage of new this quarter, right, given some of the new channels we were picking up. But the bigger -- a driver on the P&L is the relative efficiency of the new channels, which will be less as we get started and then we'll converge as we get better at them.

And then the other piece will be how much of it we hold, of course, which allows us to change how we recognize the acquisition cost. So that will be the other driver of the -- on the efficiency side, not the total dollars.

Reginald Lawrence Smith: Got it. That makes sense. And then what can you share about demand, interest appetite from whole loan buyers and might -- it sound like possibly the shift to this new channel may make whole loan buyers more interested in buying loans? Am I thinking about that correctly? Or how can you frame that potential there?

Scott C. Sanborn: I mean I'd say the demand for the asset is pretty strong, right? We've had several years of really strong performance and really outperformance as we come into this year and that's what you're seeing reflected in some of the announcements we made. And as Drew talked about, I mean, what we're balancing is delivering the in-period returns, which we get to book and recognize that right away versus what do we got a 10-point swing or so versus when we put it on the balance sheet, the other way, right?

So we're balancing the higher lifetime earnings of holding the loan and the more resilient income of holding the loan against the -- hey, let's make, hay while the sun is shining or whatever that...

Andrew LaBenne: I think you got it right.

Scott C. Sanborn: Okay. And tap the market. So we're balancing that and would like to continue to grow both because what we're aware of is the balance sheet, as we've seen over the last few years, our ability to stay profitable through times when the capital markets were a bit more volatile is a key differentiator.

Reginald Lawrence Smith: Congratulations on the quarter, guys.

Operator: The following comes from Tim Switzer with KBW.

Timothy Jeffrey Switzer: I wanted to follow up on some of your guys' comments about the new deposit programs you guys have put in place, the new deposit accounts. So what's the kind of like incremental funding improvement that gives you 100 basis point kind of basis there. And then as the Fed begins to cut rates, does that spread widen?

Scott C. Sanborn: So in terms of that, one, the -- making sure the strategic driver of this product is actually less funding than it is engagement with the borrowers. We know we're already very good at once someone has -- they come to LendingClub because we offer a compelling savings opportunity, and they stay because we make it so easy to do business with us, and it gets easier over time. We're already pretty good at that.

What we believe and industry data would support is having the checking relationship is just going to increase that reengagement with us, increase that lifetime value, because instead of getting a loan, paying it off and then a few years later, having a baby or moving or whatever, getting married and needing a loan again, you're kind of interacting with us the whole time. And we can see what's happening in your financial life and with LevelUp Checking and DebtIQ, we can actually see what's happening both on your income as well as on your debt and provide that opportunity for you.

So the driver is really what we think will be higher lifetime value, higher cross-sell of additional products, less on funding. That said, the blended cost of this product will be fairly materially below, right, what we're paying on the high-yield savings accounts, even though the rewards compared to the rest of the market are pretty compelling. There will be a higher cost for active PL borrowers who are getting the cash back reward on their PL account. But I think roughly 1/3 of the borrowers who signed up for the account are prior LendingClub borrowers. So they don't even have an active loan.

It's a bit of an indication of how much they like the brand and the experience that they're signing up just to have the banking experience with us.

Andrew LaBenne: Yes. Tim, to sort of summarize the financial aspects of it. I don't -- we don't see it in the near term at least being a major driver of lowering interest expense or funding costs on the balance sheet. But it has all the other benefits, Scott was talking about in longer term, there is probably potential there.

Timothy Jeffrey Switzer: Okay. That's helpful. And as for your guidance for a more flat NIM, assuming no rate cuts, what kind of benefit do you think we would see if we do get 1 or 2 rate cuts in the back half of the year. And with these new products you're bringing in, like is 100% beta sustainable for a few more quarters? Just curious your thoughts on that.

Andrew LaBenne: Well, if the Fed doesn't move, then 100% beta is...

Scott C. Sanborn: Really easy. We got that.

Andrew LaBenne: We're already there, right? I think the incremental moves that the Fed may do, we still have a growth posture for our deposit franchise. And so we're going to be thoughtful in terms of lowering rates and making sure we're getting the deposit growth that we need to get to grow the balance sheet. So that may mean that the next 25 bps, we're not going down 25 basis points. But we're going to manage it more -- it should move down with the Fed, but probably not 100% beta.

Scott C. Sanborn: And keep in mind, the other benefit we will get will be depending on the reason the Fed moves down and how that changes the outlook, but if we see movements in the 2-year curve, which is an important metric for loan buyers, we should get that in -- through in sales price improvements.

Operator: I'd now like to turn it back to the LendingClub team to answer a few questions submitted by retail investors.

Artem Nalivayko: Thanks, Tamia. So Scott and Drew, we do have a couple of questions here that were submitted by some of our retail investors. The first question, given all the innovation over the last couple of years in some of your acquisitions, you've talked about a rebrand in the past. Any updates for us there?

Scott C. Sanborn: Yes. So we agree that as we put more products into the market like DebtIQ and LevelUp Checking, a name that gives us broader permission than LendingClub since lending is in the name would be very helpful. And we are actually doing that work this year. We've brought in agency on board or doing the research and the development of that this year. And in terms of timing, that will be -- it will likely be next year coinciding with our opening up of LevelUp Checking. Right now, LevelUp Checking is only available to our existing members. DebtIQ is only going to be available to our existing members while we stand it up and optimize the experience.

As we enter next year, that will be -- those will be open market products. And we think having a new brand umbrella over the top could be very beneficial over the medium term to take advantage of that. So stay tuned.

Artem Nalivayko: Thank you. You answered the second question, which is an update on the mobile-first multi-platform offering, but any additional insights there?

Scott C. Sanborn: Yes. So we've talked about the fact that for an institution our size, what's very unique is we completely control our mobile stack. We are now -- this is not a white label service where we file tickets to make changes. We can completely customize this for our customers and our product set and our use case, and what that means is we can create more seamless experiences. So we're live on that platform.

It's what Checking was introduced on, it's what LevelUp Savings was introduced on, and what we haven't talked about, but those of you on the call who are using the products would experience, if your CD expires at a traditional bank and you would like to roll that over into a savings account, what that requires at a traditional institution is paperwork, opening a new account, sometimes mailing something in. At LendingClub, that's a few clicks. So we're -- that multiproduct experience is already on the, let's call it, the deposit side already very much in play, and we're benefiting from that in terms of our balance retention rates, CD rollover rates and all of that.

With LevelUp Checking, you're starting to see us cross that divide where there's interplay between checking and lending. And so you're going to get an extra reward if you have a loan with us, right? And what that will enable is you'll be able to deposit your loan in your LendingClub checking account, get instant access to your funds. And so -- yes, so it's live, it's working, and we're just now starting to click the products in place, and our first goal was to make the core products that drive our business work, that's happening now. And the next goal is to add this engagement layer on it that keeps people coming back.

And then the third step will be to introduce new products into that ecosystem and make them work seamlessly with the products I just talked about.

Artem Nalivayko: All right. Perfect. That's all the questions we had. So thank you. With that, we'll wrap up our second quarter earnings conference call. Thanks for joining us today. And if you have any questions, please e-mail us at [email protected].

Operator: This concludes today's conference call. Thank you for your participation. You may now disconnect your line.

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DATE

Tuesday, July 29, 2025 at 12:00 a.m. ET

CALL PARTICIPANTS

Chief Executive Officer — Dave Mosley

Chief Financial Officer — Gianluca Romano

Need a quote from one of our analysts? Email [email protected]

TAKEAWAYS

Revenue—$2.44 billion for the June quarter, up 13% sequentially and 30% year-over-year.

Non-GAAP Gross Margin—37.9%, expanding 170 basis points sequentially, described as a record high for the company.

Non-GAAP EPS—$2.59 non-GAAP earnings per share.

Fiscal Year Revenue—$9.1 billion in revenue for FY2025, representing nearly 40% growth.

Non-GAAP Operating Profit—$2.1 billion in non-GAAP operating profit.

Annual Non-GAAP EPS—$8.10 non-GAAP EPS.

Mass Capacity Revenue—Over $2 billion, up 40% year-over-year.

Nearline Shipments—137 exabytes shipped for nearline products, representing 91% of mass capacity exabytes shipped, up 14% sequentially and 52% year-over-year.

Total Volume Shipments—163 exabytes, up from 144 exabytes in the prior quarter.

Legacy Segment Revenue—$270 million in legacy market revenue, up 6% sequentially; other product lines contributed $163 million, up 3% sequentially (component figures do not sum to total revenue).

Adjusted EBITDA—$697 million, up 24% sequentially and 73% year-over-year.

Non-GAAP Net Income—$556 million in non-GAAP net income.

Operating Expenses (GAAP)—$286 million, up 4% sequentially.

Capital Expenditures—$83 million in capital expenditures for the quarter and $265 million for FY2025, or 3% of revenue.

Free Cash Flow—$425 million in free cash flow, nearly double the prior period's $216 million.

Shareholder Returns—$153 million returned via dividends, with nearly 75% of annual free cash flow distributed to shareholders.

Cash and Liquidity—$2.2 billion in cash and equivalents, including a $1.3 billion revolving credit facility.

Gross Debt—Approximately $5 billion at quarter-end; debt reduced by ~$150 million in the quarter.

Net Leverage Ratio—1.8x, with further reduction anticipated as profitability expands.

Sequential DRIVE Revenue—$2.3 billion in DRIVE revenue, a 14% sequential increase led by nearline cloud sales and seasonal VM market strength.

September Quarter Revenue Guidance—$2.5 billion plus or minus $150 million, reflecting a 15% year-over-year increase at the midpoint.

September Quarter Non-GAAP Operating Expenses—Approximately $290 million (non-GAAP), with the period including an extra week.

September Quarter Non-GAAP Operating Margin Guidance—Expected to reach the mid- to high-twenties percentage range.

September Quarter Non-GAAP EPS Guidance—$2.30 plus or minus $0.20 GAAP EPS guidance, based on a 16% tax rate and 221 million diluted shares.

HAMR Ramp—Mozaic 3+ products progressing in volume, with three major cloud service providers qualified and broader qualification advancing as planned.

Product Transition—Qualification for the 4 terabyte per disk platform has begun, with volume ramp targeted for the first half of calendar 2026.

Contracted Capacity—Build-to-order nearline capacity is largely booked through mid-2026, with visibility building into the latter half of the year.

Pricing Strategy—Chief Financial Officer Romano stated, “our like for like pricing will continue to slightly increase every time we negotiate a new lead to order.”

Capital Allocation Plans—Share repurchases are expected to resume in the current quarter.

SUMMARY

Seagate Technology Holdings plc(NASDAQ:STX) reported record-setting revenue growth and non-GAAP gross margins, driven by demand for higher-capacity drives from cloud and enterprise customers. The company is executing a technology transition to HAMR-based products, with significant customer qualification and a clear timeline for ramping advanced platforms. Build-to-order contracts secure nearline capacity through mid-2026, with further visibility into the second half of the year. Shareholder capital returns remain a core focus, with nearly three-quarters of free cash flow distributed and a plan to restart buybacks. Capital expenditures are projected to rise but remain within the 4%-6% of revenue target as production shifts to next-generation technologies.

Chief Financial Officer Romano stated, “Demand is strong, it's above supply,” attributing guidance constraints primarily to production capability and customer qualification needs rather than market weakness.

Gross margin gains (non-GAAP) are attributed to improved product mix, stronger pricing, and advancing manufacturing efficiencies, with further benefits expected as HAMR contributions scale.

Free cash flow is projected to expand further in the second half of the fiscal year, despite anticipated higher variable compensation outlays.

Beginning in FY2026, Seagate will be subject to a global minimum tax rate in the “mid-teens,” with both GAAP and non-GAAP tax rates aligning at 16% as specified in the outlook.

Long-term demand forecasts remain intact, with mid-twenties exabyte growth and top-line growth in the low- to mid-teens anticipated as customers shift toward higher-capacity, HAMR-enabled drives, as discussed at Seagate's Analyst Day.

Seasonality is described as diminishing in importance due to the ongoing transition toward mass capacity products, according to management’s commentary during the Q4 FY2025 earnings call.

INDUSTRY GLOSSARY

HAMR: Heat-Assisted Magnetic Recording, a next-generation hard drive technology enabling higher storage density per platter.

Exabyte: One billion gigabytes, used as a metric for large-scale data storage capacity shipments.

Nearline: Hard disk drives designed for high-capacity, high-availability storage in data centers, typically used for secondary or archival data.

BTO: Build-to-order; contractual arrangements with customers that determine production and allocation of product capacity over a specified time frame.

PMR: Perpendicular Magnetic Recording, a legacy drive technology preceding HAMR in high-density storage applications.

TCO: Total Cost of Ownership, reflecting combined capital and operational expenses associated with deploying storage solutions.

Full Conference Call Transcript

Dave Mosley, Seagate's Chief Executive Officer; and Gianluca Romano, our Chief Financial Officer. We've posted our earnings press release and detailed supplemental information for our June quarter and fiscal year-end results on the Investors section of our website. During today's call, we'll refer to GAAP and non-GAAP measures. Non-GAAP figures are reconciled to GAAP figures in the earnings press release posted on our website and included in our Form 8-K. We've not reconciled certain non-GAAP outlook measures because material items that may impact these measures are out of our control and/or cannot be reasonably predicted. Therefore, a reconciliation to the corresponding GAAP measures is not available without unreasonable effort.

Before we begin, I'd like to remind you that today's call contains forward-looking statements that reflect management's current views and assumptions based on information available to us as of today and should not be relied upon as of any subsequent date. Actual results may differ materially from those contained in or implied by these forward-looking statements as they're subject to risks and uncertainties associated with our business.

To learn more about the risks, uncertainties and other factors that may affect our future business results, please refer to the press release issued today and our SEC filings, including our most recent annual report on Form 10-K and quarterly report on Form 10-Q as well as the supplemental information, all of which may be found on the Investors section of our website. Following our prepared remarks, we'll open the call up for questions. In order to provide all analysts with the opportunity to participate, we thank you in advance for asking one primary question and then reentering the queue.

Dave Mosley: Thanks, Shanye, and hello, everyone. Seagate closed out fiscal '25 delivering strong financial results for the June quarter marked by 30% year-over-year revenue growth and record gross margins, which improved for a ninth consecutive quarter, a trend that is set to continue as HAMR adoption gains momentum. We achieved non-GAAP earnings per share near historic highs and generated strong free cash flow. For the fiscal year, revenue increased 39%, non-GAAP gross profit dollars nearly doubled and operating profit more than tripled, demonstrating our focus on supply-demand alignment and ongoing cost discipline. Our execution resulted in one of the most profitable fiscal years in the company's long-storied history.

The structural changes in our business model and strong product pipeline make Seagate well positioned to deliver improving profitability and cash generation in fiscal '26. Reflecting our confidence, we expect to resume share repurchases later this quarter, enhancing capital returns to shareholders. Operationally, in fiscal '25, we started the high-volume ramp of two new nearline platforms, including the industry's first heat-assisted magnetic recording hard drive, an engineering feat more than a decade in the making. These new cost-effective and energy-efficient platforms aligned well with data growth driven by traditional compute workloads and increasingly from AI-supported applications. Looking at the current end market dynamics, we see a continuation of strong global cloud demand for our nearline products.

The visibility afforded by our build-to-order strategy indicates our nearline exabyte production capacity is largely spoken for through the middle of next calendar year with visibility building into the second half. We believe BTO contracts are also beneficial for our customers by providing predictable assurance of supply. With installed data center capacity expected to more than double by 2029 on a gigawatt basis, these contracts support the CSP's efforts to keep pace with end-user demand. Within cloud data centers, we see an evolving diversity of workloads and applications addressed through a combination of storage media, optimized across a multitude of factors, including performance, cost, floor space, and energy efficiency.

The diverse solutions that emerge are shaped by how these factors are prioritized and the scale that is required. For instance, one of the world's largest cloud service providers recently developed a tiered storage solution to support an application for a widely used social media platform. Leveraging hard drives for both mass data storage in addition to a caching layer to enable fast, repeatable data access, this customer was able to realize significant cost savings and efficiency gains compared with alternative storage solutions. In today's data-driven world, the growing need for mass capacity storage extends beyond the cloud to edge data centers. There are multiple trends that underpin this view.

First, as more data is created at the edge, it will be replicated and retained across multiple locations to capture actionable insights through AI models. To preserve the integrity of these models, large volumes of data are being retained longer to support checkpoints and inferencing. Additionally, today, roughly 50% of the world's data centers are concentrated in just 4 countries. As data sovereignty regulations evolve and proliferate around the globe, we expect a growing demand for localized data storage. In this context, mass capacity hard drives will be critical from a footprint, efficiency and TCO perspective, ensuring data is safe, secure and compliant.

For data centers at the edge, we expect enterprise storage demand will mirror the trends we've seen in the cloud, where upfront AI infrastructure investments led to increased demand for mass data storage over time. Supporting this point of view, a leading enterprise IT infrastructure provider is introducing new tiered storage system solutions later this year for AI applications designed to optimize their end customers' TCO and data utilization requirements by integrating high-capacity hard drives based on HAMR technology. While momentum for our high-capacity HAMR drives builds, we also have continued to increase exabyte shipments of our PMR 24 to 28 terabyte platform to address demand.

In fact, in the June quarter, we achieved record quarterly sales and volume shipments for any nearline product with this platform. Leveraging the commonality across our PMR and HAMR platforms, we are executing the volume ramp of Mozaic 3+ products. We are tracking to plan with shipments expanding to additional CSPs in the September quarter. Across the board, qualifications are progressing exceedingly well, and we continue to expect the key global CSP customers to be qualified by mid-calendar 2026. Our progress in bringing HAMR-based Mozaic drives to market at scale strongly positions Seagate to address the significant opportunities we foresee in the cloud and at the edge.

The top priority during fiscal '26 is executing our 4-plus terabyte per disk qualification and volume ramp. This product will support cloud workloads with capacities of up to 44 terabytes and also supports lower capacity drives ideal for edge workloads. As planned, we recently started qualification with a global CSP on the 4 terabyte per disk platform and expect to begin volume ramp in the first half of calendar 2026. This timeline is consistent with our target for exabyte shipment crossover on HAMR-based nearline drives in the second half of calendar '26. Ongoing investments in innovation such as granular on platinum media and breakthrough photonics technology are critical to delivering our aerial density roadmap.

We continue to make steady progress with 5 terabytes per disk technology, aligning to our goal of introducing it into the market in early calendar 2028, a time frame when we also expect to demonstrate double that capacity, 10 terabytes per disk in the lab. To close, I believe this is one of the most exciting periods in Seagate's history. Recall at our Investor and Analyst Day in May, we discussed how Seagate is in the right markets with the right technology and the right execution to enhance shareholder value. Demand for mass data storage is expected to grow as our cloud and edge IoT customers continue investing in AI-driven strategic imperatives to unlock and protect data value.

Amid this strong demand backdrop, we are mindful of the evolving trade policy landscape. Based on our current outlook, we expect minimal tariff-related impacts to the business. We will continue to closely track developments and stand ready to deploy mitigation strategies that minimize potential future impact to Seagate and our customers over the long term. In this dynamic environment, our HAMR-based technology roadmap makes us uniquely positioned to capture these growth opportunities in the cloud and at the edge as we push forward aerial density gains to efficiently expand exabyte output. While enabling our customers to benefit from the improving total cost of ownership.

As a result, we are confident in our ability to produce compelling growth in revenue, profitability, and cash generation in fiscal twenty-six and beyond. I'd like to thank our global teams, my partners, and customers for your contributions to a strong fiscal year and to Seagate's ongoing success. Let me now turn the call over to Gianluca.

Gianluca Romano: Thank you, Dave. We capped fiscal twenty-five delivering strong double-digit and bottom-line growth, and achieving record gross margin levels. June quarter revenue came in at $2.44 billion, up 13% sequentially and up 30% year over year. We expanded non-GAAP gross margin by 170 basis points sequentially to 37.9%. And we increased non-operating margin by 270 basis points to 26.2%. Our resulting non-GAAP EPS was $2.59 as a high end of our guided range. For fiscal twenty-five, we grew revenue by nearly 40% to $9.1 billion. We achieved non-GAAP operating profit of $2.1 billion marking one of our strongest annual performances. And recording non-GAAP EPS of $8.10.

These results underscore our solid operational execution and the ongoing momentum for data center demand particularly among global cloud customers. Spent from nearline cloud sales, along with seasonal improvement in the VM market, led to a 14% sequential increase in our DRIVE revenue. Reaching $2.3 billion. Volume shipments increased to 163 exabytes from 144 exabytes in the March quarter. Mass capacity revenue topped the $2 billion mark. Up 15% sequentially and 40% year on year. Husqvarna shipments 151 exabytes compared to 133 exabyte in the prior quarter. The airline shipments into cloud and edge data center made up the vast majority of mass capacity volume.

In the June quarter, New Airline represented 91% of mass capacity exabytes, with shipment of 137 exabytes. Up 14% sequentially and 52% year on year. Our 24 and 28 terabyte PMR products have been widely adopted by global cloud and enterprise data centers. To support their massive data workloads. At the same time, we are ramping our HAMR-based Mosaic products which continue to build customer momentum. Three major cloud service providers are qualified on our Mosaic products. With additional qualification proceeding extremely well. On top of strong payment growth from cloud customers, the airline sales into the enterprise OEM market show a modest sequential improvement in the quarter and we expect stable demand over the next few quarters.

The remaining 80% of revenue came from legacy and other product lines. Based on the legacy market, totaled $270 million up 6% sequentially while revenue from our other product lines increased 3% sequentially. To $163 million. Starting the September quarter, we plan to adjust how we discuss our end markets. We will focus on two main areas, data center and edge IoT. The data center market accounted for about 75% of our fiscal twenty-five revenue. And include the airline products and systems sold into cloud and enterprise customers, as well as cloud-based via application. Edge IoT include consumer and client-centric markets. Along with network attached storage.

We believe this new framework is better aligned with industry practice and reflects the AI-driven market we serve today. Moving on to Celestia, of the income statement. Non-GAAP gross profit increased to $926 million up 19% quarter over quarter and 59% compared with the prior year period. Our resulting non-GAAP gross margin expanded to 37.9%. We continue to benefit from a favorable mix including increased adoption of our latest generation products and ongoing pricing adjustments. These factors combined with a strong demand environment for data center products supported non-GAAP gross margin for the enterprise business above the corporate hedge. On GAAP operating expenses, totaled $286 million up 4% for quarter and in line with our expectations.

Other income and expenses, decreased 9% sequentially to $73 million due in part to the over net interest expense during the quarter. Adjusted EBITDA was $697 million up 24% quarter over quarter and up 73% year on year. Non-GAAP net income was $556 million resulting in non-GAAP EPS of $2.59 per share. Based on the diluted share count, of approximately 215 million shares. Turning now to cash flow and the balance sheet. We invested $83 million in capital expenditures for the June quarter and $265 million for fiscal twenty-five. Which equates to 3% of revenue.

Looking ahead to fiscal twenty-six, we anticipate capital expenditure to be inside our target range of 4% to 6% of revenue while we continue maintaining capital discipline. Free cash flow nearly doubled in the June quarter to $425 million up from $216 million in the prior period. Based on our current outlook, we expect free cash flow generation to expand further the second half of year twenty-five, compared to the first half. Even accounting for a substantial variable compensation payout in the September quarter, which is consistent with our strong performance. In the June quarter, we returned $153 million to shareholders through the quarterly dividend. And we returned nearly 75% of free cash flow to shareholders for the fiscal year.

Demonstrating a strong commitment to our capital return strategy. Cash and cash equivalents increased 9% sequentially close the June quarter with ample liquidity of $2.2 billion including our Androna revolving credit facility of $1.3 billion. We reduced our debt balance by approximately $150 million during the quarter, including retiring $505 million through a new $400 million notetations and cash on hand. We exited the quarter with gross debt of approximately $5 billion. The combination of lower debt and strong profitability resulted in net leverage ratio of 1.8 times with further reduction anticipated. In the coming quarters as profit expands. Turning now to September quarter outlook.

From a demand perspective, the visibility gained through our BTO strategy instilled confidence in sustained demand trend for our high capacity nearline drives. We support both revenue and margin expansion in the September quarter. As previously communicated, starting in fiscal twenty-six, we will be subject to a global minimum tax rate in the mid-teens. Accounting for factors and for the fourteen-week period, we expect September quarter revenue to be in a range of $2.5 billion plus or minus $150 million. As a midpoint, this reflects a 15% improvement year over year. Non-GAAP operating expenses are expected to be approximately $290 million replacing the fourteen-week period partially offset by lower variable compensation as we reset the annual plan for fiscal twenty-six.

Based on the midpoint of our revenue guidance, non-GAAP operating margin is expected to expand into the mid to high twenties percentage range. And on GAAP EPS, it's expected to be $2.30 plus or minus $0.20. Business sixteen percent tax rate. And non-GAAP diluted share count. Of 221 million shares. Our EPS guidance reflects estimated dilution from our twenty-eight convertible notes, and equity compensation. Allusion to non-GAAP earnings from the convertible notes of course, when the volume weighted average price of SEG stock trades above approximately $108 during the period. We target to partially offset the dilutive impact of the convertible notes through share repurchases. Which we expect to resume in the current quarter.

To close, see a strong June quarter performance. Underscores our continued focus on driving growth enhancing profitability, and optimizing cash generation. We are executing our strategic objectives underpinned by structurally changed business model and leading technology roadmap. To deliver on our financial targets enhance value for both customers and shareholders. Operator, let's open the call up for questions.

Operator: We will now begin the question and answer session. If you have further questions, you may reenter the question queue. And your first question today will come from Erik Woodring with Morgan Stanley. Please go ahead.

Erik Woodring: Super. Good afternoon, guys. Thank you very much for taking my question. So, Luca, I just want to kind of ask you about the maybe implied growth margin guidance for the September quarter. Over the last eight quarters, you've expanded gross margins by over 200 basis points sequentially on average. I believe at the midpoint of your guide, depending on the interpretation of mid to high twenty percent operating margins, you're guiding to something of, like, 20 basis points of sequential margin expansion.

Can you maybe one just to confirm that math and then two, just help us understand the puts and takes and maybe why we're not seeing that gross margin imply gross margin expansion in September, you know, despite the confidence that we're hearing from you guys about getting to 40% gross margins in a few quarters. Thanks so much.

Gianluca Romano: Thank you, Eddie. I would say your estimate is a bit low. Actually, I say it's significantly lower than what is implied in the guidance. So we have just achieved a new record high in our history in terms of gross margin and having a very high operating margin. But we are guiding up revenue. We are guiding up gross margin and operating margin, I'll say, significantly more than what you are modeling right now. So our path to achieve the milestone or the fourth milestone that we discussed at our investor day just a few weeks ago is intact. Now we are going exactly in that direction. I think we can be there fairly soon.

Operator: And our next question today will come from Asiya Merchant with Citigroup. Please go ahead.

Asiya Merchant: Great. Thank you for taking my question. If you can tell a little bit on the AI inference edge demand, both on the cloud side, maybe also on the edge side. You know, what are you seeing perhaps in the customer commentaries that you're having that would suggest that, you know, there is an uplift here from AI? And sort of what's kind of your as you look ahead into the next few quarters, what are you implying or what are you seeing in terms of AI exabyte demand just specifically from inferencing? And workloads that are sort of baking you know, workloads that you're expecting for your guidance. Thank you.

Dave Mosley: Thanks, Asiya. Yeah. It's a fairly complex space a lot of different things being called AI. What I would say generally speaking in the cloud it's about video properties. We've seen this for many quarters in a row now. Where video is actually stored in the cloud and the diversity of video that's actually coming in from all parts of the world that gets stored in the cloud, those are tremendously rich data sets for us to ultimately store on hard drives.

As far as edge goes, you're starting to see all kinds of different applications, whether they're video applications themselves, factories, safety, factory efficiencies, hospitals, there's a lot of big data sets that exist, especially video data sets that exist at the edge. Some of those applications are taking lots of call inferencing, but they need a lot of data to be fed with at the edge. And then there's also just the normal growth of, I'll call it, data and analytics text data analytics still. But interestingly at the edge, starting to crossover from a point where you maybe treated data as something that you had to sort through and then delete. Now it's just snapshot set.

Snapshot just keeps saving lots of snapshots at the edge because you might wanna go back and look through it. So those are actually driving from the edge the edge growth that we've made reference to as well.

Asiya Merchant: If I may just you know, how does that affect kinda what you guys shared? I'd be analyst event in terms of you know, exabyte CAGR as you kind of look ahead? Thank you.

Dave Mosley: Yeah. I think the biggest wildcard in that, it was still sticking to the same and y keggers that we talked about, you know, mid-twenties that we're comfortable with that. But there are we are watching some of these new applications that people talk about viral applications that happen to be very data dependent or very interesting to us. And most of those are edge applications because there's a lot of data at the edge that ultimately gets just thrown away. And so if it could be processed or stored longer, it's more interesting to us. So I think the cloud knows how to deal with the data that actually ultimately resides on the cloud very well. Great.

And especially big sovereign datasets. Sorry. Especially sovereign datasets. Where people are wanting to keep the data locally like we made reference to in the prepared remarks. I mean, those are interesting as well.

Operator: Thank you. And your next question today will come from James Edward Schneider with Goldman Sachs. Please go ahead.

James Edward Schneider: Good afternoon. Thanks for taking my question. Maybe if you could talk a little bit about the HAMR contribution you saw in terms of revenue in this quarter and whether you expect how much you would expect that to increase if at all in the September quarter? And then maybe, you know, following on to that, any kind of impact you expect that would have on, gross margins either positive or negative in the out quarter? Thank you.

Dave Mosley: Yeah. Thanks, Jim. So, the HAMR is growing steadily, and we're very happy as we get more people qualified like we talked about, then we'll continue to ramp. What we're very focused on in the company right now is getting to the four terabyte per plat platform. And we're, you know, sit in some sense winding up for that, which you know, we'll expect that ramp early in calendar twenty-six, like we said in the prepared remarks. As far as gross margin, the current product sets are still accretive to gross margin. As we get higher and higher, we expect it to be more accretive, but Gianluca, do you want to give some more color on that?

Gianluca Romano: Yeah. No. We are ramping HAMR. Highest quarter over quarter and we have already three major cloud customers that are qualified on Mosaic three. And we are starting Mosaic four terabyte per disc. So we are executing our roadmap. One of it, you know, we recently discussed at our investor day. And we expect Q1 to be another step higher in thermal volume and, of course, in terms of revenue. And as we discussed, because HAMR is higher capacity drive, and lower cost per terabyte, we expect a positive impact to our gross margin.

James Edward Schneider: Thank you.

Operator: And your next question today will come from Wamsi Mohan with Bank of America. Please go ahead.

Wamsi Mohan: Yes. Thank you. Yeah. You had a strong quarter, clearly, but you guided revenue slightly below consensus for the September quarter, and your DSO also jumped up. So I was wondering if you could clarify if there was anything that you would point out in linearity in the quarter. And I guess the question is, how well is your HAMR capacity ramp aligned with qualifications and demand? Like, are you tracking better on production versus demand because of qualification, which could maybe potentially drive some catch up in the in the December quarter. Thank you so much.

Dave Mosley: Yeah. I'll let Gianluca jump in here, but relative to the HAMR ramp, sorry. Let me just talk about this quarter versus last quarter. Last quarter, obviously, the planning for these quarters is six months, nine months ago with build to order or more. In some cases. And so have to look at what is qualified exactly to your point and then what's going to be qualified in six months or nine we're leaning into the product transitions that happen along the way. If anything, we could make more product of any time, we would make it, but we're also trying to incentivize these product transitions to three plus and then four plus as well.

And we're consuming a lot of our operational efficiency that way. Maybe there was a little bit of an over poll to your question last about last quarter and that's indicative of strong demand. I mean, the demand may be stronger as we get out to the back half of the year. We certainly see fairly strong demand right now. We're trying to balance our manufacturing capability and that planning that we've done long term, what we had promised people nine months ago. We're trying to balance all that together, but also prioritizing the product transitions.

Gianluca Romano: Yes. No. Once you said, well, we had a very strong June quarter. We now achieved better results than also what we were estimating at the beginning of the quarter. And we are guiding a better quarter in September. Demand is strong, it's above supply. So our guidance is mainly based on what we think we are ready to supply during the quarter. And that volume of exercise, they will be fully sold. We also need to dedicate a little bit of our production to qualification. So some of our volume is dedicated to call, and as you know, we are qualifying a big number of customers on HAMR.

And so now, of course, we are slightly impacted in the volume that we sell. Because now we need to keep some volume for a for customer call. But we are going in the direction that, you know, we recently discussed is another step further into our improvement in not only revenue, but even more importantly in profitability. And when you look at our guidance, of course, you need to remember that starting this quarter, we will be subject to the global minimum tax. So when you look at EPS, of course, there is an impact from the tax expense. And there is also an impact from an iron number of share outstanding because of the convertible and equity compensation.

So when you model all those things correctly, you will see actually a fairly good improvement in both gross margin and operating margin.

Wamsi Mohan: Thanks, Gianluca. Just to clarify that one last point you made around the capacity ramp and some of the capacity being tucked away sort of for these calls, would you say that's something that just continues to roll forward as you're qualifying more customers, or do you have a potential for really meaningful step up once you get into December because now you've got these CSPs called on Mosaic three. Thank you so much.

Gianluca Romano: We don't guide December, but as I said before, we are going into the direction of continuing to improve revenue and profitability and, of course, part of this revenue now is coming from having a little bit more supply available. So we are executing our plan now. We don't see any major constraint right now in achieving what we said recently. We are very, very confident.

Operator: And your next question today will come from Thomas James O'Malley with Barclays. Please go ahead.

Thomas James O'Malley: Nice. Thanks for taking my question. On the HAMR side, I'll ask a different way. I don't think you guys wanna give out the exact percentage of revenue over the next couple of quarters. I think you did a good job at the Analyst Day of showing where the crossover point was in the first half of fiscal year twenty-seven. But maybe from a customer perspective, like, a large part of the ramp thus far has been with a single customer. You're talking about multiple customers qualified. At this point, are customers two, three, etcetera, outside of customer one, making up a significant portion of the ramp. Like, ten percent or more, let's say.

I just been trying to get an understanding of the adoption outside of the first guy. Thank you.

Dave Mosley: Thanks, Tom. Yes. Simple answer to your question is yes. The other customers are starting to ramp as well, and the pull is pretty strong. Also, depending on who's called where, they may ask for more of the last generation product or may wanna wait till the four terabyte per floater, but everybody has pretty good visibility, and we have multiple customers pulling our And that's indicative of the exabyte demand. Maybe to the earlier question that Wamsi was asking, you know, we add exabyte capacity by getting through these transitions. And so that's been our move is we're not really trying to add gross capacity of number of drives.

We're trying to, you know, get through these transitions as fast as we can to be much more efficient with the exabytes.

Thomas James O'Malley: Oh, cool. And in terms of that transition, I think you guys previously said on the mass capacity side, like, where you kind of ran into a wall in terms of where you were willing to produce with, like, a hundred and sixty exabytes. On the mass capacity side. Is that still the right way to think about where things are stopping before you get just the growth from the technology side, or are you looking at in any different way Just wanted to see if there was an update there.

Dave Mosley: With continued ramp of MOSAIA three plus platforms, we could continue to grow. But, you know, four plus allows significant growth above that. Yeah. So it's not a wall so much anymore. You know, it really was when we were stuck in the middle of two terabytes per plat or product, but, you know, but we're way past that now.

Thomas James O'Malley: Super helpful. Thank you.

Operator: And your next question today will come from Amit Jawaharlaz Daryanani with Evercore. Please go ahead.

Amit Jawaharlaz Daryanani: Thanks a lot. Good afternoon, everyone. Dave, as you think about the LTAs that are giving you visibility sounds like into early twenty-six right now. Can you just touch on what pricing assumptions are you seeing embedded on an exabyte basis in these contracts? And, really, as you think about the HAMR products are the ramp up over the next twelve months. You end up in a pretty good cost advantage, I think, on a per exabyte basis on HAMR exabytes. Do you think these LTA will enable you to keep those cost savings for Seagate or would you see a bigger drop in price per exabyte that you have to engage with the customers with at that point?

Dave Mosley: Yeah. No. We don't have to incent it's a good question. Don't have to incentivize the transition. I mean, there's a significant TCO benefit of running these new products in your data center. So if you think about a forty terabyte versus a thirty terabyte to for example, and you're gonna run that for six or seven years. That's a huge TCO benefit. So there's an incentive baked in right there. You know, we know what our costs are going to be and we know what pricing we want to incentivize and we know what margin would that we need to be able to go back and refeed our R&D and our supply chain and everything else.

So we're balancing all these things in the planning that we're doing. Gianluca, do you wanna talk about pricing?

Gianluca Romano: Yeah. We are not changing our pricing strategy that we have started more than two years ago. So our like for like pricing will continue to slightly increase every time we negotiate a new lead to order. Of course, the mix is going into more higher capacity drives, so but it's also that part also set. But again, everything is aligned to how we are executing our plan that we presented just a few weeks ago.

Amit Jawaharlaz Daryanani: Perfect. Thank you.

Operator: And your next question today will come from Aaron Christopher Rakers with Wells Fargo.

Aaron Christopher Rakers: Yep. Thanks for taking the question. I wanna ask a little bit about free cash flow generation and how we think about share repurchase. So I think in the prepared comments, you had pointed out that you should be in your CapEx revenue or CapEx spend range of 4% to 6%. I guess the first part of this is that would seem to apply, you know, apparently healthy, you know, uptick in the CapEx spend. Year over year for fiscal twenty-six versus fiscal twenty-five. And I guess why would that be?

And then the second question is, you know, kind of tied to that is that as we see the generation of free cash flow, you've hit the sub $5 billion gross debt level. You know, how do we think about the right level of cash operationally you're willing to hold or how maybe in the opposite way we should think about excess cash, you know, being built and capacity for share repurchase. Any thoughts around that would be helpful. Thank you.

Dave Mosley: Thanks, Aaron. I'll hand it over to Gianluca in just a second. But just to handle from an operations perspective, I mean, obviously, given what we've been through in the last few years, we were pretty tight on CapEx. So I'm not sure that looking at a year ago or two years ago baseline is a great way to think about it. Some of our gear needs to be replaced. There's a small pickup for that, but then there's also us looking forward into FY twenty-seven and FY twenty-eight and saying how do we make sure we stage for four terabytes a platter and five terabytes a platter make sure we have the right gear for that.

There you know, that may drive CapEx a little bit. We'll still be well within our range though. And then Gianluca on the Yes, Aaron. So free cash flow is improving a lot. Now you have seen already in the June quarter a major step up. This will continue, as we said, during the second part of calendar twenty-five, and we'll also continue for the second part of our fiscal twenty-six. We have reduced our debt, as you said, at the target level. We were targeting since more than a year at this point. And Dave just announced that we are restarting share buyback.

So again, we are executing our plan I think, obviously, it's a good time to restart the share buyback. And in terms of liquidity, you were asking and excess cash flow, or excess cash We don't have excess cash right now. I think we can maybe still increase a little bit our cash position, but the vast majority of our free cash flow of course, will go back to our shareholders through the dividend and through the share buyback. Thank you.

Aaron Christopher Rakers: Thanks.

Operator: And your next question today will come from Ananda Prosad Baruah with Loop Capital. Please go ahead.

Ananda Prosad Baruah: Thanks, guys, for taking the question. Dave, just going back to your prior remarks about the AI drivers that you're seeing in your business. And this is this would be sort of not at the edge of the data center remarks. And did you actually make mention that you're seeing multiple types of AI video drivers And if you are, could you do you mind just sort of speaking to those again? I just wanted to get clear on those. Thanks.

Dave Mosley: Well, yeah. I would say, Ananda, there's the video properties that I call them, the things that are storing a lot of video on the cloud and then sharing that video across many users around the world. Right? So we all are familiar with those and use those every day. There's also just unstructured data that's coming into the cloud for processing. Could be video content as well. And then there's video generation from some of the newer AI applications also that, you know, some of those are starting to go viral as well. That's a small trend so far.

So the video processing, the unstructured data processing is big and then the video properties, as I call them, is just huge. Creating, you know because humans are creating all kinds of diverse content and then storing them through these applications.

Ananda Prosad Baruah: And are you seeing from the autonomous sector anything starting to happen with generative AI? Any visibility into that? And that's it for me. Thanks.

Dave Mosley: That's an interesting question. So we do have some partnerships with people that are making autonomous vehicles. Typically, so far, the data is actually gathered in the field and then processed in a local cloud. And it's fairly data rich. But so far, there hasn't really been a generation of data at the extreme edge and then monetization somewhere else besides just teaching the car how to drive better. Should that ever happen, you know, so that the cars themselves become units that are actually picking up a lot of data and then sharing it some other way. That could be a huge opportunity. So far, we haven't seen that.

It's more about training and inferencing just to make sure that the vehicles are driving right and staying safe.

Ananda Prosad Baruah: Got it. Thanks a lot.

Operator: And your next question today will come from C.J. Muse with Cantor Fitzgerald.

C.J. Muse: Yeah. Good afternoon. Thank you for taking the question. So I was hoping to better understand your ability to drive revenue growth both short term and longer term. So the September quarter, you're guiding up 2%. You have an extra week, but you talked about select HAMR bits. Know, going to qualification. So I would have thought perhaps with the extra week, maybe you could have had more output. So is there something else going on there? Is there a mix issue? Would love to have help there. And then for fiscal twenty-six, you know, at your Analyst Day, you talked about longer term growth of low to mid-teens top line.

And I'm just curious at what point in the HAMR ramp do you think you'll have capacity to support that type of growth? Thanks so much.

Dave Mosley: Yeah. I'll let Gianluca deal with the longer term period. But, you know, obviously, as I said before, the quarter of quarter stuff was a lot of the supply perspective on these quarters was dictated six months ago or nine months ago under build to order. And I don't think our customers look at it as fourteen week or an extra week or whatever. So if there happens to be a little bit more demand at the end of the quarter, you know, maybe it'll come our way. It you know, there's maybe some evidence that it did last quarter. I don't really get into the, you know, what happened in one week period.

From our perspective, the way we put more exabytes online is to go through the product transition, not necessarily by capital to try to, you know, build more for demand because that would be a long, long lead time anyway. So we're actually very focused on getting the new products in, qualified, up the ramp, so on and so forth to and that'll help build our margins.

Gianluca Romano: Yes. The mix is going in the right direction. So we are increasing both mosaic, so the HAMR product, and the last generation of PMR product. So you will see the increase in exabyte that are not implied in our guidance and also what we have done in the most recent quarter. We are increasing exabyte. We are not increasing unit. So this is all technology transition. So more and more, we move customers to HAMR. More and more we have the opportunity to increase the exabyte and, of course, that will result in higher revenue. In terms of what we said at our analyst term of revenue growth. So the low two meetings regarded next quarter at $2.5 billion.

If you look where we were a year ago, I think it's probably 15% higher. So I don't see any you know, anything different compared to what we were saying a few weeks ago and what we are executing, of course, every quarter is different, and as I said before, we guide based on what we think we are producing in the quarter. If we will produce it to be more, we will be able to generate a little bit more revenue. But right now, this is a visibility.

C.J. Muse: Very helpful. Thank you.

Gianluca Romano: Thanks, C.J.

Operator: And your next question will come from Krish Sankar with TD Cowen. Please go ahead.

Krish Sankar: Hey, guys. This is Eddie for Krish. Just a question on the guide. It seems that your guidance implies incremental gross margins about, like, 50% Even though we are still below the $2.6 billion revenue baseline, you outlined on the Analyst Day. I wonder as you go from the $2.5 billion in September to $2.6 billion and above, why would your incremental gross margin not be better than the 50% number you guided at the Analyst Day? Like, are there some headwinds in the near term? It's just, like, a little bit puzzling, especially given that the HAMR ramp is still in very early stages.

So someone should expect, like, revenue gross margin accretion above the 50% you guided, but I so any color on that regard would be helpful.

Gianluca Romano: Yes, guys. I think you need to look at your mods a bit deeper because they implied gross margin as a guidance is way higher than what you are saying. Again, look at your model, look at the impact of the increase in the share outstanding, the increase in the tax. But the gross margin in our guidance is much higher than 50 basis points sequentially.

Krish Sankar: Sorry, Gianluca. I meant 50% incremental gross margin. Not 50 basis point.

Gianluca Romano: Okay. Perfect. Well, no. I'll say that now every quarter will be a bit different depending exactly from, you know, the mix that we change quarter over quarter. But I'll say our first goal is to achieve a $2.6 billion in revenue and the 40% gross margin. And I think we are trending well in that direction. And after that, our goal is to continue to increase revenue in the not the low to mid-teens as we discussed, as the analyst Dave and increase our profitability for incremental 50% gross margin. So I would say nothing changed in only the last eight weeks. So I think the plan is ongoing, and we are executing well.

Krish Sankar: Got it. Thank you.

Gianluca Romano: Thank you.

Operator: And your next question today will come from Timothy Michael Arcuri with UBS. Please go ahead.

Timothy Michael Arcuri: Thanks a lot. Dave, you made a comment I haven't heard you make before. You said the capacity is booked out to mid twenty-six and visibility is extending into the back half. What does that mean? Because build to order I mean, the lead time to build to drive is a year. So if you place an order now, you're not gonna get the drive until this time next year anyway. So sort of by definition, you have a year, you know, worth of visibility. Are you changing how you book that? Capacity? And I guess part of that is, what does that really give you? Like, do you know exactly what's gonna ship in December?

I know you don't wanna give us guidance, but can customers push out, like, if you wanted to guide December, could you tell us what you're gonna ship in December? You know, I'm just wondering if something changed for you to give that comment. Thanks.

Dave Mosley: Nothing's really changed. So you're and you're somewhat right. Remember, we're leaning through these product transitions. So we have customers who are driving us to not only start the ramp of Mosaic three plus, start the ramp of Mosaic four plus and so on. And they're working with us on qualifications. And that's some of the stuff that we talk about visibility. They generally want exabytes. They don't want specific boxes, but they want the most efficient boxes they can get. And so do we have pretty good visibility into that? Yes. And we have long lead times you know, some of the components, so we have to make sure we start those components right now.

If that helps you comment, Tim.

Timothy Michael Arcuri: Yeah. I guess I'm just trying to figure out, like, do you know exactly what you're gonna ship in December? I know you don't wanna give guidance, but, I mean, could December be down potentially, or do you visibility to say, look, we know exactly what we're gonna ship in December and, you know, we don't wanna tell you, but we at least know what's gonna be.

Dave Mosley: Right. I would say we know what the customers want. And, you know, demand is very strong. That's why we made we you know, as far as what else might happen in the world, I don't know what else might happen in the world. But, you know, from our perspective, demand is still strong, probably stronger than what we have capacity for. And even though we're building capacity as we get through some of these transitions, via exabyte capacity via the transition.

Gianluca Romano: And Tim, we said previously also in prior calls, we expect calendar twenty-five to sequential increase revenue and profitability. So we continue in that direction. So December will be higher revenue and higher profitability.

Timothy Michael Arcuri: Thank you.

Operator: And your next question today will come from Steven Bryant Fox with Fox Advisors. Please go ahead.

Steven Bryant Fox: Hi. Good afternoon. I was just curious if there's a seasonality we have to think about as we figure out the full fiscal year quarters. It seems like there's a lot of positive quarter on quarter. You know, tailwinds as you go through the year. What kinda seasonal warnings would you throw up Gianluca?

Dave Mosley: The season is starting to really diminish in our business. So, you know, if the legacy and other businesses are still have some seasonality. And then VIA is interesting because as time marches on Vias, some of the Vias workloads are moving to the cloud as well. And so we're seeing not the typical seasonality that we would have seen in the via markets. Is more muted now, but I think the bulk of our business, there really isn't any seasonality anymore.

Steven Bryant Fox: Thanks. And just real quickly know what that Again, sorry.

Gianluca Romano: Sorry. In total, I would say mass water is usually our lower quarter in terms of revenue. But as Dave said, that season nineteen, but every year becomes a little bit smaller.

Steven Bryant Fox: Thank you. And just real quick, if I could squeeze one in. Know someone asked you about receivables. I'm not clear on the answer in terms of why the receivables were up so much the quarter. Thanks.

Gianluca Romano: Oh, there's nothing strange. As you know, in the past, we did also some factoring, and we didn't do any factoring this quarter. And that's because now our free cash flow was really strong already. So nothing unusual, I would say, in the business. Bed drive. Receivable higher. Yeah. I'd say we're back to running the business the way we want to and, you know, we've got the supply chain moving the way we want to. So we're, you know, very pleased with the progress in FY twenty-five.

Steven Bryant Fox: Great. Thank you.

Operator: Your next question today will come from Tristan Gerra with Baird. Please go ahead.

Tristan Gerra: Hi. Good afternoon. High level question. It looks like NAND hasn't been cannibalistic to HDD demand for some time. Each storage type has their own respective market. And there's been so much in terms of capacity cuts in NAND recently that has precluded any production cost down. So as eventually NAND capacity normalizes and production costs return to a normal curve. Should we view this as a potential pressure HDD demand in certain end markets or the dynamics such that, notably with HAMR, your density versus production cost may the gap with NAND.

Dave Mosley: Yeah. It's a complex question, but I would say that your last point is the way we think about it. We're continuing to increase the capacity point per drive and also, you know, keep our costs in line. We have a great value proposition for customers, and so therefore, in the markets that we that are really material to us, like the cloud markets, the interface between NAND and HDD is not really changing that much. And when I say interface, keep in mind, there's a lot of NAND in the cloud. Right? There's a lot of front end memory in these application spaces and in some cases, some are very memory dependent.

But when it comes to mass data storage, the interface between all demand that's being used and all the hard drive bits that are being used is changing that much. And because of the economics that you talked about, because of the like we've talked about in the analyst day, the total amount of capital that would be required to replace the bytes in that are HDD with NAND. So NAND's a great technology. It's got a lot of interesting applications on the edge. They need to manage the business well.

That may be the result that may be what's resulting in some of the behaviors that you made reference to, but in the bulk of mass storage application certainly in the cloud, the architectures are not changing.

Tristan Gerra: Great. Thank you very much.

Operator: And your next question today will come from Vijay Raghavan Rakesh with Mizuho.

Vijay Raghavan Rakesh: Yeah. Hi, Dave and Gianluca. Just first question on the gross margin side, assuming your margins, you know, go to, like, like, 38.7, 38.8, 3.8% in the September quarter, is that pickup coming from pricing, utilization, the HAMR mixer? Can you give us some attribution? Like, what person goes to from the pricing improvement versus utilization versus the HAMR mix? And then I follow-up.

Gianluca Romano: And you're talking about the SAP Yeah. September quarter. Sorry. Yeah. Oh, yeah. Yes. Oh, I would say all those factors that you mentioned. So HAMR volume will be higher and VCs of course, a good add to our gross margin. And the pricing strategy, as we said before, is not changing. So for the few contracts that we will have in the September quarter, we will have a little bit better pricing. And we are selling all our production. So of course, also on the cost side, we are getting fairly good cost per terabyte decline. So I would say not differently from the last few quarters.

We are trending in the same direction, and we are continuing this sequential improvement.

Vijay Raghavan Rakesh: Got it. And Dave, you mentioned three customers on HAMR now. And I think you guys have said five customers by the end of fiscal twenty-six. Can you talk to what the how the other two are going and how you expect the number two and number three ramps to progress, I guess? Thanks.

Dave Mosley: Yeah. So earlier, I talked about the fact that there were more people ramping the product. So that is relative to the three customer comment. We haven't really set five yet, but we've said major customers will be qualified by early twenty-six. That's what it said in the prepared remarks. And we actually talk about that at Analyst Day as well. So we're still on exactly that path to your question. About how are the calls going. They're going very well. I think as customers need more advice, they see that as they get through qualification, they see that an option and then they're creating that demand.

Obviously, we, with the build order, we have to be very prescriptive of it. So we know exactly what we're gonna be able to build. We know which wafers are flowing and we know what heads of media capabilities we're going to have to hit those things. We'll be as predictable as we can for them. But the progress on the qualifications is going quite well.

Vijay Raghavan Rakesh: Alright. Thank you.

Operator: And your next question today will come from Mark S. Miller with The Benchmark Company. Please go ahead.

Mark S. Miller: Yeah. I'm trying to get my arms around the impact of this global minimum tax, which kicks in fiscal twenty-six. Believe you said the non-GAAP tax rate will be sixteen percent. Can you give any insight what the GAAP tax rate will be with this global minimum tax?

Gianluca Romano: Yeah. It will be very similar. So, like, whatever minimum task is impacting us on both GAAP and non-GAAP.

Mark S. Miller: Okay. Thank you.

Dave Mosley: Thanks, Mark.

Operator: This concludes our question and answer session. I would like to turn the conference back over to management for any closing.

Dave Mosley: Thanks, Nick. Thanks everyone for joining us today. Fiscal twenty-five was an incredible year for Seagate and I'm really proud of our team's execution. We are operating in a strong demand environment, driven in part by advancements in Gen AI and the march towards all these agentic models. These breakthroughs have solidified data as one of the world's most critical resources. Hard drives are a key component in powering businesses to harness the full value of their data. And Seagate's leading technology roadmap makes us uniquely positioned to capture value from those growing opportunities.

We appreciate the ongoing support of our customers, our suppliers, our employees, and the shareholders, and we look forward to sharing our progress in the quarters ahead. Thank you.

Operator: Conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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DATE

Tuesday, July 29, 2025 at 12:00 a.m. ET

CALL PARTICIPANTS

Chief Executive Officer — Stephan Von Schuckmann

Chief Financial Officer — Andrew Charles Lynch

Senior Director of Investor Relations — James Entwistle

Need a quote from one of our analysts? Email [email protected]

RISKS

Performance Sensing revenue declined approximately 10% year over year, with continued softness in on-road truck production across North America and Europe expected to persist.

Adjusted earnings per share decreased by $0.05 year over year due to divestitures.

Heavy vehicle and off-road production declined more than 20% in the first half of 2025 across North America and Europe, with expectations for continued market weakness in the second half.

TAKEAWAYS

Total Revenue: $943 million, down from $1.036 billion year over year, primarily due to divestitures, but up $32 million sequentially from the first quarter.

Adjusted Operating Income: $179 million, with a 19.0% margin, representing a 70 basis-point sequential margin improvement from the first quarter.

Adjusted Earnings Per Share: $0.87, up $0.09 sequentially, but down $0.05 year over year due to divestitures.

Free Cash Flow: $116 million, representing a 91% conversion rate of adjusted net income and a 17% increase year over year.

Net Leverage: 3.0 times trailing twelve-month adjusted EBITDA, down from 3.1 times at the end of the previous quarter.

Share Repurchases: $20 million executed in the quarter; $18 million dividend paid to shareholders.

Performance Sensing Revenue: $652 million, down 10% year over year, with margin expansion of 20 basis points, inclusive of tariff impact.

Sensing Solutions Revenue: $291 million, up 9% year over year, with margin expansion of 50 basis points.

Capital Return: ROI of 10.1%, up 30 basis points year over year.

Tariff Impact: $12 million in both tariff costs and offsetting pass-through revenues, resulting in a 20 basis-point adjusted operating margin dilution.

Cash Accumulation: $74 million in incremental cash added to the balance sheet during the quarter.

Guidance for Next Quarter: Revenue expected between $900 million and $930 million; adjusted operating margins projected at 19.0%-19.2%; adjusted EPS expected at $0.81-$0.87.

Sensing Solutions Industrial Growth: High single-digit outgrowth, attributed to gas leak detection business ramp.

Sensing Solutions Aerospace Growth: Revenue growth of more than 5%, outpacing roughly 3% market growth.

Operational Initiatives: Cash conversion rate improved to 91% from 74% last quarter as a result of working capital optimization.

SUMMARY

Sensata Technologies Holding plc(NYSE:ST) achieved a record 91% free cash flow conversion of adjusted net income, with sequential and year-over-year improvement. Management emphasized ongoing deleveraging, capital deployment for shareholder returns, and maintaining adjusted operating margins at or above 19%. Sensing Solutions growth, driven by new industrial and aerospace content, partially offset Performance Sensing declines linked to heavy vehicle and off-road market weakness. Additional margin expansion is targeted through operational productivity, inventory benchmarking, and cost containment. CEO Von Schuckmann noted, "Over 90% of year-to-date new business wins are with the top five local OEMs and leading new energy vehicle players" in China. The previously announced cybersecurity-related disruptions were fully recovered without material financial or customer impact. Company guidance for the next quarter assumes $15 million in tariff costs, up from $12 million, but projects continued margin expansion and dividend continuity.

Chief Executive Officer Von Schuckmann said, "We have significantly increased our pace of new business wins in China, primarily on NEVs."

Chief Financial Officer Lynch said, "In the short term, we'll look to reduce net leverage by accumulating cash on the balance sheet," with a target to move below 3.0 times and toward 2.5 times.

Management confirmed both segment adjusted operating margins—Sensing Solutions at 30.2%, Performance Sensing at 22.5%—expanded year over year despite tariff pass-throughs.

The gas leak detection business is expected to reach approximately $70 million in revenue in 2025, with a goal of exceeding $100 million in 2026, and is now operating at normalized industrial margins.

Company benchmarking, both internally and externally, is driving operational and inventory management improvements.

Regional market updates indicate persistent weakness in North America and Europe for on-road trucks, while China auto provides outgrowth opportunities as newly won programs launch.

CapEx is expected to normalize at around 4% of revenue, up from the quarter's lower level, but management does not anticipate material headwinds to free cash flow conversion from this shift.

INDUSTRY GLOSSARY

HVOR: Heavy Vehicle and Off-Road; Sensata's segment serving truck, agricultural, and construction equipment manufacturers.

NEV: New Energy Vehicle; electric and hybrid vehicles, a focus for growth in China's automotive sector.

TPMS: Tire Pressure Monitoring Systems; sensor-based product line cited as key to recent technological wins in China.

DS rates: Duty structure or tariff rates, usually in the context of trade between the United States and China.

A2L / A3 / HOL: Specialist classifications for refrigerants and associated leak detection sensors, especially for regulatory-driven industrial markets.

Full Conference Call Transcript

James Entwistle: Thank you, Jamie, and good afternoon, everyone. I'm James Entwistle, Senior Director of Investor Relations for Sensata Technologies Holding plc, and I would like to welcome you to Sensata's second quarter 2025 earnings conference call. Joining me on today's call are Stephan Von Schuckmann, Sensata's Chief Executive Officer, and Andrew Charles Lynch, Sensata's Chief Financial Officer. In addition to the financial results press release we issued earlier today, we will be referencing a slide presentation during today's conference call. The PDF of this presentation can be downloaded from Sensata's Investor Relations website. This conference call is being recorded, and we will post a replay on our Investor Relations website shortly after the conclusion of today's call.

As we begin, I would like to reference Sensata's Safe Harbor statement on slide two. During this conference call, we will make forward-looking statements regarding future events or the future financial performance of the company that involve certain risks and uncertainties. The company's actual results may differ materially from the projections described in such statements. Factors that might cause such differences include, but are not limited to, those discussed in our forms 10-Q and 10-K, as well as other filings with the SEC. We encourage you to review our GAAP financial statements in addition to today's. Much of the information that we will discuss during today's call will relate to non-GAAP financial measures.

Our GAAP and non-GAAP financials, including reconciliations, are included in our earnings release, in the appendices of our presentation materials, and in our SEC filings. Stephan will begin the call today with comments on the overall business. Andrew will cover our detailed results for the second quarter of 2025 and our financial outlook for the third quarter of 2025. Stephan will then return for closing remarks. We will then take your questions. Now I would like to turn the call over to Sensata's Chief Executive Officer, Stephan Von Schuckmann.

Stephan Von Schuckmann: Thank you, James, and good afternoon, everyone. Before I begin discussing our results for the second quarter, I'd like to take a moment to congratulate Andrew Charles Lynch, who was named our Chief Financial Officer last week. Andrew has been a valuable partner to me since I joined Sensata Technologies Holding plc, and the board and I have full confidence in him. Andrew's extensive financial and operational experience at Sensata has prepared him well for this role. I'm excited to have him as a partner on Sensata's transformation journey. Now let's begin on slide three.

We delivered a strong quarter of 2025 revenue, adjusted operating income, and adjusted earnings per share, all exceeding the high end of our guidance for the second consecutive quarter. This is an important proof point for the resilience of our business and our team's determination to execute in the face of challenges such as volatile end markets, geopolitical uncertainty, and the cybersecurity incident that we disclosed in April. When I first spoke to you in February, I introduced three key pillars which would serve as my initial focal points for shareholder value creation: improving operational performance, optimizing capital allocation, and returning to growth.

In our May call, I provided an update on some of the specific work we are doing on each of these pillars, and much of the focus of that update was operational excellence. Today, I'll go a bit deeper on capital allocation and growth drivers. Before we get to capital allocation and growth, I'll share a brief update on operational excellence. We rolled out a number of initiatives over the last six months, and I'm pleased with our recent accomplishments on this journey. Our cash conversion rate in the second quarter was 91%, a significant step up from our first quarter 2025 conversion rate of 74%. This improvement reflects our focus on unlocking cash to execute our capital allocation strategy.

With operational excellence initiatives, we're optimizing our working capital and creating margin resilience in our business, enabling us to deliver on our earnings commitments. Now I'd like to go deeper on our next pillar, optimizing our capital allocation. Simply put, we will deploy capital in a manner designed to maximize shareholder returns. In the first quarter, we seized the opportunity to repurchase $100 million of shares. In the second quarter, we repurchased another $20 million of shares and funded our dividend while also accumulating an additional $74 million of incremental cash.

In turn, we reduced our net leverage ratio from 3.1 times trailing twelve-month adjusted EBITDA at the end of the first quarter to 3.0 times at the end of the second quarter. This further strengthened our already strong balance sheet. In the past, you've heard me talk a lot about benchmarking as we look to drive operational excellence. We are using extensive external benchmarks for each of our key pillars. As we look at comparable companies across the market, our differentiated margin stands out, and our cash conversion is improving. However, our capital structure and net leverage is a bit of an outlier.

For the balance of this year and into 2026, you can expect us to continue to prioritize deleveraging. Now I'm excited to share our progress on our growth pillar. Just like capital allocation, growth is enabled by operational excellence. Over my decades of experience in the industry, I have learned that the right to win is earned by consistently serving customers on time, at the lowest possible cost, with high-quality products. Operational initiatives will ensure that we do exactly that. It's equally important that we're disciplined about the new business we pursue. We need to win with the right technologies, the right platforms, and the right customers.

Over the last several months, I have worked with the Sensata team to study our past business wins a bit deeper and to identify the characteristics of our most successful programs. By using those learnings to be more selective about how and where we invest and what business opportunities we pursue, for us, it means the following: First, stick to our core product technologies: pressure, temperature, electrical protection, and certain specialty sensing such as force, position, flow, and leak. Next, prioritize platform-driven applications where high switching costs favor incumbency, with an emphasis on regulated or mission-critical sockets. And finally, focus on the right end markets that expose us to key secular tailwinds and appropriate diversification.

As we apply these criteria, our priorities become clear. In our Sensing Solutions segment, HL Gear gas leak detection is a recent example of a business opportunity that checked all the boxes for us. We were able to leverage our core sensing capabilities to win a regulated sensor socket on air conditioning system platforms. We established a market leadership position in the US, which we are continuing to grow. In 2025, this business is on track to deliver approximately $70 million of revenue, and we continue to increase our market share with the goal of well over $100 million of revenue next year.

We look forward to leveraging our incumbency with key OEMs to win globally with similar regulatory requirements on the horizon in both Europe and Asia. In our Performance Sensing segment, we've spoken a lot about the content opportunities on both ICE and EV platforms, as well as the rapidly evolving new energy vehicle or NEV market in China. It is clear that we need to win in China to maintain and grow our global market share. The China market is opportunity-rich with the rapid adoption of NEVs and the growth of local OEMs. The high-voltage applications on NEVs offer incremental content opportunities for us compared to the traditional ICE business.

Our China team is actively driving business development with local OEMs in China to support their growth ambitions both in China and beyond. We have significantly increased our pace of new business wins in China, primarily on NEVs. Our customers are placing value on our product performance, proven field quality in the local market, cost competitiveness, and well-established production scale. More than 90% of these wins are with top local OEMs and leading NEV players. Due to shorter design cycles in the China market, we expect many of these business wins to materialize into revenue later this year and serve as the foundation for a return to more consistent market outgrowth in 2026.

The content wins we are securing include NEV-specific electrical protection, as well as powertrain-agnostic content such as tire pressure monitoring systems or TPMS. One of these recent TPMS wins featured new tire burst detection technology, and we are excited to share that we were the first to bring this technology to market for an active safety application. Tire burst detection enables the vehicle to activate its stability control features at the first sign of a tire rupture event, dramatically improving occupant safety. This is exactly the type of technological differentiation that gives us an edge in the market.

Now that we've spoken about our key pillars, I'd like to talk a little bit more about what we are seeing in our end markets today. Let's turn to slide four. I'll start with tariff and trade policy. Through a combination of reimbursement agreements with our customers and modifications to our supply chain, we have now successfully mitigated all of our tariff costs in the second quarter, compared to approximately 95% when we spoke to you in May. Since our last update, we've also seen a reduction in our exposures in connection with the DS rates between the United States and China.

Additionally, we're pleased to report that we have not seen significant impacts from recent tariff escalations on commodities or from export controls on rare earth materials. More broadly, in our end markets, we're seeing a mix of volatility, resilience, and growth. I'll share a few highlights now, and then Andrew will provide more specifics as he walks you through our results and guidance. On the performance sensing side, we are pleased with automotive production holding up stronger than initially expected with trade tensions escalated. Global production has grown in the first half as the market in China has been very strong.

HVOR markets have been soft, particularly with on-road trucks, and we're starting to see off-road production slow down as well. As a result, we're managing our costs accordingly. In our Sensing Solutions segment, we're seeing more growth, which highlights the advantages of our end market diversification. Our industrials business grew over 9% in the second quarter as markets have stabilized, and our new leak detection product is delivering meaningful outgrowth. In aerospace, we saw over 5% revenue growth in the second quarter, against a market that grew roughly 3%. Our market outlook for both industrial and aerospace in the second half is largely consistent with what we saw in the second quarter.

In summary, I'm happy with what we have achieved so far this year, and our Q2 results demonstrate the progress we are making on our transformation plan built upon three pillars. As we progress through the balance of 2025 and into the new year, we'll maintain our focus and rigor on these initiatives to drive shareholder value. With that, I'll turn the call over to Andrew to provide greater detail on Q2 financial results and our guidance for the third quarter.

Andrew Charles Lynch: Thank you, Stephan, and good afternoon, everyone. I want to begin today by extending my gratitude to Stephan and our board of directors for placing their confidence in me as Sensata's Chief Financial Officer. I would also like to thank the Sensata team and our finance organization for their support over the last several months. Let me start on slide six. We delivered another strong quarter in Q2 with results above our expectations across all of our key metrics. We reported revenue of approximately $943 million for the second quarter of 2025, as compared to revenue of $1.036 billion in the second quarter of 2024.

While revenues were lower year over year primarily due to the previously discussed divestitures, we saw $32 million of top-line growth sequentially from the first quarter of 2025 and exceeded the top end of our guidance range, reflecting our rapid recovery from the cybersecurity incident in April and general resilience in our end markets. Adjusted operating income was approximately $179 million, or a margin of 19.0%, and included approximately $12 million of zero-margin pass-through revenues related to tariff recovery, which were 20 basis points dilutive to our adjusted operating margins. Adjusted operating margins improved 70 basis points sequentially from 18.3% in the first quarter of 2025.

Adjusted operating margins were consistent with the prior year quarter at 19% and increased 20 basis points year over year, excluding the dilutive impact of tariff pass-throughs. Adjusted earnings per share of $0.87 in the second quarter of 2025 represent an increase of $0.09 sequentially from the first quarter of 2025, as we delivered on our margin expansion plans, and a decrease of $0.05 as compared to the second quarter of 2024 due to divestitures. We achieved robust free cash flow of $116 million in the second quarter, an increase of 17% year over year.

This represents a conversion rate of 91% of adjusted net income, an increase of 17 percentage points compared to the first quarter of 2025 and 20 percentage points compared to the second quarter of 2024. As Stephan mentioned, free cash flow is a key focus for us, and our improvements accelerate our ability to execute our capital allocation strategy. Now let's turn to slide seven, and I will discuss capital deployment. In the second quarter, we executed share repurchases totaling $20 million and returned $18 million to shareholders through our regular quarterly dividend. We reduced our net leverage to 3.0 times trailing twelve-month adjusted EBITDA compared to 3.1 times at the end of March.

With our capital allocation strategy, we delivered ROI of 10.1%, up 30 basis points compared to the second quarter of 2024. Looking ahead, you can expect us to continue to deploy capital in a manner designed to maximize shareholder returns, with an emphasis on deleveraging in the near term. Turning to slide eight, I'll talk through the results for our segments as well as provide more color on what we are seeing in our end markets. Let's start with the segment results. Performance Sensing revenue in the second quarter of 2025 was approximately $652 million, a decrease of approximately 10% year over year, primarily due to product divestitures and lower on-road truck production in North America and Europe.

Performance Sensing adjusted operating income was approximately $147 million, or 22.5% of Performance Sensing revenue, representing year-over-year margin expansion of 20 basis points inclusive of any dilutive impact from tariffs. Sensing Solutions revenue in the second quarter of 2025 was approximately $291 million, an increase of approximately 9% year over year. This marks our second straight quarter of year-over-year growth, driven by new content in our industrials business and market outgrowth in our aerospace business. Sensing Solutions adjusted operating income was approximately $88 million, or 30.2% of Sensing Solutions revenue, representing year-over-year margin expansion of 50 basis points, again inclusive of any dilutive impact from tariffs.

As a reminder, corporate and other costs have been recast to exclude certain costs previously referred to as megatrend spend, which are now presented within the two reporting segments. Corporate and other adjusted operating expenses were up $4 million versus the second quarter of 2024, primarily driven by higher variable compensation due to better underlying performance. Now I'll provide color on what we are seeing in our end markets. In our automotive business, production estimates have been volatile, and trade policy has evolved throughout the year. We have seen double-digit market growth in China in the first half, partially offset by market weakness in North America and Europe.

Looking ahead to Q3, we see auto production moderating to roughly flat year over year and down about one million vehicle units sequentially from the second quarter on typical seasonality. In our heavy vehicle and off-road business, we have seen softness throughout the year, with on-road truck production down more than 20% in the first half across North America and Europe. We expect this softness to persist in the second half of the year. Global off-road markets have seen modest growth in the first half, but we are now experiencing a significant slowdown in Q3. In our Sensing Solutions segment, we are seeing market strength.

Both industrials and aerospace are seeing low single-digit market growth, and we are seeing high single-digit outgrowth in industrial as our gas leak detection business has ramped nicely. The market outlook I just discussed is reflected in our guidance, which I will take you through in a moment. Looking a bit further ahead to Q4, we are monitoring third-party forecasts and customer demand signals, and we expect more clarity as trade policy develops in the days and weeks ahead. Lastly, before we get to our guidance, I'd like to give just a brief update on tariffs. Let's turn to slide nine.

When we guided the second quarter, we estimated that we would incur $20 million of tariff costs, which we expected to fully recover on a dollar basis based on reimbursement agreements we were able to secure in partnership with our customers. At this level of cost and pass-through revenue, we expected 40 basis points of adjusted operating margin dilution. Subsequent to our second quarter guide, we saw a de-escalation of tariff rates between the United States and China. Additionally, we continue to work on our supply chain to manage our exposures. The net result of this was that we incurred approximately $12 million of tariff costs in the quarter and recorded $12 million of pass-through revenues.

Accordingly, tariff pass-throughs were approximately 20 basis points dilutive to our adjusted operating margin. With that, let's turn to slide ten, and I will walk through our expectations for the third quarter of 2025. We expect third-quarter revenue of $900 million to $930 million, adjusted operating income of $171 million to $179 million, adjusted operating margins of 19.0% to 19.2%, and adjusted earnings per share of $0.81 to $0.87. At the midpoint of our guidance range, we see approximately 10 basis points of sequential margin expansion. However, we have assumed $15 million of tariff costs and associated pass-through revenues in our third-quarter guide, slightly higher than the $12 million we reported in the second quarter due to business mix.

On a pre-tariff basis, we expect approximately 20 basis points of sequential adjusted operating margin expansion compared to the second quarter, in line with the margin expansion targets we talked about last quarter. As noted in our press release and earnings materials, our guidance and tariff assumptions are based on trade policies and tariff rates in effect as of July 28. Earlier this month, we announced our third-quarter dividend of $0.12 per share, payable on August 27 to shareholders of record as of August 13. Finally, before I turn the call back to Stephan, just a brief update on the cybersecurity incident that we disclosed in April.

In connection with this incident, we experienced approximately a two-week disruption in our business. Thanks to our team's preparation and resiliency, our business has fully recovered. We are grateful to have this incident behind us without any significant disruption to our customers and without material financial impact. With that, I will now turn the call back to Stephan.

Stephan Von Schuckmann: Thank you, Andrew. I said this last quarter, but it warrants repeating. There is a significant transformation underway at Sensata Technologies Holding plc. The foundation of this transformation is the key pillars that I've discussed on each of our earnings calls since I joined Sensata at the beginning of the year. I would like to conclude today's remarks by sharing a bit more about why these are key to our vision and what you can continue to expect from us. Operational excellence is about stabilizing our core business to serve as an enabler to both our capital allocation and growth pillars.

Our capital allocation strategy is to utilize our cash flow improvements to deploy capital in a manner designed to create shareholder value in the short term and long term, with an emphasis on deleveraging. And finally, our return to growth will be supported by a focused product strategy and a clear evaluation criteria for growth opportunities. Success on our key pillars will be apparent in phases. Today, consistent execution with adjusted operating margins at or above 19% and free cash flow conversion at or above 80%. In the next several quarters, net leverage continues to improve. And in the years ahead, a return to more consistent growth.

I'm excited about what the future holds, and I look forward to continuing to update you on our progress moving forward. I will now turn the call back to James for Q&A.

James Entwistle: Thank you, Stephan and Andrew. We will now move to Q&A. Jamie, please introduce the first question.

Operator: We will now begin the question and answer session. To ask a question, you may press star and then one on your touch-tone phones. If you are using a speakerphone, we do ask that you please pick up the handset prior to pressing the keys to ensure the best sound quality. To withdraw your questions, you may press star and two. Our first question today comes from Mark Delaney from Goldman Sachs. Please go ahead with your question.

Mark Delaney: Yes. Good afternoon. Thanks for taking my questions. I see the free cash flow conversion pickup. And Andrew, congratulations on the expanded role. I wanted to start with EBIT margins. They expanded 20 bps year over year excluding tariffs even as organic revenue was down, I think, about 2%. And you expect sequential margin improvement again in Q3. Can you go into more detail on what's driving that margin improvement both in Q2 and Q3? And I guess as you look longer term, do you see a path to 20% plus EBIT margins?

Stephan Von Schuckmann: Look, Mark. Nice to hear. Thanks for the question. So first of all, as mentioned in the call, we're undergoing quite a significant transformation at Sensata Technologies Holding plc. And we've basically designed a number of initiatives that we're focusing on. So we didn't start a huge amount of initiatives. It's basically six initiatives that we're focusing on. And just to mention a few, some of these initiatives are focused on pure operational excellence, something I've been speaking about frequently now in the calls in the past. So that's improving plant performance. And what we're doing is we're benchmarking our plants against each other where we have so-called similar products.

So for example, in TPMS, we try to improve the plants that are weaker than the best benchmark within Sensata. As one example. Another example is we're working on commercial excellence. So we have a much stronger rigor on that. And like I said, there are other examples. So we're working, for example, on improving our procurement and gaining effect from that. And that's basically the effect that you see with other initiatives. That you could see the margin improvement. But for more details, let me pass on to Andrew.

Andrew Charles Lynch: Thanks, Stephan. Mark, I think to summarize, it's primarily operational productivity that's driving the sequential margin expansion. And we feel pretty good about our margin levels in the 19% range in the near term here. In terms of longer-term margin expansion opportunity, we've not established any targets at this time. We're really focused on short-term and margin resilience. We'll provide more clarity on what the longer-term outlook looks like as we get into the 2026 guide period. But for now, we're focused on just margin resilience at the current level and sequential margin expansion quarter on quarter.

Mark Delaney: That's helpful. My follow-up is also around EBIT margins and how mix may or may not affect that. You talked about diverging trends you're seeing in some of these end markets, industrial picking up. You said HVOR seeing signs of weakness. And if you see those sorts of divergent trends by end markets, what might that mean, if anything, for EBIT margins? Is that a potential headwind or tailwind from mix that investors should potentially expect? Thanks.

Andrew Charles Lynch: Yeah. Good question, Mark. So mix definitely matters in our business. I think as we've highlighted before, our lowest margin business is our automotive business. Our highest margin is our aerospace business. HVOR and industrial are kind of in between. As we look at what we're seeing in the current quarter and Q3, we've seen softness in the HVOR business and strength in industrial. And so we base that any mix headwind from the HVOR softness with the outgrowth that we're driving in industrial. And we feel good that the business mix kind of moving forward throughout the balance of the year will support the margin expansion that we've committed to.

Mark Delaney: Thank you.

Operator: Our next question comes from Joe Giordano from TD Cowen. Please go ahead with your question.

Joe Giordano: Hey, guys. Thanks for taking my questions. Have you, Stephan, as you've kind of gone through the portfolio now for a little bit longer, where do you think you stand on more product rationalization, SKU reduction that you need to do, scrubbing of backlog that you'd won kind of a long time ago that's been pushed out? Like, where do you think you stand on those things?

Stephan Von Schuckmann: Alright. Can you just repeat the question and get it lost?

Joe Giordano: So I'm just curious on where you stand as you evaluate the portfolio now that you've been here a little while. Like, how much more SKU reduction is necessary or small divestments and things like scrubbing of the backlog to see how realistic delivery is on things that were won, you know, maybe a long time ago and when markets were different.

Stephan Von Schuckmann: Well, look, I think a lot of the SKU reduction or let's call it portfolio cleansing has been done in the last year. There's been significant work done by the team and around the interim CEO, COO Martha Sullivan. Look, it's a continuous process. So I'm looking at all types of SKUs, be it in automotive, be it in HVOR, but also industrial. And anything that we don't feel that doesn't fit our portfolio at this point in time, we will cleanse of our overall SKUs. It's a continuous process. It's not something that is finished after we've gone through all of them. It's something that we follow through month for month, actually.

Nothing significant at this point in time, but something I'll keep a focus on.

Joe Giordano: And on the backlog, like, the recoverability of stuff that you won a while ago.

Andrew Charles Lynch: Yeah. I think you're probably referring to some of the EV wins and program wins from years back. I mean, as the market shifts on that, we work with our customers to make sure that we're securing offsets, whether it's new opportunity to quote on new business, whether it's commercial recovery, pricing discussions. So we factor all that in as we negotiate with our customers moving forward. But I think the driver there is pretty clear. It's that the time horizon of certain EV programs has moved to the right. And we're just focused on supporting the market as it is today.

Joe Giordano: Thank you. And then the follow-up, I know it's still early, but just any incremental, Stephan, you can give us on the China positioning? I know this is a big priority of yours to evolve how Sensata was positioned in China, with the local OEMs. So maybe any updates there? Thank you.

Stephan Von Schuckmann: Yes. Yes. Of course, I can. So look, I think generally, we need to say there's been quite an extreme shift from multinational to local OEMs. We see that the market is roughly at 70% local now, and see that government incentives have benefited 2024. And they basically continue to drive 2025. On the other hand, it's still encouraging, obviously, to see that multinational OEMs are continuing to make meaningful investments in China. So what does that mean for Sensata? I would say it's a return to outgrowth. So 90% of all the business of the year-to-date new business wins are basically with the top five local OEMs. And with leading so-called new energy vehicle players.

And around that, if I break that down to more products, the high concentration on high voltage and powertrain agnostic content. So we basically expect modest outgrowth in the back half based on third-party forecasted production mix, and we are also pretty confident that it's going to be more consistent outgrowth in the beginning of 2026.

Operator: Our next question comes from Wamsi Mohan from Bank of America. Please go ahead with your question.

Ashley: Hi. This is Ashley on the call for Wamsi. Just one question for me. We were wondering if you saw any pull forward of demand that impacted the Q2 time period, specifically in autos, just any color you could give us here? Thanks.

Andrew Charles Lynch: Sure. Happy to answer that. So the short answer is no. I think there are a few dynamics at play here. So in the second quarter, the early part of the quarter, the supply chain was coming up the curb on USMCA compliance, particularly in April. And so I think what we saw there was the OEMs consuming inventory earlier in the quarter and then replenishing it in the back half of the quarter. But effectively, Q2 was basically normal. And then looking ahead to the third quarter, our order book's pretty solid and filled to where we would expect it to be relevant to where we guided the quarter.

And certainly, as we talk to our channel partners on the industrial business and other end markets, we're not seeing any pull ahead in our business. I mean, that may be more of a dynamic further down the supply chain, but where we sit, it's pretty much business as usual in terms of order book correlation to production.

Ashley: Alright. Thank you. I'll pass it back.

Operator: Our next question comes from Kosta Tasoulis from Please go ahead with your question.

Kosta Tasoulis: Hey, guys. Thanks for taking my question. Andrew, congratulations. My first question is for you. So, you know, you've been at Sensata, I think, for a majority of all your professional career. You've been there a while. You've probably seen a lot of the maybe archaic processes that have been in place as you've moved up the ranks. But now you're literally a chief decision maker. So I just want to see, like, what are the things you're looking to improve within Sensata?

Andrew Charles Lynch: Thanks, Kosta, and thanks for the question. You know, my primary focus here is on enabling the transformation that Stephan has outlined here in his key pillars. I think we've got the right priorities to drive performance. There's a lot of work behind the scenes that goes into enabling these key pillars. As Stephan mentioned, there's a bunch of initiatives that underpin the operational excellence pillar. And a lot of that comes down to making sure that we've got the right analytics and the right data to drive the right decision-making. So that's part of the role of the finance org from a tactical standpoint, and so certainly focused on enabling that.

And then the other piece around capital allocation and growth, ensuring that we're applying the right rigor to our growth investments and ensuring that we're allocating capital in a way that creates shareholder returns. So I think that just reiterates the pillars that Stephan has outlined, and I'm fully on board with enabling those.

Kosta Tasoulis: Great. I'll just dig in on free cash flow a little bit. How should we think about these cost optimization efforts impacting your inventories? Right? So it sounds like part of the strategy is standardization. Right? So are you bringing in a single component across your products that would reduce cost and variability? And, you know, definitely got to keep a high stock of that component, and that kind of reduces the working capital tailwind.

Andrew Charles Lynch: I think as we think about inventory, it's two levers. So certainly, focusing on productivity and working unit cost reduction to drive inventory costs down and drive product costs down ultimately frees up more working capital. The other piece is just the amount of inventory that we carry. And one of the things we talked about on past calls about a potential driver for that is better integration of our supply chain planning and demand planning. And making sure that we're using our systems and the data that's available in the end market to optimize our lead times, optimize our demand signal, and optimize our production planning. All of that culminates in an inventory reduction opportunity.

And that's a lever to continue to drive higher levels of free cash flow conversion.

Stephan Von Schuckmann: And if I may add into what we do, something I mentioned initially is that we're benchmarking our inventory levels plant for plant. On the one hand, benchmarking plants amongst each other with similar products to try and figure out who has the best inventory level and what can other plants strive for. But then on the other hand, it's also looking outside of Sensata. And looking at who's the best in class in inventory levels and measuring ourselves against them. And redefining our measures and trying to drive inventory levels down.

Kosta Tasoulis: Thanks for taking my questions, guys.

Stephan Von Schuckmann: Thank you.

Operator: Our next question comes from Joe Spak from UBS. Please go ahead with your question.

Joe Spak: Thanks so much, everyone. Actually, I want to pick up on the free cash flow theme and how you're thinking about it for the second half. I think I heard, you know, 80% sort of a conversion. I'm not sure if that's a long-term target, mid-term target. And then also just on capex, and maybe this is obviously part of free cash flow, it looks like you're at 3% of sales in the first half. I think that's, you know, below historical, but maybe this is sort of the new normal for Sensata. So maybe just some help there on how you're thinking about that.

Stephan Von Schuckmann: Thanks for the question. Look, generally, we've set ourselves an ambition to strive for a cash conversion rate at 80% or more.

Andrew Charles Lynch: Yeah. And I would just add to that. So good point on the lower level of CapEx in the second quarter. The dynamic there was candidly just as we were looking at uncertainty in the end markets and we saw production forecasts drop dramatically early in Q2 following the trade policy or tariff rate escalations, we throttled back some of our capex to respond to potentially lower revenue levels. Obviously, that didn't materialize. We saw that demand get restored. And so we'd expect an uptick in capex in the back half of the year. That said, I expect to be able to maintain pretty high levels of free cash flow conversion going forward. And 80% really is the floor.

We have plenty of levers available to us to maintain reasonably solid cash flow conversion here moving forward. Inventory hasn't come down dramatically yet. There's still opportunity there. CapEx, while it may not be as low as it was in the second quarter, we still have the opportunity to understand or spend at a level consistent with depreciation. And so I don't see that as a meaningful headwind.

Joe Spak: Okay. So even with depreciation is a good guide. Is that and I guess, like, versus I think in the past, it's sort of been, like, a 4% level. Do you think going forward, it can be a little bit below that?

Andrew Charles Lynch: I think 4% is probably a good proxy for what sort of normalized run rate CapEx looks like. It can vary in any given quarter. And certainly, we adjusted up or down based on kind of our view on market certainty, the investment opportunities ahead of us, you know, whether those are sort of near-term automation opportunities to drive productivity or longer-term opportunities around growth investment. Try to keep that all in balance.

Joe Spak: Okay. And then just on the deleveraging comment, you know, I guess I want to confirm how you're really thinking about this because you mentioned sort of net leverage going high, which to me sort of implies like, you know, the EBIT that's really coming from higher EBITDA. Or are you also planning to say sort of gross debt down? And are there any sort of leverage targets or how should we think about minimum cash just so we know what's available for dividend, share repurchase, or debt repayment?

Andrew Charles Lynch: Yeah. In the short term, we'll look to reduce net leverage by accumulating cash on the balance sheet. That's just a function of where our debt maturities sit and what the current interest rate environment looks like. We don't have any debt maturities until 2029. That doesn't mean that we're going to wait until 2029 to address gross debt. There will be opportunities here in the coming quarters to potentially take some action there, but in the immediate term, our focus is going to be on accumulating cash on the balance sheet. And then, of course, we still have a share repurchase program.

We didn't execute in Q2 at the same level we did in Q1, but we'll still maintain the flexibility to opportunistically repurchase shares as we see fit and keep that in balance with our net leverage targets. Certainly, we'd like to be below three times levered in the near term and moving towards two and a half relatively soon.

Joe Spak: Thanks so much.

Operator: Our next question comes from Shreyas Patil from Wolfe Research. Please go ahead with your question.

Shreyas Patil: Hey. Thanks so much for taking my question. Maybe just coming back to the China auto piece. Can you just help level set how big this is for you today? And just to clarify, how much of an uplift could we see from the new launches that you mentioned, Stephan, that are starting later this year? And then just to wrap, just to put a finer point on it, how do you see the competitive landscape in China specifically on the auto business? In the past, the sense was that the mid to low end of the China market was very difficult to penetrate either given vertical integration or price competition amongst some of the local suppliers.

I'm just curious if that is still how you see it or have there been changes in the market?

Stephan Von Schuckmann: Look, it's pretty much the same. It's obviously a very competitive region, a very competitive country. As you know, there's amongst the OEMs, there's price wars going on, which obviously trickles down as an effect to the tier-one level. That leads us to obviously being extremely focused on cost. It's something that we have reinitiated. It's part of the strong history of being very cost-focused. That's something that we've been focusing on even more in China. And following through on that in a very stringent way to stay competitive within the market. So what we do is take our products, we go back into the design and take out as much cost as we can in order to be competitive.

And on the other hand, some of the products that I mentioned in my earnings script just earlier on come with a certain level of technical differentiation, like the tire burst detection system, and that allows us to enter the market first and gain market share in comparison to others that do not have these functionalities yet. So that's how we tackle the competitiveness in the market. Again, it's a very important market for us as you can imagine that some of the Chinese OEMs that are hungry for market growth are stepping outside of the country and trying to gain market share in Europe, in Southeast Asia, being in Thailand, in Malaysia, and so on.

So high dynamic there, and that makes it interesting for us as a growth opportunity because if we win with the right players like we have, mentioned that we won 90% of our year-to-date new business with the top five local OEMs, with really leading so-called new energy vehicle players. And why do I say that? Because those are the players that will most probably also show growth outside of China. That will give us a solid opportunity to benefit from that additional growth in, for example, Southeast Asia or in Europe or wherever else they're growing.

Andrew Charles Lynch: And, Shreyas, just to give you clarity on the numbers, so the China market is about a quarter of our automotive business. So about 12% or so of overall Sensata's revenue, obviously varying depending on business mix within any given quarter. The growth opportunities that we've highlighted would be sufficient to return us to kind of the low to mid-single-digit outgrowth that we've targeted in our auto business. So that'll give you a little bit of context on the size. We're not talking about specific platforms or programs yet, but that's sort of the magnitude.

Shreyas Patil: Okay. That's helpful. And then maybe pivoting to HVOR, you talked about meaningful weakness in the end market there. Curious how you're thinking about outgrowth in that business, both near term and long term. In the past, you've talked about three to six points of outgrowth as a target for auto. I'm wondering if there's a similar target for HVOR.

Stephan Von Schuckmann: Let me expand it in let me first start with the end market. With the end markets, and let me give you our perspective, and then I'll give you an outlook on how business is developing for Sensata. On the end markets, for on-road trucks, see that obviously for the entire year of 2025. Production is down. And you need to look at that from a regional perspective. So taking North America, or on-road trucks, we projected really quite a strong downturn of roughly 24% year over year for this financial year of 2025. And in Europe, on-road trucks were soft in the first half, which is roughly 6% down.

But projected to be up in the second half of this year. And looking at agricultural and construction, so it's expected to be down in a high single-digit percentage. And then the second half more positive than the first half. And then if you look at what are the actual slowdown drivers that are pushing that, so for on-roads, we're saying in North America, there's been no buy ahead on the payer twenty-seven and general macro uncertainty. And operators are not renewing their fleets, and that's what we're seeing in our numbers. Europe, we saw a soft quarter two on macro uncertainty. But we see that Q3 is pretty much normalizing on a year-over-year basis.

Now what does that mean for Sensata's business? So from a business perspective, we undergrew the market in the first half. And the reason for that is as Western production was down, our China production was up. Our content is generally higher on Western OEMs, but we actually expect this to continue in our HVOR segment through the balance of the year given the softness that we've seen in these western production forecasts.

Shreyas Patil: Okay. Great. Thank you.

Operator: Our next question comes from Christopher Glynn from Oppenheimer. Please go ahead with your question.

Christopher Glynn: Yeah. Thanks. Just give a little orienting question. To start on the guide. Third quarter is down about $30 million sequentially at the midpoint. Is that, you know, vast majority impact that performance sensing?

Andrew Charles Lynch: Yeah. That's right. We see auto production down about a million units sequentially. And then we see some softness in the off-road space accelerating in the third quarter, so all performance sensing.

Christopher Glynn: Okay. Great. And then just a couple content and outgrowth dynamics that might be in play. Curious how you see Europe phasing with some of the relaxation of the mandates for EVs if that's, you know, a CPV mix shift that progresses well in European auto through the back half of the year. And then, you know, you've talked a lot about the gains with local OEMs in China and starting to lap somewhat the share loss from multinationals. Have you indicated a timeframe when a growth crossover might be expected for China?

Andrew Charles Lynch: Sure. Let me start with Europe. So the relaxation of the mandates may ultimately lead to a slowdown in EV production in Europe. If it does, that would be a content tailwind for us. We haven't seen that yet. We've seen EV production continue to grow in the first half of the year in Europe, but that was a dynamic that played out last year for us. And so if you see that mixed shift again, that would be a potential outgrowth driver. Just a reminder there, we're about half the content per vehicle on an EV in Europe compared to an ICE.

As we move to next gens, we get above parity there, but on the current gens, that's where the content mix shifts. And then on the China question,

Stephan Von Schuckmann: Okay. Let me add something about that. So basically what to add that, Christopher, on the content side, even if EV growth is not as strong as predicted due to, you know, softening regulations. As we know, for example, in Europe, the combustion in Japan might be softened. Then we'd have probably a shift toward hybrid and mainly plug-in hybrid in the market, and, you know, Sensata has a broad portfolio mix which we could serve as well as can also obviously serve the EV market. So it's not a down for us. It's actually beneficial for us. And then, Chris, I think your question on China is one of the win start to show up in outgrowth.

So there's really two dynamics here around outgrowth in China. The first is the rapid share shift that we saw last year where multinationals lost share to locals, largely played out in the back half of last year. So we'll start to lap those comps into the third quarter. And so that outgrowth headwind starts to go away here in the back half of 2025, and we'd expect to perform more or less in line with market in China in the back half.

And then as these new businesses launch, which have design cycles and lead times that are less than a year, that'll start to show up in revenue late in 2025 and early into 2026 and set the foundation for outgrowth in China in 2026.

Christopher Glynn: Okay. Great. Thank you for that.

Operator: Our next question comes from Samik Chatterjee from JPMorgan. Please go ahead with your question.

Samik Chatterjee: Hi. Thanks for taking my questions. And, Andrew, congrats on the new role as well. Maybe if I can sort of go back to the China renewed piece of wins that you're discussing here. And great. Thanks for all the color till now, but maybe if you can sort of discuss how you're thinking about content per vehicle, where in the as you mentioned, the content per vehicle there can sometimes be lower than the Western OEMs. But in the new sort of win activity that you're seeing on that front, what are you finding out in really to content per vehicle opportunity? And do you see a road map here as you continue to drive those wins?

Is there a sort of more compression between the difference between the content on Western OEMs versus Chinese local OEMs? On that front. And I have a quick follow-up after that. Thank you.

Stephan Von Schuckmann: So, Andrew, you are starting to the point. So, basically, as I've mentioned in one of the previous calls, we've shifted our focus in China. So it's very important. Of course, you know, we want to win with the winners in China, and want to win with the right new energy vehicle producers in China. That's what we've been doing these last couple of months, and that has enabled us to win significant new business in the Chinese market. From a content point of view,

Andrew Charles Lynch: Yeah, for content in China, what really matters for us is you can look at it whether it's EV or ICE, you can look at it from a perspective of locals versus multinationals. Either way, it's about the same, which is that our content historically on EVs or on multinationals was much lower sorry. EVs or locals was much lower than with multinationals. And that's what we're starting to change. So these new wins will bring that content imbalance up to parity such that we don't have a headwind from the shift to local players as they continue to grow in the market.

Samik Chatterjee: Okay. Helpful. And just in terms of, Stephan, your earlier comments about the how you're thinking about where the incremental R&D dollars go, particularly if we do see a shift in the automotive industry towards more hybrid of EVs. That is beneficial for your content overall? How are you thinking about where the incremental R&D dollars are being dedicated in terms of platform strategy from your end? Thank you.

Stephan Von Schuckmann: Yeah. So we've, you know, we've obviously been very selective on where we put our dollars in R&D. And, you know, one good example is to your question to your earlier question, that's basically placing the dollars into applications for China for Chinese new energy vehicles. So that's the one side of it. That's what we focus on. On the other hand is, you know, we're putting more and more of our R&D dollars in the industrial area. We've got, you know, a gas leak detection product. HUL and AHRI. Just ramping up. Some of them are still in the developed phase, and we're already thinking about certain follow-up versions, so improvements on these products.

So we put a certain level of dollars of R&D in these products. And then on the aerospace side, there's also significant growth opportunity there, and selectively, we've been putting more and more dollars in that area as well. That we can tap that growth in the market that we see. At least for the future.

Samik Chatterjee: Thank you. Thanks for taking my questions.

Operator: Our next question comes from William Stein from Truist Securities. Please go ahead with your question.

William Stein: Great. Thanks for taking my question. First, Andrew, congrats on the promotion. Stefan, I think analysts and investors have sort of been waiting for a new mantra to understand the long-term growth potential either for cash flow per share or earnings per share. And I think what you're communicating, I just it's sort of a clarifying question is that your priorities are to maintain the 19% operating margin sort of bogey, stabilize it, but not necessarily have such a hard focus on expanding it. Second is to improve free cash flow conversion, and third, to decrease leverage. Do we have that right?

And is there and maybe the connection to this is I've heard a couple of analysts refer to outgrowth, but I think those are targets that were set by prior managers of this business. Do you have an outgrowth target or mantra that you want to guide us towards for the long term?

Stephan Von Schuckmann: So thanks for the question. And, you know, let me reiterate and bring some clarity some more clarity into that. So first of all, again, we're going through an entire transformation. And by the way, this transformation is working for us. And also implemented a lot more focus and rigor in our organization. And like I've said now, we're emphasizing benchmarking. We're working on consistency. And we're working on topics like standardization. So we consistently and proactively improving our operations. Working on enhancing free cash flow, and then we're setting ourselves up like you discussion around China for growth in the future. Let me not be more specific. What does that mean in numbers?

So to be precise, what we said is and Andrew actually mentioned it's the floor of 80% cash conversion rate or more. So that is basically the bottom end of it. The floor of 19% margin or more. So as you can see, in Q3 and in Q4 of this year, we're looking at expanding margins by 20 basis points. And then we also said so there is a margin expansion included in that to get to be precise on your question.

And then we also said it's important that Sensata gets back to an organic growth rate, you know, by winning business in the market, by winning business in automotive with the right players, if we're back on track in HVOR, that we're making progress in industrial, in the aerospace area. And then overall, we said we said, okay. Let's target a growth rate organic growth rate of somewhere between 2 to 4%. And that's sort of the kind of the frame that I've given the company that we're focusing on now. And, you know, that is the path and the next 12 to 18 months, and that is that's what we're focusing on.

And we'll see where that takes us, sir. Thank you.

Operator: Our next question comes from Robert Jamieson from Vertical Research. Please go ahead with your question.

Robert Jamieson: Hey. Thanks for taking my questions. Stefan, I appreciate a call earlier that you provided over the last few conference calls. On your strategic initiatives. But I want to ask about the global sales team. Have you spent some time with them? Have you seen anything in their process that needed to be changed to enable them to more effectively, you know, target the right types of customers in the right regions that you've spoken about? I'm just curious if anything's been implemented there that's driven the year-to-date wins you mentioned in China with the locals and then also in Japan year-to-date?

Stephan Von Schuckmann: Can you just repeat the first sentence of your question? I didn't hear it. It was a bit not clear for me.

Robert Jamieson: Oh, it's just about the global sales team and just having implemented like has anything been implemented to make them more effective in terms of targeting the key regions, you know, that you mentioned, like winning with the right customer, etcetera?

Stephan Von Schuckmann: Yes, we have. Look, you know, we've entirely changed the focus. So take the electrification market and the opportunities that are emerging within this market, and they differ very much per region. So I think it's very important to be extremely selective in choosing who you want to grow with. This is really important because as we know, unfortunately, not everybody's growing in the market. And but some of them actually you could face a potential risk, especially in China. We know that there's a consolidation going on in the market. Or an accelerated consolidation amongst OEMs.

So yes, you know, the team in China is very much focused and not, you know, if I may say the more blunt way, not running after every business. But trying to choose very selectively the right customers that we believe are going to be future strong outgrowers in the Chinese market, and that's been challenging. You know, it's difficult to obviously choose these right customers, but we have a good level with built up, and that's also a change, a good level of intelligence around that. And, again, being very selective. And, obviously, let me expand a bit more on China. It's not just, you know, predicting the or trying to predict the consolidation game in China.

It's also trying to understand which of these future customers are going to grow outside of China. And as you probably know, there's a huge dynamic out there. So a lot of the big customers are entering European countries. They're entering Southeast Asia. And they're hungry for growth. And so for us, as a team, as a sales team, it's very important that we try and determine who are going to be the winners outside of China so that we can grow with them when we win business for them. So that's a different type of focus. And then again, in the mix of, you know, the applications, so around hybrid applications, around combustion engine applications.

I think we've basically broadened the scope a bit more. So we said, look. There's also very good opportunities around the combustion engine applications that we still go for. You know, we have the assets. We, you know, we have the products. And we'll also try and win in that sector. And why do we do that? Why does the sales team go after that? Because that somewhat balances off the risk that you might have on the EV side, you know, trying to predict who are going to be the winner. So yes, it's a total it's a different focus. And I feel we have a lot more clarity around that.

Robert Jamieson: That's very helpful. I appreciate that. And then just pivoting to the leak detection business, just curious if you could elaborate on the total addressable market there, what's that size, and then what's the margin profile versus the legacy? And does industrial sensors, you know, business? You know, I'm also curious, what's embedded in your guidance for this business for Q3. Is it still high single-digit outgrowth versus the market? Just given some of the things that we've heard about the resi demand environment from some of the pure play HVAC names today.

Stephan Von Schuckmann: So the on the gas leak detection, the overall market size in North America is roughly $150 million. And as I just mentioned in the call, we won a significant market share in this market. And if you then convert that to Europe, where we're now going to attack that market with our so-called A3 product range, it's overall Europe is a similar size market as what we have in North America with roughly $150 million in market size. And there are more markets beyond that are actually emerging in is the interesting thing. You know, there's soon as stronger or tighter regulations come out, in South Korea, for example, or in Japan. We'll be ready with our product.

You know, we're busy scaling up HOL and hopefully we'll be ready by then with A3. And then we'll selectively tackle those markets, and that's an additional opportunity where we can gain market share and, you know, gain additional revenues. Around the margin of the product, I'm gonna pass over to Andrew. He'll explain that to you.

Andrew Charles Lynch: Yeah. We're we've been coming up the curve on margin, but at the level that we're at today, sort of $70 million or so of annualized revenue, we're basically at or very close to normalized industrial margins. So scale has certainly helped there, but I think we're over the hump on where we need to be on margin scale. And then in terms of outgrowth in the third quarter, so you're right. The resi dynamic is changed a bit. We're still expecting outgrowth in the third quarter. We were high single digits in Q2, probably low to mid-single digits in the third quarter, and then similar kind of for the balance of the year.

Robert Jamieson: That's very helpful. Thank you.

Operator: And our final question today comes from Luke Junk from Baird. Good afternoon. First question. Maybe just one for me, Stephan, and really tapping into what you're just talking about, leak detection, but maybe broadening that out and sensing solutions. It seems like tapping into non-auto markets could be a pretty interesting opportunity here. Just hoping to get your sense of urgency, prioritizing that, I mean, including the message pretty loud and clear around China on the performance sensing side of the portfolio, but how should we think big picture about ring, big earning growth? And sensing solutions, maybe even beyond the leak detection product and potentially even offsetting some of the cyclicality and performance sensing. Thank you.

Andrew Charles Lynch: Luke, thanks for the question. Yeah. It's certainly part of our strategy is looking at opportunities to diversify our end market exposure, and we're weighing that in as we evaluate the new business opportunities for investment. Beyond A2L and industrial, certainly, we're looking thematically at things like broader demand for electrical rotation and the electrical protection opportunities that come with that. We're looking at grid hardening and grid opportunities in the protection opportunities that come with that. But I think those are all sort of longer-term secular opportunities. The clear near-term winner is the A2L product at various derivatives of that for other end markets.

And so, you know, while we'll continue to look at secular opportunities longer term, the focus in the short term is on taking the business that we've already won, expanding it, expanding margin share, and bringing it to other end markets.

Luke Junk: Understood. I'll leave it there. Thank you.

Operator: And ladies and gentlemen, with that, we'll conclude today's question and answer session. I'd like to turn the floor back over to Andrew Charles Lynch for any closing remarks.

Andrew Charles Lynch: Thank you all for joining today's presentation. We look forward to seeing you at various investor events later this quarter. We currently expect to participate in the following events: Evercore ISI Semiconductor IT Hardware and Networking Conference in Chicago on August 26, Jeffrey's Industrial Conference in New York on September 3, and Goldman Sachs Technology Investors Conference in San Francisco on September 9. That concludes our second-quarter earnings conference call. Operator, you may now end the call.

Operator: Ladies and gentlemen, we do thank you for joining today's conference call and presentation has now concluded. You may now disconnect your lines.

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DATE

Tuesday, July 29, 2025 at 12:00 a.m. ET

CALL PARTICIPANTS

Chief Executive Officer and Founder — Daniel Shugar

President — Howard Wenger

Chief Financial Officer — Chuck Boynton

Need a quote from one of our analysts? Email [email protected]

TAKEAWAYS

Revenue: $864 million in revenue for Q1 FY2026, up 20% year over year.

Adjusted EBITDA: $215 million in adjusted EBITDA for Q1 FY2026, reflecting 23% growth in adjusted EBITDA.

Adjusted EBITDA Margin: 25%, an increase of 100 basis points from Q1 FY2025.

Adjusted Gross Margin: 33%, including a 150 basis point benefit from 45X related to historical shipments, resulting in a $10 million+ impact in Q1 FY2026.

Backlog: Over $4.75 billion in backlog for Q1 FY2026, a new record and marking fifteen consecutive quarters of sequential backlog growth through Q1 FY2026.

Cash Flow Generation: $70 million in adjusted free cash flow in Q1 FY2026; The company projects annual adjusted free cash flow to exceed $450 million for FY2026.

Balance Sheet: $743 million in total cash as of Q1 FY2026 with no debt at quarter-end.

Product Sales Momentum: HalePro and XTR tracker systems saw quarter-over-quarter sales increases of 43% and 22%, respectively, in Q1 FY2026.

Market Share: Global market share increased to 26% in 2024, with leadership in North America, Latin America, Oceania, and Europe.

Full-Year Guidance: Revenue is expected at $3.2–$3.45 billion for FY2026; adjusted EBITDA is projected at $750–$810 million for FY2026; adjusted diluted EPS is expected at $3.96–$4.27 per share for FY2026.

Strategic Acquisitions: Completed three transactions in robotics and AI fields, integrating autonomous inspection, robotic cleaning, and 3D site mapping into the core technology platform.

U.S. Manufacturing Capacity: More than 25 manufacturing facilities now operating across the United States.

Safe Harbor Proportion: Management stated that "a very high percentage" of the U.S. backlog qualifies as Safe Harbor under existing rules as of Q1 FY2026.

New Product Launches: EVOS solutions initiated sales during the quarter, with management expressing optimism about scaling production.

Recurring Revenue Model: Robotics and automation solutions are moving toward a robot-as-a-service structure with recurring revenue.

SUMMARY

Nextracker Inc. (NASDAQ:NXT) delivered double-digit revenue and adjusted EBITDA growth in Q1 FY2026, supported by record backlog and margin expansion. Quarterly adjusted free cash flow decreased due to increased capital expenditures and working capital, but full-year cash generation is projected to remain strong. The company advanced strategic initiatives, adding robotics and AI technologies aimed at full life cycle value for customers and transitioning the platform toward recurring revenues. U.S. policy developments, including OBBBA and pending Treasury clarifications, are cited as manageable by management, with flexible supply chain positioning touted as a core advantage. Guidance for FY2026 was provided across all major financial metrics, reflecting robust demand from global solar markets.

President Wenger described the company as the "number one tracker provider worldwide for the tenth consecutive year" during 2024, highlighting increased penetration and flagship projects in every major market.

Chief Financial Officer Boynton noted the 45X credit benefit was "a little more than a $10 million incremental benefit," tied mainly to historical vendor reconciliations, and expects future 45X impact to represent "10% of total revenue."

Management indicated that no projects dropped out of the backlog, attributing this backlog durability to "safe harboring" by tier-one U.S. customers.

Daniel Shugar emphasized that Nextracker Inc.'s platform diversification is accelerating through acquisitions, with operational and sales integration already generating customer traction in the U.S. and pipeline expansion planned internationally.

INDUSTRY GLOSSARY

Adjusted EBITDA: Earnings before interest, taxes, depreciation, and amortization, excluding certain non-recurring or non-cash items, as used by the company for operational performance benchmarking.

Backlog: The value of contracted future orders yet to be fulfilled.

Safe Harbor: Provisions allowing project developers to qualify for investment tax credits under existing rules based on project milestones such as the purchase of equipment.

45X Credit: U.S. advanced manufacturing production tax credit for domestic clean energy manufacturing, referenced as directly impacting gross margin.

EVOS: Nextracker Inc.'s product line for electrical balance-of-system solutions for solar power plants.

Full Conference Call Transcript

Daniel Shugar, our CEO and Founder, Howard Wenger, our President, and Chuck Boynton, our CFO. Following brief prepared remarks, we will transition to a Q&A session. As a reminder, there will be a replay of this call posted on the IR website, along with the earnings press release and shareholder letter. Today's call contains statements regarding our business, financial performance, and operations, including our business and our industry that may be considered forward-looking statements, and such statements involve risks and uncertainties that may cause actual results to differ materially from our expectations. Those statements are based on current beliefs, assumptions, and expectations, and speak only as of the current date.

For more information on those risks and uncertainties, please review our earnings press release, shareholder letter, and our SEC filings, including our most recently filed quarterly report on Form 10-Q, and annual report on Form 10-K, which are available on our IR website investors.nextracker.com. This information is subject to change, and we undertake no obligation to update any forward-looking statements as a result of new information, future events, or changes in our expectations. Please note, we will provide GAAP and non-GAAP measures on today's call. The full non-GAAP to GAAP reconciliations can be found in the appendix to the press release and the shareholder letter as well as the financial section of the IR website.

Now I will turn the call over to our CEO and Founder, Daniel Shugar.

Daniel Shugar: Good afternoon, everyone, and thank you for joining us. I am pleased to report our strong start to fiscal year 2026, building on the momentum we established last year. Nextracker Inc. continues to deliver consistent growth and strong financial performance, driven by technological leadership, operational excellence, and relentless focus on customer value. We delivered robust financial results across all key metrics. Q1 revenue grew 20% year over year, to $864 million, and adjusted EBITDA increased 23% to $215 million. Our backlog hit a new record of over $4.75 billion, reflecting healthy global demand and an increasingly strong competitive position. We also continue to generate solid cash flow and strengthen our balance sheet.

We are particularly pleased with our strong Q1 considering the evolving US policy environment. Our ability to consistently execute in challenging conditions speaks to the strength of our team, differentiated products, and the quality of our customer relationships. One of the most impactful developments in the quarter was the passage of the OBBBA reconciliation bill, which addressed a significant portion of the uncertainty surrounding solar manufacturing and investment tax credits. While further clarification is expected, particularly from around treasury and safe harbor provisions, we believe Nextracker Inc. is well positioned by virtue of our deep backlog and highly flexible US supply chain.

We have worked tirelessly with our suppliers to open and expand over 25 manufacturing facilities across the United States. The Federal Energy Regulatory Commission reported solar accounted for more than 80% of new US generation capacity in 2024. Globally, solar contributed more than twice as much incremental electricity as the next largest energy source. Looking forward, the International Energy Agency predicts that solar will become the largest source of global electricity supply within the next decade. These powerful trends reinforce our conviction that solar and Nextracker Inc. in particular, will play a central role in the future of energy.

We are scaling our platform to address this rapidly expanding opportunity and announced this morning three strategic acquisitions in the fields of robotics and AI. These technologies, from autonomous inspection and robotic cleaning to 3D site mapping, integrate directly with our control and monitoring systems to help customers optimize performance, reduce O&M costs, and lower risk. This initiative exemplifies our strategy of combining breakthrough engineering with digital innovation to deliver more value across the full life cycle of the project.

As we move beyond being the global leader in solar trackers and evolve into a broader technology platform for utility-scale solar, we are excited to provide a more detailed look into our strategy at our upcoming Capital Markets Day on November 12 at our headquarters. With that, I will turn it over to our President, Howard Wenger, to go deeper into our Q1 performance and the exciting developments across our technology portfolio.

Howard Wenger: Thank you, Daniel. Q1 was another great quarter for Nextracker Inc., marked by strong customer bookings and backlog and excellent operational delivery. This forward momentum continues to be driven by a flight to quality in the market. As Daniel noted, our performance is especially encouraging given the ongoing US policy dynamics and further underscores the strength of our global leadership position. According to Wood Mackenzie, Nextracker Inc. is now the number one tracker provider worldwide for the tenth consecutive year, increasing our market share to 26% during 2024. We are in the leading market position in North America, Latin America, and Oceania, which includes Australia.

We are pleased to report we are also the top provider in Europe, highlighted by flagship projects like the 550-megawatt Auricchio solar power plant in Greece, one of the largest in the region. Moving to pricing, cost, and project timing, in Q1, pricing for Nextracker Inc. was generally stable, and the company continued to manage costs well. Project timing was also stable and manageable on a portfolio basis, with some projects accelerating and some pushing out consistent with previous quarters. Our backlog and large project portfolio provided excellent visibility and helped reduce uncertainty. On the product side, we continue to experience strong demand for our core NX Horizon tracker systems and TrueCapture technology.

Our recently introduced HalePro system and expanded XTR tracker series are seeing rapid adoption with quarter-over-quarter sales up 43% and 22% respectively. HalePro is winning in the market due to its ability to reduce both hail damage risk and insurance costs. This is yet another example of innovation driven by customer feedback and, in this case, the insurance industry. We are pleased by the positive traction we are seeing as our technology platform expands to a more complete solution, including adding foundations in EBOS to our industry-leading tracker systems. Our foundation products and services continue to gain momentum, with cumulative sales of NX Earth Trust now over one gigawatt.

We are also excited by customer reaction to our new EVOS solutions, which we began selling during the quarter. We are optimistic about our ability to significantly scale our EVOS production. As Daniel mentioned, we recently executed a series of strategic technology acquisitions, extending our platform and capabilities in robotics, automation, and AI. This includes acquiring the company's on-site technology, Amir Robotics, and the IP from Sensehawk. These acquisitions complement our own internal efforts by incorporating ground-based robots and drones to provide incremental customer value across the full project life cycle. On-site's autonomous inspection robots and field-based detection technologies are already in use and available for immediate sale to US customers.

We will be providing detailed global rollout plans for these new products at a later date. To lead us in this rapidly emerging area, we have appointed Dr. Francesco Varelli as our new Chief AI and Robotics Officer. Dr. Varelli is a globally recognized leader in AI and predictive model-based control systems. He brings decades of experience in autonomous technologies, and he played a key role in developing our TrueCapture program. We are very excited about the potential of AI, robotics, and automation to further enhance the full customer experience and help drive project life cycle value.

With that, I will now turn it over to our Chief Financial Officer, Chuck Boynton, to go over our financial results in more detail.

Chuck Boynton: Thank you, Howard, and good afternoon, everyone. I am pleased to share our financial results for our first quarter of fiscal year 2026. Q1 revenue was $864 million, representing year-over-year growth of 20%. Q1 adjusted EBITDA expanded to $215 million, a 23% increase year over year. This translates to an adjusted EBITDA margin of 25%, which was an increase of approximately 100 basis points compared to the previous year. Our adjusted gross margin was 33%. We recognized a 150 basis point benefit in Q1 for 45X related to historical shipments. We continue to believe that our gross margins should be in the low thirties with OpEx in the 9% to 10% range, yielding operating margins in the low twenties.

On the cash side, we generated $70 million in adjusted free cash flow during the quarter, down from the same period last year, primarily driven by growth investments in capital expenditures and working capital. We see strong cash generation throughout the year with over $450 million of free cash flow. We exited the quarter with $743 million in total cash with no debt. Our strong balance sheet and cash flow generation remain competitive advantages. Moving on to our outlook, looking ahead, our outlook assumes that the current US policy environment remains in effect and, in addition, that permitting processes and timelines will remain consistent with historical levels.

As Daniel mentioned, we are closely monitoring potential updates to Safe Harbor provisions and other regulatory actions which could impact project timing, customer investment behavior, and our financial results. For the full year fiscal 2026, we expect revenue to be in the range of $3.2 to $3.45 billion, with relatively balanced quarterly revenue for the remainder of the year. Adjusted EBITDA to be in the range of $750 to $810 million, and adjusted diluted EPS to be in the range of $3.96 to $4.27 per share.

Our increased outlook is grounded in several key factors, including the strength and diversity of our backlog, a continued flight to quality among solar developers, and the deep capability and commitment of our global team. With that, we are happy to answer any questions you may have. Operator,

Operator: Our first question is from Dimple Gosai with Bank of America. Your line is now open.

Dimple Gosai: Thank you. Thanks for taking the question. Can you please discuss what conversations have looked like with developers post the OBBBA? Are they kind of in wait-and-see mode? And maybe you can also just expand on bookings momentum. I know you have grown from what you previously described as significantly higher than $4.5 billion to $4.7 billion this quarter. But, you know, is that pace of bookings picking up or any commentary there would really be helpful. Thank you.

Howard Wenger: Hey, Dimple. This is Howard Wenger. We are in touch with our owner developers closely. Let me just start out by saying we are really happy with the company's performance and pleased with the quarter and the outlook for the year. What we are hearing is that they are feeling good about their portfolios. As you know, we team up with tier-one developers who are quite sophisticated. They are able to safe harbor their projects and perfect their projects, and we feel what we are hearing and what we are seeing is that our backlog is solid. No projects are dropping out. We are looking forward to continuing to execute. The sales team did a great job in the quarter.

We had another sequential growth in our backlog, quarter over quarter, fifteenth quarter in a row. We are seeing a good set of demand signals across the globe. So feeling very good about where we are at this moment.

Dimple Gosai: Thank you for that.

Operator: Our next question is from Praneeth Satish with Wells Fargo. Your line is now open.

Praneeth Satish: Thanks. Good afternoon. Maybe I will touch on the new business here, the venture into AI and robotics. I know you will probably offer more details at the Analyst Day, but just generally, are you planning to offer these solutions as a service with a recurring revenue stream, or will this be primarily an equipment sale model? And then how do these robotic acquisitions integrate with your existing TrueCapture software? Are there any synergies here given that you will have all these extra data points, and can this all be wrapped up as one service?

Daniel Shugar: Hi, Praneeth. Daniel Shugar here. We are so excited about the suite of robotics technologies that we have just launched. In terms of the go-to-market, there is a range of solutions that we brought in today. For example, we have drones. We actually completed the acquisition of this technology multiple quarters ago. That is already being used. That is integrated into our existing TrueCapture technology. We are using the technology from Sensehawk that we acquired to actually create a complete as-built digital twin of the site being used in our TrueCapture technology that has been implemented for a very long time, already in use. That goes with our TrueCapture.

We have these other technologies with robotic cleaning and with the on-site technologies where we have both a ground-based robot and a stationary camera that detects a fire and other parameters on-site. How that is integrated in, we will be getting into greater detail later. But these technologies are either being offered commercially today or they are in a fairly advanced stage of productization. Thanks.

Operator: Our next question is from Brian Lee with Goldman Sachs. Your line is now open.

Brian Lee: Hey, guys. Good afternoon. Thanks for taking the questions. Just had two. One, Howard, going back to the comment around backlog, you said it did grow quarter on quarter. I know you changed kind of the language semantics a bit, so I wanted to confirm that was the case. It did grow, and I guess that implies, you know, bookings were $900 million, maybe close to a billion again, and curious if anything in the quarter you saw pauses from customers due to policy uncertainty or vice versa, any pull-forwards to try to get ahead of, you know, the bill passage and had a follow-up.

Howard Wenger: Got it. Hi, Brian. So, yeah, I want to confirm our backlog grew quarter over quarter. Your math, you can do the math in terms of, and you just did it, in terms of what we booked. At least, you are in the ballpark. We did not disclose that number, but yes, our backlog grew quarter on quarter for the fifteenth consecutive quarter for the company. Happy about that. What we are seeing is the pipeline is actually growing for the company. As you know, we have a global business, and we are still, you know, roughly tracking on the one-third, two-thirds as growth. Two-thirds being North America and one-third rest of the world.

But we are not seeing pull-ins per se when we talk about North America and the US in particular. We are not seeing pull-ins on projects in a very broad systematic way. We are seeing some pull-ins. We are seeing some push-outs, and those are, I would characterize those as normal. Because we have a broad portfolio of projects, and just that is the way project schedules are. Some can pull in from one quarter to the next, some can push out. It is a very normal fact pattern with respect to operations. Now, we expect clarity on the treasury guidance coming up in a few weeks. That could change some customer behavior.

We do not know, and we will know then. We are seeing some limited amount of safe harbor interest, and we are prepared to address that with our very robust supply chain and flex capacity. So, hopefully, that gives you more color, and you had a follow-on, Brian.

Brian Lee: No. That is great. Appreciate all that color. Very helpful. And if you could bear with me just one more math question, and then I will get out of here. On the IRA credit impact or the vendor rebate, I think it was 11 percentage points on gross margin this quarter. That was up significantly, like, three to four hundred basis points incremental versus what you have seen in prior quarters. What is kind of driving that? Because I did see international revenue growth was better than the US this quarter.

So I am curious how that worked out this quarter to be such a higher impact and then how we should think about that number in relation to gross margin maybe going forward. Is it going to stay at that level? Is it flatline? Does it go down? Thanks, guys.

Chuck Boynton: Yep. Thanks, Brian. This is Chuck. So we did have a really strong quarter. 45X was a little higher than normal. I mentioned in the prepared remarks about 150 basis points. That is a little more than a $10 million incremental benefit, and that is really relating back to kind of vendor reconciliations going back the last couple of years. Looking forward, we expect it to be, call it, 9% to 10% of total revenue. That is a little higher than it has been. That is partially driven by US demand for US-made products.

So we are actually delivering more US product to our customers, and with that, the costs are a little higher, but the 45X credit helps to offset that. So I do want to call out and say thank you to our operations team. They have just done a phenomenal job. Our on-time delivery has been excellent, and we are delivering locally around the world in the US, a real hallmark working with our manufacturing partners to deliver really compelling US-made content that does generate 45X credit benefit offsetting higher costs. Thank you.

Brian Lee: Alright. Thanks, guys. I will pass it on.

Operator: Our next question is from Philip Shen with Roth Capital Partners. Your line is now open.

Philip Shen: Hey, guys. Thanks for taking the questions. First one is on your backlog. What percentage of the backlog is Safe Harbor? And then, can you talk separately on what kind of, you know, how much risk there is with the Trump executive order expected to be released August 18th? And then finally, as it relates to the interior memo, where the secretary has to review all the permitting for projects that touch federal land, when you look at your backlog, what kind of impact could that have depending on how they enforce that? Thanks.

Daniel Shugar: Hey, Phil. Daniel Shugar here. Howard and I will tag team on this. We were thinking about this in the preparation for this as a run-up over the last, let us say, year, or even longer, you know, well, what percentage was safe harbored? When we ask our tier-one customers, do they feel about the integrity of their pipeline, their projects, they feel good about it because they safe harbored under the rules that exist. So I would say when you asked the question, I think a lot of projects in the United States benefit from that. But that is taking the longer view on the safe harbor. Howard, do you want to pick it up from there?

Howard Wenger: Sure. I mean, you heard on NextEra's call that they feel good about their portfolio through 2029. And that is indicative. They are one of the leading developers in the country, and we work with them and others, tier-one customers like them, who echo what Daniel said. They feel very good about their pipelines. They are able to manage it from a safe harbor perspective. So we believe that a very high percentage of our backlog that is US is Safe Harbor, to answer your question directly. Like, the vast majority of it. That is based on the information we have. As far as risk, again, I would point to the NextEra call.

We know it is early to digest what the interior department guidelines are and what the treasury is going to come out with in a few weeks. So I think the industry is still digesting it, but what we are hearing is that it is manageable. The early read on this is that it is manageable going forward and that through the OBBBA, which was the bill that was passed, that provided a good outcome, we think, based on our close proximity with customers, that is providing the bridge that is needed to beyond the incentive platform that we have been on for the last couple of years. That should give you, I think we have answered your questions, Phil.

Thank you.

Philip Shen: Great. Thanks.

Operator: Our next question is from Julien Dumoulin-Smith.

Julien Dumoulin-Smith: Hey. Good afternoon, team. Thanks for the time. Let me just continue on that same line of thinking here. Just first, higher-level question. I mean, how do you think about the cadence of the overall industry? If you think about both Safe Harbor dynamics that you are seeing on pull-in as well as potentially some of that same apartment material, you know, pulling off 2029, 2030. How do you think about how that squares with the timing of orders and a potential eventual pickup with Acthar? Clearly, not as meaningful here in the very near term, but how does it square with what you are expecting here at 2025 through, you know, call it the next four years? Timing-wise?

Daniel Shugar: So the connection was a little bit janky there, but I think we got the gist of it, Julien. Thank you. So we think, look, one thing that we did is under Daniel's leadership, honestly, and with the ops team, we have been having gloves for the last few years, is really sped up the US domestic supply chain. We are the first company to come out with a 100% domestic tracker. We have only increased capacity since then. We have over 25 facilities feeding US business. So we are in a really good position with a lot of flex capacity, very significant capacity.

The reason why we point that out is should the rules dictate that, let us just say the safe harbor requirement goes up from 5% hypothetically. We do not know. Let us just say it was double to 10%. We are in a position to serve our customers with additional safe harbor capability. So, yeah, there could be some, you can call it pull-in, you can call it whatever you want, but there could be additional shipments by Nextracker Inc. depending on the guidance that comes out. Yeah. I will just pile on to Howard's comment. The Federal Energy Regulatory Commission has maps that show last year over 80% of the power capacity installed in the United States was solar.

Lawrence Berkeley Lab, which is funded by the US Department of Energy, calculated over almost 7,000 projects are solar and solar plus storage. Now there is this incredible need for power in the United States. Period. You see it dominating the news, the headlines. People are talking about other ways to make power, and there is limited availability of gas turbines, nuclear way out there in terms of time frame. Solar is available, affordable, and has no fuel risk. We also see now storage in ERCOT and California at incredible scale, keeping the lights on.

You can look at the demand today and from last week online and see that with batteries, the solar power is available till 10, 11 PM when folks are going to sleep and the power drops. So we think that this is going to be an enduring story. We have a very compelling manufacturing and jobs made in USA, energy dominance, facts on the ground situation. We see policymakers responding to that. So we see the US market, despite a lot of fluidity, as it has been up into the right. Our backlog reflects that, our bookings reflect that, and our revenues reflect that. Meanwhile, we are continuing to expand overseas.

As Howard mentioned, we achieved leadership in Europe as the number one provider in Europe. We saw our total market share globally increase from 23% in 2023 to 26% in 2024. That is over a double-digit increase globally. So we are really focused on serving the global market. Global manufacturing provides tremendous strength.

Julien Dumoulin-Smith: If it is okay, can I still open a micro here? Just with respect to the diverse coming from last quarter about a third over five years, obviously, you guys have an analyst day target at November here. Can you speak a little bit more clearly to the different pieces that you are expecting on diversification? I know you have kind of said there are a couple of them out there in the market as part of the ten-second century, but any broader set or more specific sense, you can certainly tell the rest of the ones right here. Yeah. It has preview. My apologies. There are connections at this spot.

Daniel Shugar: Your connection is quite spotty, but we will speak to the growth in non-tracker technologies. So let us do a quick review. We acquired a machine learning company about ten years ago called Brightbox. We built a fantastic software business that created tremendous value for customers, helped with stickiness with our tracker, overall value proposition, improved the yield, trackers. It also demonstrated that Nextracker Inc. knows how to work with companies that we acquire and get the technology integrated in a way that is accretive. Then last summer, we acquired two foundation companies and we have introduced those products in a major launch. That suite of products is going very well with incredible customer uptake.

We are ahead of plan from a sales standpoint, and we are integrating the ops. Very pleased with how that is going. So far, those technologies have been focused in the United States. We do plan on launching the foundation technologies in selected international markets next year. The TrueCapture software suite I mentioned a moment ago has been offered globally for many years. In fact, it is on the uptake internationally. Now, the last quarter, we announced a suite of products. We are really focused initially in the United States, but we will be at the correct time ramping that internationally as well.

The acquisitions and new business as we announced today in robotics, both the on-site evaluation with Amir Robotics and owner asset management class, we are going to be rolling that out both geographically and from a product diversification standpoint over time. We will definitely be unpacking that further on the Capital Markets Day in November. Thank you.

Operator: Our next question is from Ben Kallo with Baird. Your line is now open.

Ben Kallo: Hey, guys. Thanks for taking my question, and good afternoon. Just maybe we talked a lot about safe harboring. But if you can have any color on, you know, past the ITC expiration, any kind of product development there and, you know, it is a long ways away, but, you know, how you guys think about that, you know, if how first agreements will respond in time, you know, to make projects go forward or pencil out.

And then, just maybe another question that you have talked a little bit about, but on the robotics and AI acquisitions, do you think this is, like, an add-on to the customer wallet, or should we think about it, or maybe the question is how you price it? Is it against cost or is it additional cost on top of a project? Thank you.

Howard Wenger: Thanks, Ben. This is Howard. So on part one, past the ITC, look, let us just step back and take stock of where solar stands over the last thirty, forty years. Right? We first had to validate that it was reliable and technically sound. We have done that as an industry. We then had to prove that it could economically compete. We have done that to the point now where if you go to the Middle East, solar power is now fifteen dollars per megawatt hour. One point five cents per kilowatt hour. Okay. That is an unsubsidized market. Free market. Nextracker Inc. was the first company to be in the Middle East. We are there. We have an office.

We are in a great position. We can compete in that market and win. We have a differentiated value proposition that we just keep building with these acquisitions and our own internal organic efforts. What you are seeing is that solar power, as Daniel mentioned, is the fastest growing, most impactful new energy technology going in the United States and around the world. If you look past the ITC, if we are on a level playing field, the industry can compete. When you add storage to the equation, it is really an unbeatable firm power, dispatchable power company.

So we feel, you know, in our engagement with very large owner developers, who their companies and their investors are pouring billions of dollars into them. Why? Because they have a durable value proposition that can compete to provide energy to the fast-growing electricity markets in the US, and they just needed a bridge. So we are in the middle of that bridge right now. We think we are in good stead with the OBBBA. We are going to get more guidelines. But beyond that, it is durable and it is unstoppable, and we feel really good about it. That is from an industry and company perspective for solar power. Okay. AI and pricing.

So right now, the way we are thinking about it, especially when you think about on-site, who is out in the market and has robots and customers in seven states in a couple dozen sites, with real technology being deployed and being paid for, it is done. What we are migrating towards is more of a robot as a service model, where there is recurring revenue for those services, and it is in addition to services that we provide today. But it is part of our whole platform development and constellation. Daniel talked about tracker, which is core, and we are investing a lot in Tracker. We have tripled our R&D spend in the last three years.

A lot of that going to our core tracker technology. Okay? And then we are building around that with these additional acquisitions, including robotics. Thanks, Ben.

Ben Kallo: Thanks, guys. Appreciate it.

Operator: Our next question is from Dylan Massano with Wolfe Research. Your line is now open.

Dylan Massano: Hey. Good afternoon. Just on backlog, can you give us an update on how much of current backlog you expect to ship over, call it, the coming six to eight quarters? I think that is a metric you have shared before. And then quick follow-up on BenTech. You are talking about building out the EVOS capacity. Are you looking to actually expand the current product offering beyond the products we currently make to potentially compete more directly with some of the leading EVOS players? Thank you.

Chuck Boynton: Yeah. Dylan, this is Chuck. It really has not changed much. You know, it was a metric we used to publish. We stopped because it kind of was the same each quarter, call it, you know, high eighties, low nineties would be shipped over the next eight-ish quarters. Not much movement there, and we stopped disclosing that because it was not that meaningful. The second question on BenTech products, we will have Howard answer that.

Howard Wenger: Okay. We offer two product lines through BenTech. They cover 100% of use cases currently in the solar industry. One is based on a combiner box approach, and one is based on a truck plus approach with low break disconnects. One of the reasons why we really like BenTech was that they had a robust product development effort. They have new products in their pipeline. We are helping them bring those to the market. We expect to be adding to the products, point A, to what is offered today. Point B, we are working with them to scale so that we can better match the volume that Nextracker Inc. has.

We have an incredible footprint in the US and then first US and then the rest of the world. So there is a lot of upside to the EVOS business for Nextracker Inc. Thanks, Dylan.

Dylan Massano: Great. Thank you.

Operator: Our next question is from Ameet Thakkar with BMO. Your line is now open. Well, Ameet, your line is open.

Ameet Thakkar: Hi. Thanks for taking my question. Just wanted to ask you, maybe pivoting away from the executive order, but on the section 232 tariff investment case, I was just wondering what sort of kind of feedback you have got from your customers on that and kind of given your ability to kind of maybe work with a greater array of different solar modules that might be better positioned to kind of respond to that. Have you seen kind of any kind of additional interest as a result of that? Thank you.

Daniel Shugar: Yeah. Thanks, Ameet. We are flexible to work with a wide range of solar panels. Nextracker Inc. has spent a lot of, you know, contributed a lot to making these panels compatible with our tracker. If you actually pull the specifications of a solar panel, you will see that almost every panel has a 400-millimeter hole in the frame. That came from Nextracker Inc. about twelve years ago, thirteen years ago. We have a very strong product management function that closely coordinates with their counterparts at the module companies. It is great to see the growth in the solar panel manufacturing industry here in the United States.

There are over thirty companies that have actually made and shipped solar panels in the US, which is kind of staggering from where it was five years ago. So it is great to see that and to see the expansion of both legacy players and new players. So we are very excited about that tech growth. Thank you, Ameet.

Ameet Thakkar: Thank you.

Operator: Our next question is from Joseph Osha with Guggenheim. Your line is now open.

Joseph Osha: Thank you very much. Two questions for you. First, looking at BenTech, I am wondering if we might see you start to use that platform to do completely custom harnesses without insulation piercing connectors. What the thought might be there? And then second, with the acquisitions you have just completed, you know, we do see some companies out there like you are really seeking to sort of automate the whole assembly process and all of that. Do I kind of sense that you are maybe moving in that direction with these acquisitions that you are making? Thank you.

Howard Wenger: Hey. I will do part A, and Daniel will do part B. This is Howard. So for BenTech, we are not, as I mentioned before, we are able to provide both platforms that are predominantly used in the US large-scale solar industry for wiring systems. We are not, at this time, prepared to talk about some of the development that we are doing, including the area that you discussed, which is the custom harnesses. But thank you. Thank you for the question. Daniel, do you want to talk about the second part?

Daniel Shugar: Yeah. So you asked about TerraBase, which is a great company that has a sort of field factory assembly installation process. We are supporting TerraBase 100% with everything we can do to help them. There is also another dozen companies working on the field factory or installation or automation for installation. We are supporting pretty much all the above, folks that are coming and asking for specific things to facilitate field factory installation, to make labor more efficient, safer. We think all of that is good. We think it is a hard problem. There are multiple ways to approach it. We are supporting all the leaders that we are engaged with in that particular activity.

We think that is the right approach. We have seen progress and a lot of opportunity for future progress. In our robotic programs that we have announced, these things attach basically separate buckets. We are going after things that validate, that support the EPC to validate installation quality, identify deviations to support the EPC on more efficient punch list type. We are doing it to then create a digital 3D map of the job sites that supports adaptive tracking. We think what we are doing is unique in this area, and our TrueCapture really delivers the results there and expectations we are creating. We have unique robotic technology we have acquired with Amir Robotics on cleaning.

Nextracker Inc. was a very early mover on robotic cleaning. For the last seven years, we have been supporting our customers in the Middle East to empirically evaluate how robotic cleaning technology supports work with a bunch of companies. We understand the tech. We have really leaned in. That really improves more yield gain. With the on-site technologies acquisition, it is really supporting a higher durability and reliability of the solar power assets by inspecting things like the connectors and electrical valve system. Then providing feedback on and also reducing risk on where these are going. If I could pull back for a second and just talk about why we did these robotic cleaning, or excuse me, robotic category acquisitions.

It was really customer-driven. A lot, as is a lot of our technology. We actually did not really believe in robotic cleaning if you went back ten years ago. We did not think it was very cost-effective. But we saw our customers in areas that are very dry and that have high dust storms really showed us the need. You can have a major dust storm and see array performance degrade significantly in a short amount of time. We saw the need for robotic cleaning, and so similarly, we really then worked to find who are the best teams in these areas. The Amir Robotics team is incredible, has legacy in robotics cleaning.

Fantastic domain expertise, and we really focus on the key team. Similarly, with on-site technologies, the team there really came from operations and maintenance of solar power. They have specific domain expertise. We just love how the team was thinking about it. It was not a robot in search of a solution. What they came up with was a need that was solved by a robotic technology that significantly lowered the cost, improved reliability, and reduced risk on the job site. These are our values at Nextracker Inc. Customer demand drives then how we come up with solutions to lower the levelized cost of energy, improve your building system. With that question, that concludes our call today.

Thank you all very much. As Howard mentioned, big picture, very excited about our progress. We are off to an amazing start in Q1. We look forward to welcoming you all at our Capital Markets Day in November.

Operator: That concludes the conference call. Thank you for your participation. Enjoy the rest of your day. Goodbye.

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