Thomson Reuters Corporation (NYSE:TRI) Q3 2023 Earnings Call Transcript

Thomson Reuters Corporation (NYSE:TRI) Q3 2023 Earnings Call Transcript November 1, 2023

Thomson Reuters Corporation beats earnings expectations. Reported EPS is $0.82, expectations were $0.68.

Operator: Good day, everyone, and welcome to the Thomson Reuters Third Quarter Earnings Call. Today’s conference is being recorded. At this time, I’d like to turn the call over to Gary Bisbee, Head of Investor Relations. Please go ahead.

Gary Bisbee: Thank you, Ali. Good morning, everybody, and thank you for joining us today for our third quarter 2023 earnings call. I’m joined today by our CEO, Steve Hasker; and our CFO, Mike Eastwood, each of whom will discuss our results and take your questions following their remarks. [Operator Instructions] Throughout today’s presentation, when we compare performance period-on-period, we discuss revenue growth rates before currency as well as on an organic basis. We believe this provides the best basis to measure the underlying performance of the business. I’d like to highlight this quarter a change — slight change to our non-IFRS measures. Beginning with this quarter’s results, we now add back to adjusted earnings the noncash intangible amortization expense related to acquired software.

Mike will discuss this change in more detail in a few minutes. To help with your models, note that we’ve posted a historical restatement or revision of the non-IFRS calculation to the IR website. Today’s presentation contains forward-looking statements and non-IFRS financial measures. Actual results may differ materially due to a number of risks and uncertainties discussed in reports and filings that we provide to regulatory agencies. You may access these documents on our website or by contacting our Investor Relations department. Let me now turn it over to Steve Hasker.

Steve Hasker: Thank you, Gary, and thanks to all of you for joining us today. Let me start by saying that we are deeply saddened to learn that on Friday, October 13, Reuters visual journalist, Issam Abdallah, was killed when a shell hit him while he was filming cross-border fire between Israel and Lebanon. Thaer Al-Sudani and Maher Nazeh, two other Reuters journalists, and colleagues from AFP and Al-Jazeera were also injured in the shelling. Issam was an experienced, talented, passionate journalist. And his loss is deeply felt in our newsrooms and across Thomson Reuters. Our thoughts are with Issam’s friends and family as well as our Reuters colleagues who continue to report in escalating conditions from Gaza. Reporting on world events with accuracy, integrity, independence and freedom from bias is core to what we stand for and is critically important for our journalists to be able to do so safely.

Now I’ll move to reviewing our Q3 highlights. Solid momentum continued in the third quarter with revenue largely in line and margins ahead of our expectations. As was the case in the second quarter, a majority of the margin beat resulted from the timing of expenses, which we expect to largely normalize in the fourth quarter. Mike will provide further explanation and context. Total company organic revenues grew 6% driven by healthy recurring and transactional growth. The Big 3 segments grew 7% organically. We continue to see good momentum from many areas in our portfolio. Westlaw Precision’s strong start continues with more than 3,000 sales to date. It is earning a large and rising premium that supports the upcoming launch of generative AI capabilities.

Our international businesses continued their double-digit trajectory with 14% organic growth. And many of our key products remain double-digit growers, including Practical Law, Confirmation, SurePrep and HighQ. These areas of strength are tempered somewhat by an uncertain macro backdrop in tighter customer discretionary budgets, particularly in our Corporates segment. Sales cycles at Corporates remained elongated, and growth from digital advertising and the events business at Reuters News remain subdued. All in, we are largely maintaining our full year 2023 outlook, including for organic revenue growth, adjusted EBITDA margins and free cash flow. Mike will discuss several tweaks to other guidance items in a few minutes. Looking forward, our confidence around the generative AI opportunities continues to strengthen.

We made good progress against our build, partner, buy approach in the third quarter, closing the Casetext acquisition and continuing progress on our product road maps. Reaction to Casetext and our gen AI pilots has been extremely encouraging. Customers are taking the acquisition, our commitment to heavy investment in our product road maps as a clear sign of our intent to lead in the application of generative AI. And they have expressed their confidence and trust in our ability to do so. During — due to our growing conviction in the generative AI opportunities, we’re accelerating our investment in the short term, which we expect will pay off through stronger growth over the next few years. And lastly, our capital capacity and liquidity remain a key asset that we are focused on deploying to create shareholder value, and we made good progress on this during the third quarter.

We monetized an additional $1.5 billion of our LSEG stake in September, completed the acquisition of Casetext in August and have also completed 2 smaller bolt-on purchases. Today, we are launching a new $1 billion share repurchase program, and we plan to pay down a $600 million maturing debt issue later this month with cash on hand. We remain committed to a balanced capital allocation approach and continue to assess additional inorganic opportunities. Now to the results for the quarter. Third quarter organic revenues grew 6%. Organic recurring and transactional revenue grew 7% and 9%, respectively, and Print revenue declined modestly as expected. Reported revenue grew 1% with currency having little impact and net divestitures, a 5% drag. Adjusted EBITDA increased 18% to $632 million, reflecting a 560 basis point margin improvement to 39.6%.

The margin expansion resulted in part from Change Program expenses in the prior year and expense timing that will largely normalize in the fourth quarter. Mike will discuss this in more detail. Adjusted earnings per share grew 41% from the prior year period to $0.82. Turning to the third quarter results by segment. The Big 3 businesses achieved organic revenue growth of 7%. Legal organic revenue again grew 6% driven by continued Westlaw Precision momentum. Demand for our key offerings remains healthy led by Westlaw, Practical Law and HighQ. And customer interest in our AI-driven offerings and product road map remains extremely strong, including for CoCounsel, which we acquired as part of Casetext. Corporates organic revenue growth remained stable with last quarter at 7%.

Recurring revenue grew 8%, while transaction revenue was slightly lower. Practical Law, Indirect Tax, CLEAR and our international regions remain key growth drivers. Tax & Accounting organic revenue growth — rose 12%, with recurring revenue up 9% and transactional up 20%. Our Latin America operations, Confirmation and SurePrep, each contributed meaningfully to growth. Reuters News organic revenues rose 3%, aided by the newest agreement with Data & Analytics business of LSEG and by timing of the events calendar with more events in Q3 compared with the prior year. Digital advertising revenue improved slightly compared with recent quarters, though uneven macro trends remained a headwind. And lastly, Global Print organic revenues met our expectations, declining 4% year-over-year.

In summary, we’re pleased with our results and the solid momentum in the business. So before I turn it over to Mike, I’ll provide a brief update on the Casetext acquisition and our generative AI product road map. We are very pleased to have closed the acquisition of Casetext on August 17. And we’re excited CEO, Jake Heller, and his team are now part of Thomson Reuters. Early integration is off to a very good start, and collaboration amongst the teams is strong. For example, our product teams are working well together as we begin to execute against the joint product road map. Integration of the Casetext go-to-market sales team into our Legal segment is underway, and we’re moving quickly to take advantage of the high customer interest in our joint generative AI offerings.

This includes work to accelerate our timeline to bringing Casetext’s nonresearch CoCounsel seals into several key overseas markets. While the product road map work remains in its early stages, we have agreed on several key principles that will guide our generative AI approach. First, we are taking a best of approach to bring generative AI to our legal research offerings that will result in a single legal research AI capability. This will leverage our extensive and proprietary Westlaw content and the best technology from Casetext and Thomson Reuters. Our teams are working well together, and our early testing shows this best-of-breed approach is yielding superior results. Second, we plan to brand all generative AI capabilities within our legal portfolio under the CoCounsel name.

Industry reception to CoCounsel has been very strong, and we see an opportunity to leverage a consistent identity across our growing portfolio of generative AI offerings. And third, we are working to embed and distribute the CoCounsel AI assistant across our legal offerings. Currently, while CoCounsel has very compelling skills, they’re only available through the Casetext website. We see a big opportunity to bring — to bring CoCounsel’s capabilities to the places attorneys work, including Westlaw, Practical Law, HighQ and third-party applications like Microsoft Word and Teams. In addition to the branding and distribution, we see significant value for users from the AI assistant experience. CoCounsel will help to find the right skill for the problem the customer is trying to solve, which when available across a range of applications should provide meaningful workflow automation and user experience enhancements.

And fourth, we will continue to aggressively invest to expand the skill that CoCounsel offers outside of legal research. Its current 7 nonresearch skills are an exciting opportunity for Thomson Reuters, and we have a compelling road map of future new skills in development. Our focus is to preserve the pace of development and innovation that Casetext brings as we grow the roster of skills and capabilities offered through CoCounsel. And lastly, we’re building on a single technology platform. As part of our integration, we’re building a common AI skills factory platform informed by case technology that we believe will allow us to build future skills in a more scalable and faster way. So looking forward, our confidence in the generative AI opportunity continues to strengthen.

Our teams have moved with the speed and decisiveness never seen before at Thomson Reuters. Customer feedback and reaction to the Casetext acquisition, the Microsoft intelligent drafting announcement and our early pilots have all been very positive. We’re excited about our product road map, which includes multiple key launches over the next few months. First up is bringing generative AI capabilities into Westlaw Precision, which will be debuted at a November 15 launch event in New York City. The AI-assisted research tool in Westlaw Precision provides an enhanced search experience and quality legal research memo output that leverages Westlaw’s leading content along with technology from both TR and Casetext. Customer pilots have gone very well, and excitement around this capability drove September to be the strongest month to date for Precision upgrades.

We expect to deliver a number of additional key product launches by January 2024, including CoCounsel Core and Practical Law Answers. CoCounsel Core is our new offering based on the nonresearch skills currently offered in CoCounsel and will be supplemented by additional skill launches in Q4 2023 and 2024. Practical Law Answers is our generative AI-driven CoCounsel Core experience within Practical Law. We expect to bring the Westlaw AI-assisted research, CoCounsel Core and Practical Law Answers offerings to additional geographies, including the U.K., Canada and Australia in 2024. And we have a strong pipeline of additional launches and capability enhancements that we expect to deliver through 2024. I’d also note that while this discussion is focused on our legal offerings, our teams are also innovating with generative AI in our Tax and Corporates markets.

And we’ll be sharing with customers a number of generative AI proof of concepts at our Synergy user conferences later this month. We look forward to updating you on our progress and the continued pipeline evolution over the next few quarters. And I’ll now turn it over to Mike to review our financial performance.

Mike Eastwood: Thanks, Steve. Thanks again for joining us today. As a reminder, I will talk to revenue growth before currency and on an organic basis. Let me start by discussing the third quarter revenue performance of our Big 3 segments. Organic revenue grew 7% for the third quarter, continuing the trend of 6% or better Big 3 growth that began in the second quarter of 2021. Total revenue rose 1%, including the impact of divestitures. Legal Professionals organic revenue grew 6% driven by continued Westlaw Precision momentum, the Elite divestiture and a partial quarter benefit from Casetext. Key drivers from a product perspective remain Westlaw, Practical Law, HighQ and our international businesses. We expect good momentum to continue in the fourth quarter.

On Westlaw Precision, I am happy to report penetration trends continue to go well. After 13 months, Precision is at 15% penetration and is 25% ahead of Edge on a dollar basis. In our Corporates segment, organic revenue again grew 7%. We continue to feel the impacts of the sales cycle lengthening we have mentioned in recent quarters and expect fourth quarter growth to soften slightly, in part due to a difficult comparison. Tax & Accounting had another good quarter, growing 12% organically. Recurring and transactional revenue grew 9% and 20%, respectively. We expect growth to moderate somewhat in the fourth quarter driven by a lower seasonal mix from our fastest growth offerings. Moving to Reuters News. Organic revenues increased 3%, meeting our expectations.

Lastly, Global Print organic revenues decreased 4%, also in line with our expectations. On a consolidated basis, organic revenues increased 6% for the third quarter. Turning to our profitability. Adjusted EBITDA for the Big 3 segments was $566 million, up 7% from the prior year period with a 44% margin rising 210 basis points. This exceeded our prior expectations due to the timing of several expenses, including incentive compensation, acquisition integration-related costs and productivity initiatives. We expect certain of these timing factors to normalize in the fourth quarter. Moving to Reuters News. Adjusted EBITDA was $37 million, up $4 million from the prior year with a margin of 20.4%. Revenue growth and a currency benefit drove margins.

Global Print’s adjusted EBITDA was $55 million with a margin of 39.6%, up 520 basis points. Editorial and plan expense timing benefited profitability, though we expect these to reverse in the fourth quarter. In aggregate, total company adjusted EBITDA was $632 million, an 18% increase versus Q3 2022. Excluding costs related to the Change Program in the prior period, adjusted EBITDA increased 9%. Turning to earnings per share. Third quarter adjusted EPS was $0.82, up from $0.58 from the prior year period. The increase was mainly driven by higher adjusted EBITDA with the last 12-month share repurchases also contributing. Currency had no impact on adjusted EPS in the quarter. Let me explain the change we’re making to our non-IFRS adjusted net earnings and EPS definitions.

Beginning with this quarter’s results, we now add back to adjusted earnings the noncash intangible amortization expense related to acquired software. We have historically added back nonsoftware M&A-related intangible amortization, but not the software component. This change in definition aligns our reporting more closely with how peer companies treat M&A-related intangibles. On a year-to-date basis, the change increases our adjusted EPS by $0.08, including $0.04 in the third quarter. To help with your models, we have posted a historical restatement of our non-IFRS earnings calculation to our Investor Relations website. Let me now turn to our free cash flow performance for the first 9 months. Reported free cash flow was $1.3 billion versus $814 million in the prior year period.

Consistent with previous quarters, this slide removes the distorting factors impacting our free cash flow. Working from the bottom of the page upwards, the cash inflow from discontinued operations was $24 million, which is a $90 million improvement from the prior year period. Also in the 9 months, we made $80 million of Change Program payments as compared to $275 million in the prior year period. If you adjust for these items, comparable free cash flow from continuing operations was $1.3 billion, $159 million higher than the prior year period due largely to higher EBITDA. Next, I will provide an update on our London Stock Exchange Group Holding. During September, we sold an additional 15 million shares in a public market transaction. We have now sold 55.1 million shares year-to-date and have 16.9 million shares remaining.

A couple of additional points. First, as part of our September transaction, we also wrote call options on 3.5 million additional shares with exercise dates running through next March, and we have an additional 6.1 million shares that become eligible for sale in 2024. Second, our tax basis on the remaining 16.9 million shares is approximately 750 million. For your math, we would assume a 25% capital gains tax rate on gains above 750 million. Third, the value of foreign exchange hedges held against our LSEG stake were $90 million as of September 30. We currently have approximately 92% of our remaining LSEG position hedged. Bolstered by the LSEG monetizations and healthy free cash flow, our capitalization remains strong with a net debt-to-EBITDA leverage ratio of only 0.8 times.

This remains well below our 2.5x long-term target. Due to the strong liquidity, we plan to replace $600 million bond maturity later this month with cash on hand. And as Steve mentioned, we have announced a new $1 billion NCIB share repurchase program. These announcements continue our work to deploy our capital capacity. Year-to-date, we have invested $1.2 billion in strategic M&A, returned $2.7 billion through share repurchases and the June return of capital transaction and grown our per share dividend by 10%. We remain focused on following a balanced capital allocation approach that drives long-term shareholder value accretion. Let me conclude with our updated 2023 outlook. Let me start by providing a bit of color on the financial impact of our recent acquisitions.

In addition to the Casetext acquisition Steve discussed, we have closed 2 smaller tuck-ins, Imagen, a digital media asset management platform from Reuters and the buyout of our joint venture partner for Westlaw Japan. Imagen brings compelling capabilities to Reuters News agency customers through a cloud-native digital media management and distribution platform, and fully owning Westlaw Japan positions us to bring enhanced technology and better innovation for our legal customers in the world’s third largest economy. The total purchase price across these 3 transactions was approximately $700 million, which we funded with cash on hand. In aggregate, we see these 3 businesses contributing $60 million or more of revenue in 2024, growing in excess of 25%.

And Casetext is expected to contribute more than half of its revenue. On an annualized basis, we expect these acquisitions to be approximately 80 basis points dilutive to our adjusted EBITDA margins, including roughly 30 basis points from nonrecurring integration expenses that should fall off within 24 months. For 2023, we see a 30 basis point headwind to margins from these acquisitions with an incremental 50 basis points impact in 2024. Profitability from the acquired assets is expected to improve nicely in 2025, and we see these businesses trending towards our total company margins over the long term. Let me close with a discussion of our outlook. As Steve outlined, we are largely maintaining our full year 2023 outlook, including for organic revenue growth of 5.5% to 6%, adjusted EBITDA margin of approximately 39% and free cash flow of approximately $1.8 billion.

We are making 2 updates to our 2023 outlook. First, we are lowering our interest expense outlook to $170 million to $180 million from the prior $190 million. This incorporates the accelerated pace of LSEG monetization that continued in Q3 and also the benefit from higher interest rates on our cash balances. Second, we’re updating our outlook for depreciation and amortization of software to incorporate the recent acquisitions and narrow the range with 1 quarter left in the year. We also have broken this down into 2 line items to support the new non-IFRS adjusted earnings presentation. Amortization of acquired software, which will now be added back to adjusted earnings, rises by $20 million due to the recent M&A. Looking forward, we are currently in our 2024 planning cycle, and we’ll provide more detailed 2024 guidance on our Q4 conference call in February.

However, given the significant opportunities to expand our medium- to longer-term growth profile through gen AI and growth investments, we currently anticipate reinvesting much of our underlying operating leverage during 2024. We remain confident in our ability to continue to expand margins over the mid to long term, given our business model’s operating leverage. We have conviction these organic and inorganic investments will pay off over the next few years through accelerated revenue growth. We will discuss this in more detail on our Q4 call and at an Investor Day we are planning for mid-March. I will provide one more early view on 2024. We expect our effective tax rate to be approximately 19%, rising roughly 2% due to the adoption of the OECD global minimum tax regulations across several of our key markets.

We expect our cash tax rate to increase by a similar amount but remain roughly 5% below our effective tax rate. As we enter to the fourth quarter, we expect organic revenue growth to be within our full year 5.5% to 6% range. We see our fourth quarter adjusted EBITDA margin at approximately 37%, impacted by the timing normalization of certain expenses, select growth investments and productivity initiatives and the aforementioned M&A dilution. Let me now turn it back to Gary for questions.

Gary Bisbee: Thank you. Ali, we’re ready to begin the Q&A.

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Q&A Session

Operator: [Operator Instructions] And we’ll go ahead and take our first question from Drew McReynolds with RBC.

Drew McReynolds: Yes. Just 2 ones for me. First on — and maybe for you, Mike, just on organic revenue growth in Q3. Are you able to let us know what the contribution is from divestitures and acquisitions in the quarter? And then secondly, a little bit bigger picture maybe for you, Steve, on just on the gen AI road map. Thank you for all the granularity, which is nice to see. Can you just comment on as you continue to work through and evolve this road map how are you looking at monetization of everything you’re putting in place? And what are you seeing on the competitive landscape as you move through the year here?

Mike Eastwood: Yes. Drew, on the first question in regards to the impact of M&A for Q3, it was up 5 percentage points. Our organic revenue growth was 6%. And if you factor in the reported revenue, it was 1%, leaving that delta up 5%. I just want to ensure, Drew, that I was addressing your question.

Drew McReynolds: Yes, that’s fine, Mike.

Mike Eastwood: And I think the second question related to the gen AI, Steve?

Steve Hasker: Yes. Thanks, Drew. So we expect — in terms of sort of revenue generation from the road map, we expect to deliver some revenue as a result of gen AI in 2024, especially in the second half of the year. However, I mean, based on that sort of road map timing with a bunch of releases this year and a bunch in the first quarter and the lag between bookings and revenue in our annual subscription business model, we’ll see a larger ramp in ’25 and beyond than we will in ’24. In terms of the competitive landscape, we’ve certainly seen a couple of announcements in the last couple of weeks from our sort of traditional competitors in legal. We haven’t seen as much in Tax & Accounting or risk, governments and so forth. But without sort of — hopefully without a hint of arrogance, we’re confident in where we sit.

First and foremost, because of the customer reaction to that, which we’ve put in front of them. And I think secondly, that reaction in the road map we’re putting forward reflects the fact that our starting point is, we believe, superior, unique and proprietary content with Casetext to have a pretty sizable lead in terms of access to ChatGPT-4 and the sort of science behind combining large language models with proprietary unique data sets. And we love what Jake Heller and the team are bringing to TR in the early going and then supplement that with some of the talent that we have, particularly David Wong, our Head of Products; Shawn Malhotra, Head of Engineering; and Joel Hron, who’s our Head of TR Labs. So we’re pretty confident, I hope, not arrogant, Drew, but we’ll keep our eye on the competitors, but first and foremost, our eye on the customer.

Mike Eastwood: Steve, do you want to expand, we’re starting with legal, but we see great options across tax and our full slate of offerings?

Steve Hasker: Yes, I saw — I mean, I talked in my remarks about Westlaw and Practical Law and HighQ. We’ll also bring gen AI in the short term into Checkpoint. And then next year, you’ll see us expand into our other tax and ultimately our risk products. So we’re going to move through that through the gears there in a very, very disciplined and rigorous way. We think that it not only helps us serve our existing customers, it will, particularly in ’25 and beyond, open up some new TAMs for us in terms of workflow software in and around legal, tax, risk and some of the other customer segments we serve. So we’re excited about exploring that over time as well.

Operator: Our next question will come from Aravinda Galappatthige with Canaccord Genuity. Please go ahead.