Thomson Reuters - Q2 2023

Transcript

Operator (participant)

Good day, everyone, and welcome to the Thomson Reuters second quarter earnings conference call. Today's conference is being recorded and all phone participants are in a listen-only mode, but later you will have the opportunity to ask questions. To get us started with opening remarks and introductions, I am pleased to turn the floor to Head of Investor Relations, Mr. Gary Bisbee. Please go ahead, sir.

Gary Bisbee (Head of Investor Relations)

Thank you, Jim. Good morning, everyone. Thank you for joining us today for our second quarter 2023 earnings call. I'm joined today by our CEO, Steve Hasker, and CFO, Mike Eastwood, each of whom will discuss our results and take your questions following their remarks. David Wong, our Chief Product Officer, is also available for the Q&A. To enable us to get to as many questions as possible, we would appreciate it if you'd limit yourself to one question and one follow-up when we open the phone lines. Throughout today's presentation, when we compare performance period on period, we discuss revenue growth before currency as well as on an organic basis. We believe this provides the best basis to measure the underlying performance of the business. 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 hand it over to Steve Hasker.

Steve Hasker (CEO)

Thank you, Gary. Thanks to all of you for joining us today. I'll start by reviewing our Q2 highlights. Solid momentum continued in the second quarter, with revenue largely in line and margins ahead of our expectations, although the latter was driven primarily by expense timing. Total company organic revenues grew 5%, driven by 6% recurring revenue growth. The Big 3 segments grew 7% organically. Amid an uncertain macro backdrop, we continue to see good momentum from many areas in our business. Westlaw Precision's strong start continues, with more than 2,000 sales to date. It contributed to Legal Professionals' organic revenue growth returning to 6% in the quarter. The SurePrep acquisition is going extremely well.

Our international businesses, again, all grew by better than 10%, and many of our key products remain double-digit growers, including Practical Law, Confirmation, and HighQ. These areas of strength are tempered somewhat by the impact of tighter customary customer discretionary budgets in a few pockets of our business. For example, the sales cycle lengthening we have mentioned in recent quarters has led to a modest slowdown in revenue growth at our Corporates segment, and growth in the events business and digital advertising revenue at Reuters News have softened. 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 opportunity continues to strengthen.

We made good progress against our build, partner, buy approach in the second quarter, with organic builds progressing and announcements of both an intelligent drafting solution with Microsoft and our intention to acquire Casetext. Since discussing AI on our Q1 call, our conviction around our opportunity to leverage generative AI has strengthened. As a result, we're accelerating our investment in the short term as we work to leverage these exciting capabilities for the benefit of our professional markets. 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 second quarter.

In addition to announcing our intention to acquire Casetext, we monetized an additional $1.6 billion of our LSEG stake in May, completed the sale of a majority stake in Elite, and executed the previously announced $2 billion return of capital and concurrent share consolidation, which reduced our share count by approximately 3.5%. We remain committed to a balanced capital allocation approach and continue to assess additional inorganic opportunities. To the results for the quarter. Second quarter organic revenues grew 5%. Organic, recurring, and transactional revenue both grew 6%, while print revenue declined modestly. Reported revenue grew 2%, with currency having little impact and net divestitures a 3% drag.

Adjusted EBITDA increased 18% to $662 million, reflecting a 540 basis point margin improvement to 40%, benefiting in part from expense timing that will normalize in the second half. Mike will discuss this in more detail. Adjusted earnings per share grew 40% from the prior year period to $0.84. Turning to the second quarter results by segment, the Big 3 businesses achieved organic revenue growth of 7%. Legal organic revenue growth returned to 6%, driven by continued Westlaw Precision momentum and the Elite divestiture. Demand for our key offerings remains healthy, led by Westlaw, Practical Law, and HighQ, and customer interest in our AI-driven offerings and product roadmap remains very encouraging. We expect the 6% growth pace to continue in the second half of 2023.

Corporate's organic revenue growth slowed sequentially to 7%, as the sales cycle lengthening we have mentioned in recent quarters has impacted our book of business growth. Recurring revenue grew 8%, while transactional revenue was slightly lower. Practical Law, Confirmation CLEAR, and our Latin America business remained healthy drivers. We expect second half growth to approximate the Q2 level. Tax and accounting organic revenue rose 10%, with recurring revenue up 9% and transactional up 12%. Our Latin America operations, Confirmation, and SurePrep each contributed meaningfully to growth. Reuters News organic revenues rose 1%, which was modestly below our expectations. In addition to a lower price increase than in 2022 on the news agreement with the data and analytics business of LSEG. Reuters events growth softened amid tighter corporate discretionary budgets, and digital advertising revenue continued the recent weaker trend.

We believe both are due to the uneven macro environment and see subdued growth from Reuters as likely in the next few quarters. 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. Before I turn it over to Mike, I thought it would be worthwhile to recap the exciting progress we have made on the generative AI front during the second quarter. I'll also discuss TR Labs, our internal data science and innovation group, that is playing a key role in our generative AI efforts. On our first quarter earnings call in May, we discussed the significant potential we see from incorporating generative AI across our product portfolio. We also reviewed our significant competitive advantages, including the depth of our proprietary content and legal and tax expertise.

We made commitments to invest more than $100 million annually on AI technologies and to bring these capabilities to key franchises, including Westlaw Precision, by year-end. We recently began to pilot our Ask Westlaw generative AI capability with select customers, and initial feedback is very encouraging. Later in May, we announced an intelligent drafting solution that will be offered through integration with Microsoft 365 Copilot. Legal professionals will be able to leverage Thomson Reuters content and AI solutions seamlessly when drafting documents in Microsoft Word through both a Copilot plugin and our Office plugin. In June, we announced our intention to acquire Casetext, a leading provider of generative AI-powered tech solutions through its legal AI assistant offering, CoCounsel.

We see a number of key benefits from this purchase, including accelerating our generative AI roadmap, adding new capabilities, and helping us drive new value for the legal industry through the merging of insights and workflow tools. We remain confident that our build, partner, buy investment approach positions us to take a leadership role in bringing generative AI capabilities for the benefit of our markets. In fact, our conviction in the long-term opportunity and the competitive advantage we bring to bear is rising. We'll remain disciplined in our investment approach, but we won't hesitate to make high ROI investments to capture this evolving market opportunity. Now a few words on TR Labs. Last quarter, we discussed Thomson Reuters' rich history as a leader in leveraging new technologies, including machine learning and AI.

That history stretches back more than 30 years to 1991, when an R&D group was formed within West Publishing to accelerate the capabilities of online legal research. In the decades since then, technological advancements in processing power, data storage, and network bandwidth have expanded the potential for AI and ML capabilities. Our labs group has been at the forefront, driving thought leadership, contributing to commercial success, and being an engine for innovation for both internal and client-facing applications. Currently, we have approximately 300 AI and ML practitioners within Thomson Reuters, just under half of which are in our TR Labs group. One quarter of our labs workforce are PhDs, and half hold a master's degree. We have labs teams based primarily in five global cities, Toronto, Minneapolis, St. Paul, London, Zug, and Bangalore.

Our team is a good mix of long-tenured AI subject matter experts, with additions through a number of AI-driven acquisitions in recent years. This includes Joel Hron, who joined our company through the early 2022 acquisition of ThoughtTrace, a legal AI contract analysis provider. Joel was recently appointed the new head of TR Labs and brings significant AI experience as well as a startup mentality to our efforts. In addition to talent, TR Labs has a history of thought leadership. Labs is an active member of the entrepreneurial and research ecosystems, partnering with universities, businesses, and customers. We are a founding sponsor of the Vector Institute, Canada's premier AI think tank and research center. We have sponsored a number of key industry events related to technology and our professional markets, including a recent hackathon with Stanford University focused on generative AI and the law.

Since 2020, our Labs group has been awarded 29 patents, bringing its total to date to more than 100, the team regularly, regularly publishes well-received external research papers. While talent and thought leadership are important, contributing to commercial success is really the key. From the early days, our Labs group has made many contributions. You may remember this slide from our discussion last quarter of the legacy of AI at Thomson Reuters. What we didn't say last quarter was that our TR Labs group was key in delivering most of these advancements. A few examples: In 1992, based on statistical ranking, Westlaw Is Natural was launched, becoming the first natural language search engine of industrial scale. For perspective, this was several years before Google was founded.

In the early 2000s, the team delivered a machine learning-based classification and recommendation engine called CARE, that has been used across the company to classify legal, tax, news, and finance documents to large taxonomy. Advances have continued through Westlaw Next in 2010, Westlaw Edge in 2018, and Westlaw Precision in 2022, which all brought successively more advanced machine learning and AI capabilities. Successes have included Quick Check, Litigation Analytics, KeyCite Overruled in Part, among others. Outside of Westlaw, Labs has played a key role in the launch of Checkpoint Edge, Practical Law Dynamic Search, and Legal Tracker. Looking forward, our Labs talent is an important asset that has been refocused heavily on our generative AI roadmap.

Working with our AI government, governance, and AI platform teams, our Labs talent is key to upskilling and enabling our broader engineering and product efforts to deliver compelling AI-driven capabilities for our customers in a responsible and ethical way. We are actively hiring to expand Labs beyond across our global footprint and have seen very strong applicant response and demand to our recent recruiting efforts. Now I'll turn it over to Mike to review our financial performance.

Mike Eastwood (CFO)

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 second quarter revenue performance of our Big 3 segments. Organic revenue grew 7% for the second quarter, continuing the trend of 6% or better Big 3 growth that began in the second quarter of 2021. Total revenue rose 3%, including the impact of divestitures. Legal Professionals' organic revenue growth returned to 6%, driven by continued Westlaw Precision momentum and the Elite divestiture. Key drivers from a product perspective remain Westlaw, Practical Law, HighQ and our international businesses. We expect the 6% growth trend to continue in the second half. On Westlaw Precision, I am happy to report penetration trends continue to go, go well.

After 10 months, Precision is at 10% penetration and is 8% ahead of Edge on a dollar basis. In our corporate segment, organic revenue growth slowed slightly to 7%. The sales cycle lengthening we have mentioned in recent quarters has softened our book of business growth. Looking forward, we expect second half growth to approximate the Q2 level. Tax and Accounting had another good quarter, growing 10% organically. Recurring and transactional revenue grew 9% and 12%, respectively. Moving to Reuters News, organic revenues rose 1%, which fell modestly below our expectations. Finally, global print revenues decreased 4% on an organic basis, in line with our expectations. On a consolidated basis, organic revenues increased 5% for the second quarter.

Turning to our profitability, adjusted EBITDA for the Big 3 segments was $597 million, up 14% from the prior year period, with a 44.9% margin. Segment margins rose nicely across all Big 3 segments, though I would caution expense timing drove much of the Q2 upside versus expectations. We expect this to normalize in the second half, especially amid investments in GenAI and higher SurePrep integration expenses. Moving to Reuters News, adjusted EBITDA was $45 million, with a 23.1% margin. Global Print adjusted EBITDA was $53 million, with a margin of 39.7%. Margins rose 430 basis points year-over-year, though this was largely due to expense timing related to material sourcing and labor. We expect this to normalize in Q3.

In aggregate, total company adjusted EBITDA was $662 million, an 18% increase versus Q2 2022. Excluding costs related to the Change Program from the prior period, adjusted EBITDA increased 12%. Turning to earnings per share, adjusted EPS was $0.84 for the quarter, up from $0.60 from the prior year period. The increase was mainly driven by higher adjusted EBITDA, with a lower tax rate and last twelve months share repurchases also contributing. Our effective tax rate on adjusted earnings of 15.5% benefited from the settlement of a tax audit, which added $0.06 to adjusted EPS in the quarter. Currency had no impact on adjusted EPS in the quarter. Let me now turn to our free cash flow performance for the first half.

Reported free cash flow was $729 million versus $428 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 $1 million, which is a $72 million improvement from the prior year period. In the first half, we made $74 million of Change Program payments, as compared to $186 million in the prior year period. If you adjust for these items, comparable free cash flow from continuing operations was $802 million, $117 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 May, we sold an additional 15.3 million shares in a public market transaction. We have now sold 40.1 million shares year-to-date and have 31.9 million shares remaining, of which 2 million shares are eligible to be sold in 2023. Two other quick updates. First, our tax basis on the remaining 31.9 million shares is $1.3 billion. For your math, we would assume a 25% capital gains tax rate on gains above $1.3 billion. Second, the value of foreign exchange hedges held against our LSEG stake were $49 million as of June 30th. We currently have approximately 68% of our remaining LSEG position hedged. Let me conclude with our updated 2023 outlook. As Steve outlined, we are largely maintaining our full year 2023 guidance.

We continue to expect organic revenue growth of 5.5%-6%, adjusted EBITDA margin of approximately 39% and free cash flow of approximately $1.8 billion. We are adjusting the outlook for three line items: our effective tax rate, interest expense, and CapEx. We now forecast our 2023 effective tax rate at approximately 17%, down from the prior approximately 18% when incorporating the Q2 benefit from the settlement of a tax audit as I mentioned earlier. We are narrowing our interest expense forecast to approximately $190 million, which is the low end of the prior $190 million-$210 million range. This incorporates the accelerated pace of LSEG monetization, as well as the benefit from higher interest rates on our cash balances.

Lastly, on CapEx, we now forecast full year crude CapEx as a percentage of revenue of approximately 8%. This compares to our prior view of approximately 7% plus $30 million for non-recurring real estate spend related to exiting 2 owned facilities. We continue to expect real estate spend within the new 8% target, also incorporate accelerating investment in GenAI-focused growth strategies. As Steve mentioned, we are increasingly bullish about the potential to leverage GenAI to deliver meaningful value for our professional markets and are investing to deliver to this opportunity. Looking ahead to the third quarter, we expect organic revenue growth to be on the high end of our full year, 5.5%-6% range, driven by the continued momentum of Westlaw, improvement in government, the divestiture of Elite.

We expect our 3rd quarter EBITDA margin to be approximately 36%. This incorporates the normal seasonal low point in our profitability, much of the cost timing that benefited Q2 margins normalizing and also higher SurePrep integration expenses. As is our typical seasonal pattern, we expect Q4 margins to be sharply ahead of the Q3 level, yielding the full year 2023 adjusted EBITDA margin of approximately 39%. Let me now turn it back to Gary for questions.

Gary Bisbee (Head of Investor Relations)

Thanks, Mike. Jim, we're ready to begin the Q&A.

Operator (participant)

Gentlemen, thank you. To our phone audience, joining at this time, if you would like to ask a question, simply press star and one on your telephone keypad. Pressing star and one will place your line into a queue, and we ask that if you're joining today on a speakerphone, please ensure that you return to your handset or that your mute button is disengaged to allow your signal to reach our equipment. We ask that you limit yourselves to a question and a follow-up, and if you have further comments, you may re-queue as well with star and one. Once again, ladies and gentlemen, that is star and one. We'll hear first today from Drew McReynolds at RBC Capital.

Drew McReynolds (Analyst)

Yeah, thanks very much. Good morning. Two for me. First, just with respect to the uptick in CapEx intensity, I think we're all eyes wide open to the incremental investments you're making in AI. Just wondering more broadly, what kind of sustainable CapEx intensity you see for the overall business? Has that changed versus that 6% you talked a couple of years ago? Second, just on the sales cycle, no surprise there. Just wondering what you saw through the quarter, and, you know, up until through July and August, you know, is, is, is the rate of change here in terms of deterioration accelerating? Just any granulated there would be helpful. Thank you very much.

Mike Eastwood (CFO)

Yeah, Drew, in regards to your first question on cap- CapEx or capital intensity, as I, I refer to it, I think as we move forward, we'll see rates more closely to the 2023 level. That's driven largely by what we see as opportunities to invest in areas that will generate strong returns for us. Certainly, GenAI is one aspect there, but I think we'll also see additional opportunities for in- investment. I think we'll be closer to the current rate in 2024. As we work through the 2024 plan process, as always, we'll keep you updated with the November earnings call and then certainly the, the February, because I think that's what we see with capital. I think we're working very closely with all of our teams in regards to the opportunities.

The opportunities that we see, will really be the key factor, in driving the CapEx intensity. We'll ensure that all of these opportunities drive strong returns, for shareholders. Second item before I pass to Steve for his thoughts on the sales cycle. We'll break it down into two components, Drew. First, in regards to Legal Professionals and Tax & Accounting Professionals, we remain quite optimistic. We have not seen any noticeable change, in those two segments or lines of businesses. In the Corporates segment, very consistent with prior quarters, we have seen that elongated sales cycle, happening for net sales and also renewals. That's what drove that slightly lower 7% this quarter versus 8. The second area where we've seen it is within the Reuters business.

We are quite optimistic overall, and especially within legal and tax, we have not seen any noticeable change. Steve, your thoughts?

Steve Hasker (CEO)

Yeah, just to add, Drew, on the generative AI opportunity, I think since we last checked in with you all, we've seen a couple of things which give us more excitement and more optimism about the opportunity in and around generative AI for us. The first is, I think, a growing and a very resolute consensus that the differentiator in this environment will accrue to those who own unique proprietary datasets, and that's us. You know, that view really has crystallized over the last couple of months and I think continues to strengthen by the day.

The second is, even greater customer interest in, in, in our product roadmaps, and, and our leading, both in terms of our, the, integrating generative AI into our existing flagship products, but also exploring new areas, with our customers. Our customers have given us a, a very clear steer, particularly in legal, but increasingly in tax and accounting as well, that they expect us to lead, in these spaces, and they're certainly looking forward to us doing that. With that in mind, our build, partner, buy strategy, the Microsoft announcement, the $100 million investment, and the, and the intention to acquire Casetext have all been, well received by customers.

Mike Eastwood (CFO)

Hey, Drew, if I could just add one more point in regards to the sales cycle. The January acquisition of SurePrep, led by David Wyle, that's really gone well for us through the first 6 months of the year. We expect that to continue. That SurePrep acquisition, very similar to if you go back a few years ago with Practical Law. We have the same level of optimism with SurePrep as some of the prior acquisitions.

Drew McReynolds (Analyst)

All very helpful. Thank you.

Operator (participant)

Our next question comes from the line of Aravinda Galappatthige at Canaccord Genuity.

Aravinda Galappatthige (Analyst)

Good morning. Thanks for taking my questions. I wanted to have a single question and a follow-up. Can you maybe talk a little bit more about the opportunity on the, I guess, the workflow side of legal, the contract drafting, now that you've sort of have a greater grip of Casetext and the opportunities coming out of there? I know that that's a space that's already encumbered by some players. How do you sort of see, you know, Thomson's ability to exploit that and sort of the pathway to that? Then, really quickly, the follow-up for Mike, can you just remind us for the second half, sort of the puts and takes to EBITDA from the divestitures and the acquisitions?

Steve Hasker (CEO)

Yeah, Aravinda, it's Steve. I'll start and then ask David to supplement on the first question, and Mike can take the second. With regard to the legal workflow and, and, and specifically drafting, I think it's worth noting today that we don't, we, we don't play in a very significant way. That, that is one of many new use cases and new addressable markets for us in large part. One of the reasons we were so interested in Casetext is that they have, yeah, in, in, in quick time-... harnessed access to GPT-4 with their own expertise and content to create what they call skills or particular use cases.

Most of those are new to us, so we see it as a, we see it as, as, as a, as a new market opportunity as much as anything else, firstly. Having said that, we, we haven't closed that deal yet, so, you know, more to come, once we close that deal and have a chance to work with Jake and his team. David, before handing to Mike, anything to add there?

David Wong (Chief Product Officer)

Yeah, I think I would add a couple of, couple of, other, other things. Number one is that as we've been exploring the, the drafting use case with our customers, one of the biggest questions they always ask, and the problem that they have, is a starting point. That's where Steve's point around proprietary content really comes to play. Practical Law has thousands of standard documents, standard clauses, which serves a starting point for drafting. Right now, when you use Practical Law, you click Open in Word, and then you do the drafting. We're looking to try to complete that, that, that workflow for customers by incorporating GenAI through both our own plugins as well as the Microsoft Copilot, 365 Copilot rather, plugins for, for drafting.

Again, we see a, a big opportunity in providing not only the AI tech, but also, the content, to be able to provide a starting point for, so many, lawyers that are doing drafting.

Mike Eastwood (CFO)

Yeah, Aravind, in regards to your second question on puts and takes and the impact on EBITDA margin from acquisitions and divestitures, our policy is that we update and incorporate the impact of acquisitions, divestitures when they close. That means the divestiture of Elite, in May 31st, I should say, we sold eighty-- approximately 80%. That has been incorporated with that. The Casetext acquisition that is pending closure, we would provide a further financial update upon closing, hopefully later in the second half of 2023. We update our guidance and provide updates to all of you when the acquisition actually closes. What we do, looking at Casetext, I, I would see some near-term dilution there, as expected, normally from acquisitions of this nature, but we would provide a more fulsome update upon closing.

Aravinda Galappatthige (Analyst)

Thank you very much.

Operator (participant)

Heather Urbanski at Bank of America, your line is open.

Heather Balsky (Analyst)

Hi, good morning. Thank you for taking my question. With regards to the sales environment, you talked about not seeing any material change in legal. There's been a lot of, we actually got some today, headlines around law firm layoffs. I'm just curious if you can talk to, amid all of this, your ability to upsell law firm clients on some of your new tools. Is there increased demand for these tools in an environment where headcount is being reduced? You know, is there any change in sales cycles? Any color would be helpful.

Steve Hasker (CEO)

Heather, it's Steve. I think it's, I, I think it's a little bit too early to tell, to be able to sort of prescribe, in a sense, an equation between, you know, sort of headcount to spend on technology and the extent to which one, one will be reduced and the other one will, will be increased. I think we're, we're very confident that over time, law firms will spend less on real estate and more on, on, on technology. That's a trend that really sort of appeared at the start of in terms of our, our dialogue with customers at the start of the pandemic, and it's, has continued, and if anything, strengthened. We, we see that the broad market opportunity is, is increasing. We have noted some layoffs in certain pockets, of, of, of the industry.

Exactly what that relationship looks like, I think is a little bit too early to tell.

Mike Eastwood (CFO)

Heather, I would just add, Steve and I just completed some business reviews with Paul Fischer and the legal team within the last week. We talked quite a bit about Westlaw Precision, but Practical Law, led by Emily Colbert, continues to be quite well-received, and we continue to do quite well with HighQ. The overall portfolio in legal is doing well, Heather.

Heather Balsky (Analyst)

Appreciate it. Thank you.

Operator (participant)

Now we'll hear from Scott Fletcher at CIBC.

Scott Fletcher (Analyst)

Hi, good morning. I'm just wondering now with, with the larger return of capital transaction complete, can we get an update on near-term capital allocation plans and priorities?

Mike Eastwood (CFO)

Sure, Scott. We remain in a very, very strong position. We continue to estimate approximately $10 billion of capital capacity through 2025, which gives us ample capacity to continue our three-pronged approach, which is what I refer to continuously as the and formula, which will allow us to continue to deliver dividend growth. I would anticipate another 10% increase in 2024, Scott, there for our annual dividend. Secondly, allow us to continue to do strategic M&A, and then lastly, allow us to continue additional returns to shareholders, whether that be in the form of another return of capital like we did in June, an NCIB, or other forms.

In a very strong position, Scott, and I think it will be a combination of all three as we move forward. Just as a reminder, you know, we have the 32 million shares left in the LSEG state, coupled with very strong cash flow from the business, a very low leverage. We're 1.2 times, those three factors drive that $10 billion of capital capacity through 2025.

Scott Fletcher (Analyst)

Okay, thanks. Then a follow-up on the M&A front. I'm wondering if, obviously, there's, there's still a lot of sort of startups and legal companies that are focusing on generative AI. Is there an appetite on your end to, to continue looking at more of those, something similar to, to the vein of Casetext, or is, is the lens a little broader than that?

Steve Hasker (CEO)

Yeah, I mean, Scott, the, the lens is broad. The lens is broader. I'd say a couple of things with regard to, with regard to our sort of M&A approach. The, the first is we have the same sort of set of criteria across all acquisitions. Whether that's, whether that's Casetext or, or, or, or SurePrep, anything else we're looking at. We have a very high bar for these acquisitions, and, and we think we're very rigorous about, making sure that, that the value accrues, to our shareholders and, and, and our customers. That's the first thing. We'll keep looking at, at those kinds of deals, be they, you know, in various flavors of, of, of, of AI or specifically generative AI.

The other area where, where, I think seeing great benefit is in our TR Ventures fund, run by Tamara Steffens. Basically, what she's been able to do is make a pretty significant number of acquisitions in and around the AI area, on the periphery of our core Big 3 segments. That, I think, has enabled us to open our aperture to the ecosystem and the innovations therein, and also have the core benefit accrue to the Big 3 segments and our teams within those segments. That's really our approach, and we don't see any deviation from that over the next number of quarters.

Scott Fletcher (Analyst)

Okay, thank you.

Operator (participant)

Vince Valentini at TD Cowen, please go ahead with your question.

Vince Valentini (Managing Director and Senior Equity Research Analyst)

Yeah, thanks very much. Related to the timing benefits on operating costs, just trying to get a bit more granularity on that, Mike. The two things. First, on the first quarter call, you said you expected margins to be 38% in the second quarter, and you obviously did a lot better than that at just over 40. It seems like this timing benefit happened just in the last couple of months and was a bit of a surprise. Why was that? Looks like it's about $30 million, if you can sort of clarify that. Is that gonna all reverse in the third quarter, or is it spread evenly over Q3 and Q4? Thanks.

Mike Eastwood (CFO)

Yeah, Vince, all, all fair questions. Your, your estimate of $30 million is, is very close. Let me give a little bit of granularity there, Vince. A few areas. The SurePrep integration was truly in regards to, all of these are timing related. As I mentioned, David Weil and team are working very well with Elizabeth Bystrom there. First area is SurePrep integration costs. Second area relates to marketing costs led by David Carrel and our team. Within technology, we have some cloud-related costs that were timing. Also, in technology, we had some software maintenance related items. The last item I would mention, as I, I referenced in our prepared remarks, within our global print business led by Jennifer Prescott, we had some materials and labor items. Those were 5 tangible areas.

Majority of that would be in Q3, with a little carrying over into Q4, but majority Q3, which is driving that 36% EBITDA margin estimate for Q3, along with that normally being our low point. The largest of those dollars were in legal, and in our tax and accounting segments, along with the print that was specific there. Hopefully, that color is helpful, Vince.

Vince Valentini (Managing Director and Senior Equity Research Analyst)

Very helpful. Thank you.

Mike Eastwood (CFO)

Indeed.

Operator (participant)

Now we'll hear from the line of Toni Kaplan at Morgan Stanley.

Toni Kaplan (Analyst)

Thank you so much. Wanted to just ask about, you know, margin versus growth. You know, you reset the cost base from the Change Program. Now there's this opportunity to invest in AI. Just trying to, you know, hear your updated thoughts on, you know, growth versus margin dynamics over the next few years.

Mike Eastwood (CFO)

Yeah, happy to start with that, Toni. It's something that we talk about quite a bit internally. In regards to the growth, I'll, I'll mention 2 vectors, both organic and inorganic. I referenced this a second ago. We certainly are very comfortable reinvesting where we think there are opportunities, and I think that's in the form of both organic and inorganic. We now talk a lot about GenAI, but our opportunities for growth go far beyond GenAI. We'll continue to be prepared to make those investments near term, even if there's a little bit of margin pressure or margin dilution near term, both organically and inorganically there. I think over the time horizon, it's important for us to continue to build upon our current, roughly 6% organic growth, as we look at, you know, 2024, 2025, 2026.

We're going to be very balanced and prudent, and we'll continue to invest both organically and inorganically. With those investments, there, there's full recognition that margin expansion could be tempered, as we make those investments in GenAI and other organic areas, and also by acquisitions. If you focus on our margins and free cash flow over the time horizon, given our operating leverage, we have confidence that over the time horizon, we'll be able to continue to, to build upon our margins. Near term, it could be tempered as a result of acquisitions and organic investments.

Steve Hasker (CEO)

Toni, I'll just add to that. I think, you know, we obviously ran the Change Program intensively in 2021 and 2022, and we always positioned that, I think, correctly, as a platform for accelerated growth as we go forward. You know, as you point out, along comes generative AI, and I think that from our brings that accelerated growth, I think makes it more tangible, potentially a little bit more exciting for us and our shareholders. The way I think about this is the Change Program has positioned us well to take advantage of generative AI growth.

Had we not done that, I think it would be much more difficult for us to adapt in terms of our customer service support capabilities, our, our, our ops and tech stack, and our, and our talent base. You know, one, one will feed into the other, I hope, in a fairly natural way.

Mike Eastwood (CFO)

Yeah, Toni, maybe I'll just supplement maybe just one live example. Once again, the SurePrep acquisition that closed in January, that's one that is helping us fuel growth in TAP this year and beyond. We do have some margin dilution, in calendar year 23, from a very intentional, you know, decision for us to make that acquisition and, and to invest. I think that's a live example as to how we and balance and do the trade-offs between growth and margins and, and capital intensity.

Toni Kaplan (Analyst)

Great. Then wanted to ask about the go-to-market strategy that you're developing for Casetext. Do you see that product as more of a standalone offering, or you're planning on bringing the content into Westlaw or Practical Law? You know, just in terms of technology, how you integrate the large language model that Casetext is using with what you've already developed for Westlaw? Thanks.

Steve Hasker (CEO)

Toni, we've, we've, we've obviously done a lot of thinking around that. But we haven't- because the deal hasn't closed, we, we, we haven't had all the interactions that we need to make those calls with the Casetext team. As soon as we close that deal, we'll have a chance to come back to you with, with those kinds of questions. We do see. We, we do see this as offensive in 2 ways. One, supplementing, accelerating our own internal efforts by adding more capacity in various ways. The second is, is enabling us to access new addressable market areas along the lines of the, of the skills that they've developed.

It'll, it'll be a combination of those things, but the precise weighting, we'll, we'll have to wait until, until we, close the deal and integrate it.

Toni Kaplan (Analyst)

That makes sense. I jumped the gun on that. Thank you.

Steve Hasker (CEO)

Yeah.

Operator (participant)

Next, we'll hear from Kevin McVeigh at Credit Suisse. Please go ahead.

Kevin McVeigh (Analyst)

Great. Thanks so much. Hey, I, I wonder if you could just update us on how we're thinking about pricing and then ultimately retention, you know, given what's clearly going to be deeper, I, I would call kind of modules and, you know, even more innovative product as a result of the generative AI. You know, kind of where the retention is today, and, you know, I know you've seen some success on that, but how should we think about that going forward? Then, maybe if you could weave, weave some context around pricing as well.

Mike Eastwood (CFO)

Yeah, sure, Kevin. Let me, let me start with that. I'm sure Kevin, I'm sure Steve will want to supplement there. I think, Kevin, let me start with the foundational piece that we've shared before, the multiyear contracts. We worked through those in 2022. We continue to work through those in 2023. I think the premium that's associated with Westlaw Precision continues to materialize as we anticipated. I think the price lifts in 2023, slightly higher than in 2022. The one that we are working through, Kevin, with full transparency, is the impact of Gen AI on pricing and also the related costs there. We're probably a quarter or so away from having a robust conversation with you on that.

I'll say pricing is slightly higher this year than in 2022. In regards to retention, we're up about 30 basis points in 2023. That's measuring retention based on revenue dollars, so we're slightly over 91% on a weighted average basis across total TR. As I've shared before, that's a wide distribution, with our smaller customers having lower retention and our largest customers having very high, and it also varies by product, with Westlaw being, being the highest. I think we're pleased with the momentum on both pricing and retention. We need additional time on the GenAI piece.

Steve Hasker (CEO)

Yeah, as we start to frame up the GenAI opportunity, we, we do see it as being helpful and additive along at least three dimensions. I think the first is, as you say, Kevin, pricing. The second, to Mike's point about retention, you know, we, we, we think that the GenAI, and particularly integrated across our different products, will enable us to be stickier and increase our retention. The third, as I've said a couple of times this morning, is just accessing new pools of spend, whether that be around, you know, whether that be around automating tasks that are otherwise performed by, by human beings or, or whether it be enabling firms to do more and add more value.

Well, I think that's to be determined more broadly, across, across the industries we serve. That's, that's really where we're, we've pointed our product development efforts.

Mike Eastwood (CFO)

Kevin, I add just a final point on that retention question and Net Promoter Score. We have additional opportunity to improve there. I think as we continue to improve our, our customer experience and Net Promoter Score, that should, should yield higher retentions over the time horizon.

Kevin McVeigh (Analyst)

Thank you very much.

Operator (participant)

Our next question today comes from the line of Manav Patnaik at Barclays.

Manav Patnaik (Managing Director and Senior Equity Analyst)

Yeah, thank you. I had a question, you know, all the focus has obviously been on GenAI, which it probably should be, and the legal business. Just curious on the tax side and also tied to capital allocation, you know, that's obviously been a very fast-growing business for you guys, a great business, but it is, you know, a smaller piece of the puzzle. Just curious if, you know, any thoughts around capital allocation and, you know, what can be done to maybe make tax bigger?

Steve Hasker (CEO)

Yeah, I'll, I'll start before Michael add. Manav, thanks for the question. We, we are very excited about our tax and accounting professionals business under Elizabeth Beastrom's leadership. I, I think it's an incredible franchise and one that we're very keen to invest against, firstly. Secondly, the, you know, the, the sort of strategy that, that, that Elizabeth with Piritta van Rijn and, and, and the team have laid out, really is to automate and streamline the entire end-to-end tax return process all the way to advisory services. We're running some experiments in Latin America around our Domínio asset to, to, to well and truly extend that for the benefit of tax and accounting professionals and the SMBs they serve.

SurePrep is a very significant addition to that process because it, of course, it automates the document and information ingestion process and the front end of a tax return. As Mike said in his remarks, we're very happy with that. I think David Weil and the team are doing a wonderful job since coming across on January 3. The strategy is very much in service of tax and accounting professionals to make their lives easier and more efficient. There is a, you know, the number of returns goes up, the complexity of those returns goes up, and the need for advisory services from tax and accounting professionals to their customers goes up. That the demand within the...

the underlying demand within that, within that segment continues to grow at a very healthy clip. However, there just aren't enough young people coming through with tax and accounting degrees wanting to join the profession. There's a real need for the automation and technology to streamline the process. We think we can play an important role in that. Our strategy will be very much to sort of take that end-to-end process, automate and streamline as much as possible to drive productivity and efficiency through the industry. That's where we're trying to go. In terms of specific capital allocation.

Manav Patnaik (Managing Director and Senior Equity Analyst)

Got it. Then just one-

Steve Hasker (CEO)

Yeah, sorry, Manav.

Manav Patnaik (Managing Director and Senior Equity Analyst)

Go ahead.

Steve Hasker (CEO)

You know, I don't have any, anything specific on the. We, you know, put this in the same category as, you know, under the generative AI. We think there's opportunities for us to integrate generative AI into products like Checkpoint. That will require some CapEx spend. If we, you know, as we see that ROI opportunity, we're not going to miss it.

Manav Patnaik (Managing Director and Senior Equity Analyst)

Understood. Thank you for that. Just one, you know, technical question, I guess, on the $22 million of LSEG shares available for sale in 2024, is that similar, kind of like the March timeframe when they're available? Just, just trying to think about if you can, you know, pull that forward, should you need to, you know, in terms of, you know, capital allocation.

Mike Eastwood (CFO)

Yeah, Manav, in regards to when the respective tranches, the lock-up periods expire, it's in Q1 of each year, so Q1 2024, and then also Q1 2025. It doesn't mean that we have to monetize in Q1 of each year, but that's the earliest time period upon which we can monetize.

Manav Patnaik (Managing Director and Senior Equity Analyst)

Okay, makes sense. Thank you.

Mike Eastwood (CFO)

Indeed.

Operator (participant)

George Tong with Goldman Sachs, please go ahead. Your question is next.

George Tong (Managing Director and Senior Equity Analyst)

Hi. Thanks. Good morning. You talked about the elongated sales cycles, in, in Corporates. Can you discuss why sales cycles are currently more resilient in legal and tax and accounting, and assess the likelihood that sales cycles could at some point elongate in those segments?

Steve Hasker (CEO)

I think the sort of broader corporate enterprise software environment has softened a bit. I think we see that, we, we, we see that across the different points. We're, we're more sensitive to that environment than we are, than, than we are the law firms. We think our content and our software is must-have across all the segments, but certainly, you know, corporates for us is the newest of those segments, and therefore, the degree to which it is truly embedded is a little bit less. Those have been elongated, and we've seen a little bit of softness. We don't see it getting any worse. George, within corporates, we don't see the same kind of trends in tax and accounting or legal eventuating.

George Tong (Managing Director and Senior Equity Analyst)

Got it. That's helpful. Then you reiterated your EBITDA margin expectations of 39% for this year, which would imply about 400 basis points of expansion from 2022. Where do you see most opportunity for EBITDA margin expansion by segment based on your investment requirements and efficiency gains, again, at the segment level?

Mike Eastwood (CFO)

Yeah, I think, George, as we look over the time horizon, and I emphasize the time horizon, I think we see opportunities to continue to expand margins in each of the segments. The timing and the quantum of margin expansion will be influenced, as I mentioned earlier, by the timing of acquisitions and also the timing of organic investments, whether it be GenAI, risk fraud compliance or other items there. We see opportunities across the segments, but I would just kinda temper the level and timing based on the timing and sequencing of acquisitions and organic investments.

George Tong (Managing Director and Senior Equity Analyst)

Any, any comments on specifics for the segments this year? Where do you see most opportunity?

Mike Eastwood (CFO)

I think this year, in calendar year 2023, Legal, is experiencing the largest amount of margin expansion in calendar year 2023. I think Corporates will experience the lower amount of margin expansion in calendar year 2023, George.

George Tong (Managing Director and Senior Equity Analyst)

Very helpful. Thank you.

Mike Eastwood (CFO)

Then, as I mentioned earlier, the Tax & Accounting, just as a reminder, when you look at Tax & Accounting Professionals year-over-year, you need to consider the impact of the SurePrep acquisition, which I think, Gary, during our February earnings call, we provided directional estimate on that impact for the full year. Just maybe a refresher there, also Gary can do a follow-up, George, if helpful there. The Tax & Accounting, if you look at it sequentially year-over-year, you do need to do a pro forma just in regards to the dilutive impact of SurePrep in calendar year 2023.

George Tong (Managing Director and Senior Equity Analyst)

Great. Thank you.

Operator (participant)

Andrew Steinerman at J.P. Morgan, you are welcome to pose your question.

Stephanie Price (VP)

Hi, thank you. This is Stephanie Yee stepping in for Andrew. I'll just ask one question. Can you provide a little bit more color on the Government business? I think the funding is flowing through now, but just any color on the end market and also how you are doing in that area?

Mike Eastwood (CFO)

Sure, Stephanie Yee, I'm happy to start there. We spent quite a little bit of time with Steve Rubley, Scott Smothers, Pat Evelyn, on the government team. As we look at the pipeline for Q3, Q4, it is very optimistic. I think, Stephanie Yee, as we go into the November call, we'll be able to provide you with more granular detail, just given the federal government, cycle, physical year cycle of September 30th. We have a number of opportunities in the pipeline that we believe will close during Q3, which will lead to higher revenue growth in Q3, Q4. If you look sequentially, the government revenue increased in Q2 versus Q1, and we forecast that continuing to increase in Q3, Q3, and Q4. Pipelines are very optimistic, Stephanie Yee.

We just need to close those in Q3, Steve and team, Steve Rubley and team are, are working hard there. As you know, Clear, risk, fraud, and compliance, is a key component there too, along with TRSS. Reason for a lot of optimism, but we, we do have to close the, the pipeline opportunities, Stephanie.

Stephanie Price (VP)

Okay. Okay, great. Thank you so much.

Mike Eastwood (CFO)

Indeed.

Operator (participant)

We'll hear from Maher Yaghi at Scotiabank.

Maher Yaghi (Managing Director)

Thanks for taking my question. lots, lots of excitement in AI for sure. you know, few, few parts of the hardware markets have seen a significant uptick in revenues generation already, due to AI. on the software side, as you, you probably, are aware, lots of investments being made, but, you know... you know, we have many case studies that are clearly present, but we're still waiting for an uptick in revenues. I guess my question is, and that what I'd like to hear from you is, you know, when, when do you expect to see a meaningful contribution from GenAI to help and grow your organic growth rate beyond what it's already at?

i.e., you know, is 2024 too early to see an uptick in your 5.5%-6% growth rate that you're seeing in 2023, or, it's, you know, it's a couple of years out that we'll start to see that meaningful contribution kick in?

Steve Hasker (CEO)

Thanks for the, thanks for the question. Yeah, look, we are, we are excited about it. We're excited about it because of the, the, the, the frequency, nature, volume of interest from, from our, from our customers. You know, and, and we, we don't think it's an opportunity that's sort of limited to the United States. It's not limited to any particular geography or any particular product. That, that's really why we're excited. That's why we're, we're upping, upping our investment. We will be launching products this year. David Wong has sort of put, put forth our, our product roadmap and started to discuss that with, with directly with our, with our customers.

We won't see any meaningful revenue uptick, just given the size of our base business this year. I think we'll start to see it next year. The degree, the extent, and the sort of nature of that growth curve, we're yet to define. As soon as we, we sort of have more clarity on that, as to how much, you know, is coming from the three drivers that are referred to in, in answer to Kevin's earlier question, we'll come back to you.

Maher Yaghi (Managing Director)

Thank you.

Operator (participant)

That was our final cue from our audience today. Mr. Bisbee, I'd like to turn it back to you, sir, for any additional or closing remarks that you have.

Gary Bisbee (Head of Investor Relations)

Thanks, Jim, and thanks, everybody, for joining us today. We're around today if we can help, so feel free to reach out to the IR team. Thank you.

Steve Hasker (CEO)

Thanks, everybody.

Operator (participant)

Ladies and gentlemen, this does conclude today's meeting, and we thank you for your participation. You may now disconnect your lines.