ID
stringlengths 13
18
| CONTEXT
stringlengths 45
333k
⌀ |
|---|---|
EarningCall_1100
|
Good day and thank you for standing by. Welcome to the Gentex Reports Fourth Quarter and Year-End 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speakersâ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. And I would now like to hand the conference over to your speaker today, Mr. Josh O'Berski, Director of Investor Relations. Sir, please go ahead. Thank you. Good morning, and welcome to the Gentex Corporation Fourth Quarter 2022 Earnings Release Conference Call. I'm Josh O'Berski, Gentex's Director of Investor Relations, and I am joined by Steve Downing, President and CEO; and Neil Bain, Vice President of Engineering and CTO; and Kevin Nash, Vice President of Finance and CFO. This call is live on the Internet and can be reached by going through the Gentex website and atir.gentex.com. All contents of this conference call are the property of Gentex Corporation and may not be copied, published, reproduced, rebroadcast, retransmitted, transcribed or otherwise redistributed. Gentex Corporation will hold responsible and liable any party for any damages incurred by Gentex Corporation with respect to any unauthorized use of the contents of this conference call. This conference call contains forward-looking information within the meaning of the Gentex Safe Harbor statement included in the Gentex Reports Fourth Quarter 2022 financial results press release from earlier this morning and as always shown on the Gentex website. Your participation in this conference call implies consent to these terms. Thank you, Josh. For the fourth quarter of 2022, the company reported net sales of $493.6 million, an increase of 18% when compared to net sales of $419.8 million for the fourth quarter of last year. The fourth quarter of 2022 revenue included cost recoveries from customers of approximately $15 million. Light vehicle production increased by 7% quarter-over-quarter in the company's primary markets of North America, Europe and Japan and Korea, which equates to an 11% revenue outperformance versus the company's underlying markets. The gross margin in the fourth quarter of 2022 was 31.2%, compared with a gross margin of 34.3% in the fourth quarter of last year. The gross margin in the fourth quarter of 2022 was primarily impacted by raw material cost increases, unfavorable product mix and increased manufacturing costs stemming from labor cost increases and inefficiencies created by customer order volatility. The cost increases were partially offset by cost recoveries during the quarter. The fourth quarter produced sequential improvements in gross margin of 140 basis points versus the third quarter of 2022 as a result of customer cost recoveries during the quarter, as well as some improvements in leveraging fixed costs. However, margins in the quarter were negatively impacted by sales that came in below our original forecast for the quarter, unfavorable product mix and increases in manufacturing costs. Heading into 2023, we continue to see strong demand for our products, which should result in record revenue performance for the year and will assist our ongoing efforts focused on margin recovery throughout 2023 and 2024. For the calendar year, we expect margins to begin the year in the range of the fourth quarter margin profile and then improve as the year progresses, ultimately ending at a weighted average margin of 32% to 33% for 2023. Operating expenses during the fourth quarter of 2022 were up 7% to $59.7 million when compared to operating expenses of $56 million in the fourth quarter of last year. Income from operations for the fourth quarter of 2022 was $94.1 million, as compared to income from operations of $88 million for the fourth quarter of last year. During the fourth quarter of 2022, the company had an effective tax rate of 9.7%, which was driven by provision to return adjustments, as well as increased benefits from the foreign-derived intangible income deduction and discrete benefits from stock-based compensation. In the fourth quarter of 2022, net income was $86.2 million, as compared to net income of $84.2 million in the fourth quarter of 2021. Earnings per diluted share in the fourth quarter of 2022 were $0.37, as compared with earnings per diluted share of $0.35 in the fourth quarter of 2021. For calendar year 2022, the company's net sales were $1.92 billion, which was an increase of 11% compared to net sales of $1.73 billion in calendar year 2021 and represented the highest annual sales in company history. Light vehicle production in 2022 increased by 3% when compared to last year in the company's primary markets, but total revenue for the year outperformed the underlying market by 8% despite the many supply chain challenges and customer order volatility encountered during the year. For calendar year 2022, the gross margin was 31.8%, compared to a gross margin of 35.8% for calendar year 2021. The largest impact to gross margin on a year-over-year basis were increased raw material costs, increased manufacturing costs, higher freight and logistics costs and certain previously agreed to annual customer price reductions. For calendar year 2022, operating expenses increased 14% to $239.8 million, when compared to operating expenses of $209.9 million for last year. For calendar year 2022, the company's effective tax rate was 13.8%, as compared to an effective tax rate of 13.3% last year. Net income for calendar year 2022 was $318.8 million, down 12% compared to net income of $360.8 million last year. Earnings per diluted share for calendar year 2022 were $1.36, compared to earnings per diluted share of $1.50 last year. Thank you, Steve. Automotive net sales during the fourth quarter of 2022 were $482.9 million as compared to$409.6 million in the fourth quarter of 2021. For calendar year 2022, automotive net sales were $1.87 billion, which was a 10% increase over 2021. Other net sales in the fourth quarter, which includes dimmable aircraft windows and fire protection products were $10.7 million, an increase of 5% compared to other net sales of $10.2 million in the fourth quarter of 2021. Fire protection sales increased by 37% for the fourth quarter of 2022when compared to the fourth quarter of 2021. Other net sales for calendar year 2022 were $44.2 million, compared to other net sales of $33.9 million in calendar year 2021. Fire protection sales in 2022 increased by 53% year-over-year, while dimmable aircraft window sales were down 33% in 2022 compared to calendar year 2021. The company expects that dimmable aircraft window sales will continue to be impacted until there is a meaningful recovery of the aerospace industry and the Boeing 787 production levels improve. Share repurchases. The company repurchased 0.8 million shares of its common stock during the fourth quarter at an average price of $27.17 per share. For the year ended December 31 of 2022, the company repurchased 4.04 million shares of its common stock at an average price of $28.19 per share for a total of $113.9 million. As of December 31 of â22, the company has 20.8 million shares remaining available for repurchase pursuant to its previously announced share repurchase plan. The company intends to continue to repurchase additional shares of its common stock in the future in support of the previously disclosed capital allocation strategy, but share repurchases may vary from time to time and will take into account macroeconomic issues, market trends and other factors the company deems appropriate. Shifting over to the balance sheet. The items mentioned today are values as of December 31 of 2022 and are compared to December 31 of 2021. Cash and cash equivalents were $214.8 million, down from $262.3 million, primarily due to capital expenditures and cash flow from operations. Short-term and long-term investments combined were $176.9 million, down from $213.1 million. Accounts receivable was $276.5 million, up from $249.8 million due to the timing of sales within the quarter. Inventories were $404.4 million, which increased from $316.3 million, primarily in raw materials while up from December 31 of 2021, inventory levels have decreased sequentially from $418.3 million. The company continues to take a measured approach of inventory management as the supply chain constraints are starting to lessen and the company is looking at certain areas to reduce inventory levels. However, customer order volatility still remains and forecasting in the short-term remains challenging, so the company will continue to have higher levels of certain components to help manage risk and meet customer demand. And accounts payable increased to $151.7 million, up from $98.3 million, primarily due to increased inventory purchases, capital expenditures and change in payment terms. Let's take a look at preliminary cash flow items for the quarter and calendar year. Fourth quarter 2022 cash flow from operations was $101.8 million, which was an increase from $69.1 million in the fourth quarter of 2021 and year-to-date cash flow from operations was $338.2 million, compared to $362.2 million for calendar year 2021. Capital expenditures for the fourth quarter were $38 million, compared with $30.8 million for the fourth quarter of 2021 and calendar year 2022 capital expenditures were $146.4 million, compared to $68.8 million for calendar year 2021. And depreciation and amortization for the fourth quarter was $23.3 million, compared to $24 million for the fourth quarter of 2021 and calendar year 2022 depreciation and amortization was $96.6 million, compared with $99.1 million for calendar year 2021. Great. Thanks, Kevin. Earlier this month, Gentex participated in the 2023 Consumer Electronics Show. We utilized CES to showcase our current and potential future product portfolio. Our booth was designed to help automakers envision a path toward the autonomous age with scalable products and features ready for implementation on today's vehicles. . This year at CES, our automotives and aerospace customers were able to experience Gentex technologies in new and exciting ways. We displayed advanced vehicle and aircraft fuselage simulators that allow those attendants to experience firsthand the benefits of our technology right on the show floor. Our unique vehicle demonstrator showcased a scalable yet holistic approach to driver and in-cabin monitoring. The driver monitoring system track the driver's head pose and monitoring. The driver monitoring system track the driver's head pose eye gaze and other relevant movements to determine distraction, drowsiness, sudden sickness and readiness for the return of manual control in semiautonomous vehicles. This system is easily expandable to include 2D and 3D cabin monitoring for detecting passengers, behaviors, objects and even presence of life. Our goal with this system is to provide solutions for today's vehicles and the transition to autonomous vehicles and that means engineering a comprehensive and scalable monitoring platform based on our competency in digital vision and sensor fusion techniques. Our CES booth also highlighted the company's industry-leading Full Display Mirror, an intelligent rear vision system that uses a custom camera and mirror-integrated video display to optimize a vehicle's rearview vision. The FDM also serves as a platform for additional innovation. Add-on features that we demonstrated included a mirror integrated digital video recorder, scalable trailer cam system, touchscreen display, lane line projection overlays and mirror integrated camera for video conferencing or capturing photos within the vehicle cabin. Also displayed at CES were large area dimmable devices including Sunroofs that darken on-demand or with system intelligence. And Sun visors that fold down like a traditional visor but include a clear dimmable panel that can darken on demand based on sun load. We also highlighted small scalable dimmer devices that have many different use cases, including the ability to darken and improve contrast and visibility for transparent displays, consuming of sensors and dynamic adjustment of camera exposure. Many of the products that we initially developed for the automotive industry are built on technology platforms and can be customized for other industries. For CES 2023, Gentex developed an aircraft fuselage simulator that allowed us to demonstrate how these same technologies can be deployed into aerospace. These technologies included dimmable glass and smart lighting, where we utilize the camera system to control the location and color temperature of cabin lighting. Few slides also showed various dimmable devices, including our dimmable windows and further advancements in this technology for dimmable partition devices to create privacy and cabin separators. We also included various biometric systems where we demonstrated the use of facial recognition to create a personal experience for the passenger and then utilize iris-based biometrics for a more accurate identification of a passenger for secured transactions. These technologies can make the flight experience safer, more enjoyable and more personalized. Overall, CES 2023 was an excellent opportunity for us to demonstrate to our current and hopefully, some future customers. What is driving our business today and what things we're working on to drive our growth in the coming years. In terms of launches, for the fourth quarter of 2022, there were 27 net new nameplate launches of our interior and exterior auto-dimming mirrors and electronic features. Approximately 50% of these new nameplate launches were advanced features with Full Display Mirror and HomeLink leading the way. Now for an update on Full Display Mirror. During the fourth quarter of 2022, we began shipping FDM on seven new vehicle nameplates. These new vehicle nameplates are, the Chevy Bolt EUV, the Kia Telluride. The Mercedes Sprinter, the Subaru Soltera, the Lexis Rx, the Toyota Prius and Toyota Sequoia. Including these seven new nameplates in 2022, Gentex began shipping FDM on 18 nameplates, and are currently shipping FDM on 86 nameplates. The technology continues to have growing interest and growth potential and we are excited to see how well this product is being received by our OEM customers and the end consumers. 2022 is an extremely challenging year, but the teams at Gentex did an outstanding job executing the high volume and extremely complex new launches that have been driving our new business growth, all while managing through the product redesigns that have been necessary due to component shortages that our industry has been facing. As we look forward, our launch rates continue to look strong and as we continue to come out of this redesign cycle, I am excited about our ability to refocus all of our development efforts to new products and technologies. Thanks, Neil. The company's current forecast for light vehicle production for calendar year 2023 and 2024 are based on the S&P Global Mobility mid-January 2023 forecast for light vehicle production in North America, Europe, Japan, Korea and China and can be found in our press release. For calendar year 2023, light vehicle production in these markets is forecasted to increase 4% when compared to calendar year 2022 and is estimated to increase an additional 4% for calendar year 2024. Based on this light vehicle production forecast, the company is providing the following estimates for 2023. Revenue for the year is expected to be approximately $2.2 billion. Gross margins for the year are expected to be between 32% and 33%. Operating expenses are expected to be between $260 million and $270 million. Our estimated annual tax rate is forecasted to be between 15% and 17%. Capital expenditures are expected to be between $200 million and $225 million. The company intentionally delayed capital expenditures in 2020 and 2021, given the mandated shutdowns and the industry downturn. During 2022, the intent was to spin that previously delayed capital However, availability of materials and capital equipment further delayed that spend. As a result, 2023 and 2024 CapEx will be higher than our typical rate, but represents the level of spend needed to support the book business driving our growth and future R&D projects. Lastly, depreciation and amortization is forecasted to be between $100 million and $110 million for 2023. Additionally, based on the company's current forecast for light vehicle production for calendar year 2024, the company expects calendar year 2024 revenue growth of approximately 10% above the 2023 revenue guidance range of approximately $2.2 billion. Calendar year 2022 will be remembered as a very difficult operating environment that was negatively impacted by customer order volatility, supply and component constraints, cost deflation and raw components, labor and almost every other facet of the business. As we look into 2023, we are working hard to make sure that this coming year will be remembered as the year where we broke through the $2 billion revenue threshold and continued the process of improving the margin profile of the business. While we fully anticipate continued margin pressure for the first half of 2023, we also expect that the margin will improve throughout the year with the work done this year, setting the stage for further margin improvement throughout 2024. While there may be some lingering effects from supply and labor constraints that could limit global light vehicle production growth rates, we still believe our forecasted growth rate, in combination with our focus on cost control and other margin improvement efforts will move us to our targeted margin profile of 35% to 36% by the end of 2024. Our current model for the next two years includes an improving revenue environment driven by our product portfolio, as well as improving margins from a better supply environment and internal cost control. These factors we believe will result in record revenue and improved margin performance that should result in increasing shareholder returns over the next two years. Good morning. Thanks for taking my question. I want to start with gross margin this morning. Good to see the initial cost recoveries flowing in here in the quarter. Now that youâve been having a lot of those conversations and relative to what you're guiding for 2023, how good is your line of sight to that level of gross margin at 32% to 33%? Or said differently, how much do you already have in hand versus negotiations that are still undergoing at this point? Thank you. Yes. For the first quarter, we feel pretty good about where we're at on the recovery side to get to that range for the year. Like we mentioned in the prepared comments, we think the first quarter is going to look a little bit more like Q4 from an overall margin percentage perspective. But a lot of these recovery will start to take effect throughout the year and the growth rate will obviously help with the overhead side to help leverage the business to get to that range for the full year. Maybe just to follow-up on that, specifically, the negotiations themselves, Steve, is that still ongoing? Or what's reflected in the guidance is more so leaning towards things that you've already agreed to with customers? Yes. The guidance is really about 60% to 70% of what's needed to hit that range or already agreed to. We do have several customers that are still outstanding that we need to reach agreement with. Okay, that's helpful. Thank you for that data point. And then my follow-up question on FDM and then kudos to your supply chain, your engineering team for what is I mean, I think it's understated to say a very impressive result in2022, but is it right to think that may still have been short of where take rates from your customers were last year? And along those lines, does this rebase your expectations for FDM unit growth going forward? And maybe if you could comment what's in the guidance as well. Thank you. Yes. So the take rates didn't worsen because of that. Really what happened though is they were increasing throughout the year. What I would say is FDM shipments in 2022 were probably 100,000 to 150,000 units short of what customers would have liked them to be, and that was driven almost exclusively by availability of components. And to your point, and thanks for recognizing and pointing that out, but Neil's team did an incredible job of even the work to even get to this level was Herculean. So it was a pretty crazy year in terms of how much work had to go in just to try to get to this level of performance. In terms of going forward, we've been talking 200,000 to 300,000 units per year is kind of what our expected growth rate was over a longer period. I actually think '23 will be slightly above that, so probably north of the 300,000 unit range going into 2023. Thank you. One moment please for our next question. Our next question will come from David Kelley of Jefferies. Your line is open. Hey, good morning, guys. Thanks for taking my questions. Maybe to follow-up on the gross margin discussion and appreciate also the color on cost recoveries, but the other impacts in the quarter, raw material, labor cost increases, can you give us a sense of the impact there? And then I also wanted to ask about the order volatility in the quarter. Is that still supply chain constraint related? Yes. So the order volatility is really supply issues across the entire industry that's impacting OEMs and then, therefore, we are being impacted because of how much change is happening at the OEM level. On the margin on a year-over-year basis, if you look at Q4 of 2022 versus 2021, one of the things we like to point out is there is actually about 500 basis points of margin headwind that from cost side, we â obviously, with cost recoveries, we are able to recover about 200 basis points. So the net is 300 on a year-over-year basis is what you see the margin down. But the total headwind was actually 500, a little over 500 basis points. Of that, about 350 basis points were bill materials-related, so cost increases, there was about 100 basis points of labor and then another 50 to 60 basis points of various things, mix and overhead being the primary drivers of that headwind. Okay, got it. That's helpful. And outside of the pricing and pass-through dynamic, how should we think about kind of raw material labor expectations baked into that second half margin ramp that you're expecting in the guide? Yes. I mean, if you look at on the bill materials side for 2023, we're expecting a pretty stable environment, so basically flat on the material side, there will be some ups and downs inside of that. But the bottom line is we think we'll get through 2023 with pretty much net neutral position in terms of billing materials. Obviously, labor is going to continue to move based on market conditions. What we see though is that we think we've addressed most of those over the last few years in terms of labor costs, but you would expect to see normal kind of inflationary pressure going forward on the cost of labor. So we think the increase in those issues should be less than what we've experienced in the past, and the growth rate will obviously produce a higher rate of revenue, which should help us with our overhead side to get to a slightly improved overall cost position. Okay, perfect. Thank you. And then last one for me, the OpEx guide, and you mentioned the kind of key focus, our ongoing focus on growth products, how should we think about R&D levels going forward? Any meaningful step change in the spend there? No, it's roughly in line with our revenue growth rates. Really, the R&D forecast is tracked pretty well. I mean there is a little bit of lumpiness as it relates to when the revenue actually comes to fruition. But the increases in R&D attractive over the last five years have tracked roughly in line with our sales growth level. Thank you. Again one moment please for our next question. Our next question will come from James Picariello of BNP Paribas. Your line is open. On the customer cost recoveries, you achieved $15 million in the fourth quarter. Just curious on a finer point, I know this has been indirectly asked, but how should we be thinking about what that cost recovery number looks like for this year? Is the 100 basis points in net pricing still the right target for this year? Because, right, that would imply maybe 3 points of net positive price relative to your typical 2% APR. So that's something on the order of $55 million to $60 million in recoveries implied for this year. Is that the right range to be thinking about? Yeah, so I'd say you're exactly right about the goal for this year and where we think we can end is at about a net positive of 100 basis points. Okay. And then the trajectory out for 2024 still encouraging from both the top line and gross margin is a maybe now more still weighted in 2024. Just focusing on the cost side of the equation, can you quantify what the total addressable cost bucket is in terms of as an exit rate for 2022, what that what that cost bucket is in terms of how that winds down through 2024. What's addressable, what allows you to get to that 35% to 36% exit rate in 2024 from a cost perspective? The biggest piece is obviously raw materials that have gone up by 350 basis points over the last 18 months. So that's addressable as we get into the late half of next year into 2024, we would expect to start to see that improve. The thing we didn't talk about in here was freight. That's also been about 150 basis point headwind over the last 18 months that is starting to show signs of improvement. And then, the last piece really is between mix and leveraging our overhead, right? So I mean, you have a lot of things put in place for growth that has been stalled a little bit because of mostly supply chain constraints. But as you see, our forecast this next year move into roughly 15% growth and another 10% next year. But the investments in CapEx will start to be leveraged with that sales growth. Yes. And I think, James, the other one too, that we're pretty optimistic about is the labor cost increases have been very significant, but really even driving that more has been overtime cost because of the lack of staffing and headcount that we needed. We've made a lot of progress over the last month or so on the direct labor side. And we feel like that will help limit the amount of overtime costs. And so there could be another 50 to100 basis points of tailwind over the next 18 months as we get the staffing in place and trained and become more efficient from an operations standpoint. . Thank you. And one moment please for our next question. Our next question will come from Josh Nichols of B. Riley. Your line is open. Yes. Thanks for taking my question here. Just thinking a little bit more about cash flow given some of the investments that are going on for CapEx and what not for 2023 I did know so inventory levels were actually down in 4Q. Are you at a level where you think youâd probably don't need to invest more in inventory? And is that going to be a source of cash flow for 2023? Or is it going to hold around current levels? I'm just curious your thought process given the demand dynamic that you're seeing right now? I think it'll â we certainly did see a retrench. Our teams did a really good job of kind of selectively looking at where inventories were not needed as sales continue to grow. You should see that be at least flat. It may be a source of cash, but probably not an excessive source of cash. I mean you are talking $10 million, $15 million,$20 million. We feel comfortable with kind of the lead time environment, our supply chain. We're not going to get too aggressive on that until we see consistent stability in the market probably for another 18 months. Perfect. And then last question for me. I think it's appropriate coming out of CES this month. But just thinking a little bit longer term, I mean, you look back 5, 7 years ago, the company wasn't really generating any revenue from FDM. Everyone can see just what a growth driver that's been and the type of performance that you put up this year despite being a capacity-constrained environment. I am just curious, your thoughts about some of the technology that you had on display at CES this year. And what are two items do you think are probably the closest to commercialization and the time line that it may be until those could start generating more material revenue? Well, I'd like to say all the products are about ready to get to the market, but a little longer than others. I think a lot of the excitement is on dimmable devices is clearly, the market that I would pick has got the most excitement from CES, and that's large area devices as well as visors. And I think both of those have great opportunity and those are probably â you're still going to be three years, three-plus years out before we see those come to market. The second one, you asked for two. The second would be in the driver and in-cabin monitoring. Positioning the mirror area as a platform for positioning cameras, emitters, processing, I think we'll see that start gaining some more traction. There was a lot of interest over the last couple of years at CES and I think there will be more traction in there And I think that's within the two to four year window from being market ready. Thank you. One moment for our next question. Our next question will come from Ryan Brinkman of JPMorgan. Your line is open. Hi, thanks for taking my question. With regard to the $15 million of customer recoveries in 4Q, I am curious if these are the first materials sort of non-contractual customer recoveries that you've realized since costs seem to inflect around 3Q 2021? And if maybe you have a sort of rolling tally internally of the total amount of excess costs that you've incurred, sense costs began to inflect and that recovery is partly offset, right? And then like what percentage of those cumulative excess costs that you aim to or expect to recover over time or said differently, how many more of these recoveries for past costs do you think that investors can expect going forward? Yes, I would say if you look at, yes, we absolutely have the tally of the paying that has been deferred over the last 18 months is one of those areas that you try to forget, but unfortunately you canât. Itâs very real. But if you look at the numbers we are talking about earlier, about 350 basis points of margin degradation. I mean really, if you do that on a â on the total revenue, you've got your number there. So you're north of anywhere around $70 million to $80 million in cost increases that we've had to endure over the last 18 months. Like we mentioned, we've got some already that we got in the Q4area. And then we expect to have net positive increase in pricing this year of 100 basis points. So if you look at what we were expecting, normally, you'd see in a down market or a negative APR market to now be positive pricing. We think we'll probably pick up a good $20 million to $30 million on an annual basis this year of those costs and then we're obviously going to be looking at how do we either get further recoveries into2024 or do we get book of business and awards that will allow â at least allow us to offset those and hopefully get back into a deflationary pricing market from a supply base. And so, it is a longer strategy it's definitely one that we feel comfortable with the numbers. We understand what we need to do to get that margin profile back to 35%, 36%, and we're off to a good start. Thank you. One moment please for our next question. Our next question will come from Mark Delaney of Goldman Sachs. Your line is open. Yes. Thanks. Good morning and thank you very much for taking the questions. First one is on the mix of products this year and have OEM take rate plans for higher-end products like FDM changed at all for 2023 in light of the current macroeconomic situation? No, as of right now, we haven't seen a single change. In fact, still a lot of pressure from OEMs to try to get the type of components and at the take rates they want. The market is still constrained. Obviously, it's not as bad or as severe as it was mid last year. But there is definitely a strong demand right now for higher-end features and content. That's helpful. Thanks. And my second question was on the overall revenue guidance 2023 I believe as of last quarter, the company was anticipating 15% to 20% revenue growth for 2023 and now you're guiding for about 15%. So I am hoping to better understand what's changed in the assumptions for revenue growth for this year? Yes. The primary one was two things. Number one is, the light vehicle production for2023 has come down a little bit. And we would tell you that we're a little bit pessimistic on the second half of the year of those numbers actually happening. And so, we just manually adjust that S&P forecast based off what we understand and what we're seeing from a customer basis and also from a consumer standpoint. So â just given the borrowing rates and what interest rates are looking like, we think there will be a little bit of a slowdown in terms of light vehicle production in the second half. . Thank you. One moment for our next question. And our next question will come from David Whiston of Morningstar. Your line is open. Hi guys. Just two questions from me. In the press release, you talked about an unfavorable product mix in the quarter. And I'm just curious, does that imply there were advanced feature products that lagged? And was that just all FDM and HomeLink or something else? Yes. I mean it's mostly just a combination of the higher cost on some of the more advanced features and then, yes, shortage shipping really what we were expecting kind of going into the quarter. So it really resulted in last year at this time, we had really, really strong outside mirror growth, as well. This year was a little bit more flat in the fourth quarter. And you see a lot of that. I mean we didn't â this year's â the last couple of years have been a little odd just because of everything else that's been going on. Normally in Q4, you do see our Tier 1 customers usually focus on inventory adjustments. So usually in December, you'll see them take a little less HomeLink outside mirrors, which are primary products that we ship through Tier 1. Okay. And I think what Kevin was answering a question earlier on margin heavens and particularly called out raw materials and freight. It sounds like then those are the single biggest gross margin headwinds by far or in the past, it seems like suppliers is always just been we need more volume and nothing else is as important. No, I mean raw materials, the biggest headwind we've experienced is what I was referring to over the last 18 months. It's certainly the biggest part of our build material and with the electronics piece of it being a big portion of our business, that's certainly where the most opportunity for improvement over the next 2 years exists. We've done -- if you remember back during COVID, we kind of right-sized our operations in our overhead structure so that it was built for this size. And so as we grow, we should be able to leverage that as well, but it's not as big of a headwind as kind of the material side. So, if you had your choice of dramatic improvement in raw material costs now or say, a much more normalized SAAR at a higher level, you'd take the raw materials? Thank you. [Operator Instructions] And one moment please for our next question. Our next question will come from Ron Jewsikow of Guggenheim Partners. Your line is open. Just first, hey guys. You mentioned the guide assumes a stable cost environment. Does that include freight and overtime pay or are those potential sources of upside? And how is that trending, I guess, so far in January? No we think that will be stable as well, if not a slight â on the labor and overtime side and even on the freight, we actually think that will be a slight tailwind in 2023 versus 2022. Okay. And then this is maybe more of a question for Neil, but how many FDM nameplates do you think you can get to exiting 2023? So we think we can pick up another probably between 15 to 20 somewhere in there based on current so much of it's variable depending on the last half of the year in the fourth quarter. Sometimes they bump into the first quarter of the following year. So it just kind of depends on alignment. But I would say 15% is probably a pretty good number right now. Okay. And then last question for me is, you referenced earlier on the call, but late quarter orders slipping into the first quarter, it does look like foreign exterior and both domestic interior exterior where maybe a bit weaker than we would have expected. And if so, can you quantify like the magnitude of what may have been destock or shipping into the first quarter? Overall, our total forecast was about $20 million to $25 million below our beginning of the quarter forecast. Probably somewhere 30%, 40% of it may have been destocking. It's hard to tell exactly what's going on. I mean, especially with our foreign side, there's a little bit of lead time on shipments. So it's just a little bit of shortage on the outside mirror side. Thank you. And I do not see any further questions in the queue. I would now like to turn the conference back to Mr. Josh O'Berski for closing remarks. This does conclude today's conference call. Thank you all for participating. You may now disconnect. Have a pleasant day, and enjoy your weekend.
|
EarningCall_1101
|
Ladies and gentlemen, welcome to the Virtu Financial 2022 Fourth Quarter Results Call. My name is Glenn, and I'll be the moderator for today's call. [Operator Instructions] Thank you, Glenn, and good morning, everyone. Thank you for joining us. Our fourth quarter results were released this morning and are available on our website. On this morning's call, we have Mr. Douglas Cifu, our Chief Executive Officer; Mr. Joseph Molluso, our Co-President and Co-Chief Operating Officer; and Ms. Cindy Lee, our Deputy Chief Financial Officer. We will begin with prepared remarks and then take your questions. First, a few reminders. Today's call may include forward-looking statements, which represent Virtu's current belief regarding future events and are, therefore, subject to risks, assumptions and uncertainties, which may be outside the company's control. Please note that our actual results and financial conditions may differ materially from what is indicated in these forward-looking statements. It is important to note that any forward-looking statements made on this call are based on information presently available to the company, and we do not undertake to update or revise any forward-looking statements as new information becomes available. We refer you to disclaimers in our press release and encourage you to review the description of risk factors contained in our annual report, Form 10-K and other public filings. During today's call, in addition to GAAP measures, we may refer to certain non-GAAP measures, including adjusted net trading income, adjusted net income, adjusted EBITDA and adjusted EBITDA margin. These non-GAAP measures should be considered as supplemental to and not as superior to financial measures as reported in accordance with GAAP. We direct listeners to consult the Investor portion of our website, where you'll find additional supplemental information referred to on this call as well as a reconciliation of non-GAAP measures to the equivalent GAAP term in the earnings materials with an exhibition of why this information â why management deems this information to be meaningful, as well as how manage â as well as how we use these measures. Thank you, Andrew, and good morning, everyone. Thank you for joining us today. In my remarks today, I will focus on Virtu's fourth quarter and full year 2022 financial and business performance, 2022 milestones and the progress we've made toward our key strategic initiatives and goals. Following my remarks, Joe and Cindy will provide additional details on our performance. Turning to our full year and fourth quarter results, which are summarized on Slide 2. We generated $5.8 million of adjusted trading net income per day in 2022, including $4.4 million per day in the fourth quarter. Total adjusted EPS was $3 per share for the full year, including $0.37 in the fourth quarter. Our Market Making segment, which earned an average of $4.2 million per day in adjusted net trading income for 2022 comprises our customer wholesale business where we received flow from 250-plus retail platforms, as well as our noncustomer or proprietary market-making business. In the fourth quarter, our customer market-making business witnessed decreased opportunity as the overall spread opportunity and retail participation ebbed and the quality of the flow we receive from our retail customers was significantly less desirable. As we have noted before, parts of our market-making business can be more variable than our other businesses and as a consequence, should be viewed over the long-term in conjunction with the significant cash flow it generates. We remain extremely bullish on the long-term value of our customer business, which has proven to be durable and profitable over the past 20-plus years. Our noncustomer business, which provides liquidity across asset classes globally, experienced a strong quarter, as well as a strong overall year, as our ongoing investments in our growth initiatives, particularly around options market making continued to perform well. While the integration of our businesses and increased internalization means that efforts to improve one market-making business often generates benefits across our entire Market Making segment, this quarter's market making results were driven by improvements that we deployed to existing strategies in both our customer and noncustomer market-making businesses. For our customer market-making business, although the opportunity was down in the fourth quarter, we performed in line or even better than our own internal metrics projected. We have historic - we have historical capture rate metrics, and these didn't deteriorate, but we continue to focus on ways to improve and capture more of every opportunity in every environment. And while market share alone is often not a helpful gauge of performance, it's worth noting that our market share in the wholesale business remains within historic ranges. A couple of significant bright spots in our thriving noncustomer business include energy and natural gas, specifically as well as our continued growth in options globally. To give you some additional perspective, our noncustomer market making business was flat year-over-year from '21 to '22 and up 11% from the third to the fourth quarter of 2022. Turning to our Execution Services segment. Our adjusted net trading income was $1.4 million per day in the fourth quarter, essentially flat from the third quarter. For the full year, VES delivered $1.6 million per day or 28% of our total ANTI. In general, VES results include revenue that is more recurring in nature compared to the inherently more variable market-making businesses. Given the contraction of the buy-side execution wallet and declining institutional engagement, particularly in Europe, we believe our Execution Services segment performed in line with the opportunity this quarter and the full year. We are bullish as well about VES's progress and the opportunities ahead. We have built our global multi-asset execution business as part of the acquisitions of KCG and ITG and we continue to onboard new clients to our highly scalable technology platform. We're excited about the growth opportunities the future holds from cross-selling across regions, products and assets as well as adding more subscription revenue to VES' platform. In the very early days of 2023, we are seeing some modest enhanced opportunity in our customer market-making business and our efforts to improve our capture rates are beginning to bear fruit. Overall, we are pleased at how we performed against the opportunities the market has given us in 2022 and how we have deployed new businesses that are in the infancy or non-existent only a few years ago. Our performance in the fourth quarter, full year 2022 and in the start of 2023 is the result of the ongoing investments we are making in people, technology, integration, deploying strategies to new products and ongoing innovation to expand our abilities to address more opportunities become more efficient and capture incremental revenue from each existing opportunity. As always, we remain relentlessly focused on cost and realized a 59% adjusted EBITDA margin for the full year and a 46% adjusted EBITDA margin in the fourth quarter. Reviewing some of our growth initiatives in options, our business had a record year in 2022 as we've expanded across venues, as well as across asset classes and geographies. We remain very pleased with our decision to focus our early efforts and options in the most liquid issues as we build our footing. In the U.S., market-wide options volumes were - were up 5.5% in 2022, while ANTI from our growing options business was up over 100% for the second consecutive year. However, given the size of this growing global cross-asset opportunity, we consider ourselves in the early innings of a multiyear effort. In Block ETF, we continue to make progress in our adjusted net trading income in 2022 was up despite lower opportunity overall. Closely related to our ETF Block Desk is our growing investment to build our fixed income business. In the same way that our growing options business complements our global equities market-making activities, success in our fixed income business enhances our ETF Block Desk. In addition to our growing investments in resource allocation, we continue to actively hire and develop talent to help us realize these and other opportunities. Crypto. I previously talked about crypto as a growth initiative and notwithstanding the industry turmoil kicked off by the FTX bankruptcy and continuing today, we continue to view crypto as a long-term growth opportunity. In the aftermath of recent events, I'm proud to say that we manage the risk around the events of this quarter, as you would expect from Virtu. Although we had an approximate 8-figure fiat and coin balances deployed across several venues when the FTX news broke, we acted quickly and did not realize any material losses. Finally, I know you will have some questions on the SEC's latest proposals. In short, the proposals did not include anything new as compared to the rhetoric, which preceded and our position remains the same and is consistent with the broader industry as well as numerous academics and commentators. Today's retail investor receives immediate competitive and commission-free executions on over 10,000 securities. Main Street investors enjoy this level of service, thanks to a myriad of offerings from hundreds of retail brokers who leverage an intensely competitive landscape of wholesale execution service providers like Virtu and many, many others. It is more clear than ever that the SEC's proposal would directly hurt individual investors and reduce their engagement in our capital markets. In addition to a less transparent and less fair landscape for the average retail investor on top of increased cost and worse execution quality, the SEC's proposals would also harm liquidity and increased costs for institutional investors and issuers. Further and importantly, the half Harrison [ph] rulemaking, lack of any real engagement with stakeholders an abbreviated comment period has resulted in a proposal that is internally inconsistent, theoretical analysis that ignores empirical evidence and an experimental approach that disregards the likely cost everyday investors. It is extremely unlikely to withstand any degree of scrutiny in the upcoming process, which could take several years. Sadly [ph] as we have noted before, we believe the proposal is a politically motivated solution in search of a problem. Lastly, as I have mentioned several times, these proposed rules, while they would be terrible for the average retail investor would not necessarily be terrible for scaled wholesalers like Virtu. Remember, today's wholesalers like Virtu are service providers that compete for business by immediately filling all orders we accept and by providing price improvement as part of our commitment to our retail broker customers. Under the SEC proposal to mandate options, we would be able to and in fact, we will be required to send flow, we do not internalize to an exchange retail auction. Today, we incurred significant fees, including payment for order flow, price improvement and exchange, SEC and other transaction fees on orders we do not internalize. These costs would be dramatically reduced under the proposal. We also internalized tens of thousands of orders daily in small and mid-cap listed companies as part of the overall wholesale service we offer to our clients, which we could now simply route to exchanges at a substantial savings to ourselves, but this savings would come at the expense of retail investors. So the preliminary analysis of the trade-off suggests that the exchanges in wholesalers may stand to benefit under key aspects of this plan. And at worst, we will be in a neutral position. I'm sure we will discuss these issues further in the Q&A to follow. Thank you. Doug touched on options and ETF Block, in particular, as drivers of our growth initiatives. I'll review some of the growth information we provide, as well as review where we stack up versus the grid of expected outcomes to Virtu and finally, discuss expenses and capital overall. On growth, growth initiatives constituted $602,000 per day on average in the fourth quarter and $665,000 per day overall in 2022. These numbers were 11% and 14% of our global ANTI, respectively. ANTI-from options grew dramatically as well, doubling its contribution. While we maintained our presence in the crypto markets in the fourth quarter, we did, like many others, significantly reduce our activity. We remain bullish on crypto as a growth area in the future and remain - and we remain excited about EDX, our joint venture. I mean view many of the challenges facing the crypto space as validation of EDX's best-in-class custody clearing and settlement model. On expenses, we ended the year with cash operating expenses that were flat year-over-year at $609 million. We consider this a significant accomplishment given the most inflationary environment in decades and the marketplace for talent, especially early in the year, becoming intense. Our cash compensation ratio is at 21.5% for 2022, right in the range of where we would expect it to be in a year such as this. Other expenses remain relatively constant. The outlook on expenses is more of the same. You can expect our compensation ratio to fluctuate within the ranges you see on Slide 8 in the supplemental materials and a continuation of the trend for our other major expense categories. You will note a marked increase in operations and administrative expense in the fourth quarter. This is due to a foreign exchange valuation swing related to our foreign subsidiaries that increased its expense by $9 million this quarter. For the full year, however, the FX translation was an overall benefit to Virtu of $9 million. We generally don't call these amounts out because they tend to be small. But given the strength of the dollar versus the euro and pound, sterling this year, it was a significant benefit overall. Additionally, we estimate the amount of revenue that was reduced - revenue we earned in pounds and euro and translated into dollars was approximately $10 million. So these amounts largely offset and so did not significantly impact earnings. In terms of expense guidance for 2023, we would expect our cash operating expenses to remain relatively flat to up 1% to 2%. On capital and debt, we manage our capital as efficiently as our expenses, and you can see our trading capital remained relatively constant throughout the year. We maintained our public $0.96 annual dividend, which we have paid steadily now for 7 years. And you can see on Slide 6 that payout has remained steady despite the volatile results over the long term. In addition, we repurchased $45 million in our own stock in the fourth quarter. For the full year, we repurchased $460 million in stock, representing 16.2 million shares. Our period-end share count is now 171.8 million shares and we have repurchased net almost 13% of our company in the 2 years since beginning our share repurchase program. We remain committed to both our public dividend payout as well as our share buyback program, consistent with the ranges we have provided in the past. We were very pleased to have refinanced our long-term debt in January before interest rates really took off. As of year-end, we have $1.8 billion of maturities turned out to 2029 and all but $275 million is subject to a rate cap. So our total debt at a blended rate of 4.95% pretax interest represents a favorable outcome to us. And with that, I'll turn it over to Cindy to review the financial details before opening the call to your questions. Thank you, Joe. Good morning, everyone. On Slide 3 of our supplemental materials, we provided a summary of our quarterly performance. For the fourth quarter 2022, our adjusted net trading income, which represents our trading gains, net of direct trading expenses, totaled $274 million or $4.4 million per day, which is a 43% decrease year-over-year. Market making adjusted net trading income was $185 million or $2.9 million per day. Execution Services adjusted net trading income was $89 million or $1.4 million per day. Our fourth quarter 2022 normalized adjusted EPS was $0.37, and our full year 2022 normalized adjusted EPS was $3. Adjusted EBITDA was $125 million for the fourth quarter 2022 and $859 million for the full year, which was a decrease of 62% and 34% compared to prior year, respectively. Our full year adjusted EBITDA margin was 59%, which is down from 68% in 2021. On Slide 8, we provided a summary of our operating expense results. For the fourth quarter of 2022, we recorded $185 million of adjusted operating - adjusted operating expenses, which was a 6% decrease year-over-year. The full year 2022 operating expenses were $675 million, which was $2 million lower compared to 2021. We continue to maintain an efficient cost structure and disciplined expense management, which has helped us to control our operating expenses during the inflationary environment. Financing interest expense was $25 million for the fourth quarter of 2022 compared to $20 million in the prior year fourth quarter. With the benefit of the interest rate swap contracts we entered in prior years, we were able to keep a blended interest rate around 4.95% for the long-term debt in aggregate. Our capitalization remains accurate. We repurchased 2.1 million shares or $45 million in Q4 2022 and 16.2 million shares or $460 million [ph] in full year 2022. Since the inception of our share repurchase program, we have bought back a total of 32.8 million shares, which is $910 million today. We remain committed to our $0.24 per quarter dividend. The combination of our dividend policy and share repurchase program demonstrate our continued commitment to return capital to our shareholders. Thank you. [Operator Instructions] We have our first question comes from Rich Repetto from Piper Sandler. Rich, your line is now open. Yes. Good morning, Doug and Joe and Cindy. I guess, first, the question is on the retail flow. I know you do a lot of analytics, Doug, and you mentioned that you performed in line with the opportunity. And I guess just to understand the opportunity a little bit better, if there's any one or two things that you could have changed about the nature of the retail flow, you know, your peers also in channel checks reported much of the same. But if there was this one or two things the change about the order flow that would help - that would improve profitability. What might they be? Yes. Thank you. It's a great question, Rich, and I appreciate it very much. I think as we've been very upfront about, and obviously, a lot of these metrics are public in terms of the aggregate number of shares that we receive and then obviously, our 605 metric. So what we do here is we measure within that sub-segment of our business, basically the spread of the bid offer in all of the orders that we received at the time that we receive them. And think of that, if you will, is the opportunity â the opportunity set. And historically, and it started to break down over the last couple of quarters, that spreads some or that opportunity correlated very linearly with volatility. So the higher the volatility, higher spread some was in the retail customer flow that you received. For reasons that you know, I would just be speculating that, that correlation has broken down over the last quarter, quarter and half, and it was particularly egregious, if you will, in the fourth quarter. And so the opportunity was vastly different than the volatility would otherwise - the opportunity within customer market making was vastly different than the volatility would otherwise have projected. So we measure that. We obviously measure our market share and how we're being competitive against the other seven or eight wholesalers. And all of those metrics check out. We obviously have invested and continue to invest tens and tens of millions of dollars in technology to improve and to capture more flow and to increase our ability to monetize flow. But at the end of the day, we are somewhat beholden particularly in that business to the orders that we're receiving. And so as we have said - and obviously, there's been quarters where spread sum has widened, significantly we've had outsized quarter. So that business, which is a sub-segment, obviously, of our Market Making segment, by definition, will be much more volatile. This is, unfortunately, a quarter where we see decreased opportunity. And therefore, we're disappointing, if you will, you guys when we get that, but there are other quarters where we've surprised to the upside. So what we have always said and what we will continue to say is we love that business. We think it's a great business. We provide terrific service to 250 retail brokers over the long haul. It's been incredibly profitable when Knight ran it for the last 20 years, and we continue to run it. So we love the business. It's just a business that can be a bit challenging in the context of a public company that needs to report quarter-by-quarter. Morning, everyone. Just a kind of follow-up on Rich's question. I know you don't speculate on the reasons, but maybe you could give us some speculation or the reason for the opportunity set diminishing, maybe is increasing sophistication of retail investors? Or is it a flow mix between the retail brokers? And also, you mentioned enhanced opportunity in customer market making in January with efforts to improve the capture rate that's bearing some fruit. Maybe you could give us some color just on what efforts those are? Yes, sure. Look, I mean, the easiest and most I think on point answer is that, in the retail business, the whole idea behind the retail business, which smarter guys than me created 30-odd years ago was that you're going to have smaller orders, Chris, that are typically not correlated with the wider market. So as a market maker, you can absorb those markets - those orders, excuse me, internalize them, price improve them and give a retail investor as compared to an institutional investor that will have much larger desires and enhanced experience, better service, et cetera, you kind of get that. In the quarter, and it might be the mix of - as you say, the mix of the business, maybe more institutional investors were sliding into âretail brokersâ, et cetera. In the quarter, you have more flow that tended to be more correlated with the larger marketplace, and that makes it more of a challenge for a market maker. We don't have some magic Elixir in terms of - if the stock continues to go up during the day, as I've said many times, that is the yin and the yang of being a market maker. Under the current ecosystem construction, we don't have a choice. We need to take all the flow that comes our way, small, medium and large, regardless of what the stock is doing and many times, that results in negative selection and a negative P&L with regard to that stock for a day, a week, a month, whatever it is. And so that's probably the best answer I can give you. What I can tell you, since 2017, when we first acquired the Knight customer business, we've seen quarters like this when we've seen quarters where the opposite is true, where the flow is a lot softer, the spread sum is significantly larger than we've had outsized quarters. So again, I repeat the mantra, which is, we look at this business over an incredibly long period of time, and we contended to be very bullish about it. In terms of enhancements and investments we've made to increase our monetization of the flow, it's what we've talked about historically. Obviously, we've done a lot of the re-platforming and migrating all of this flow to the legacy. Virtu infrastructure, which is lower latent and more performance. But in as well, we've enhanced significantly the internalization opportunities for that flow, right? So internalizing it against both our own non-customer market making flow, but also making it available to our institutional investors who are very, very keen to get access to it. So all of those things, we've made significant progress. And frankly, it has borne considerable fruit in this quarter and prior quarters. But again, we are somewhat beholden to the outside world and the opportunities presented. Got it. Just a quick one. Just on the FX, the $9 million in the quarter, offset by the $10 million in revenues. The $10 million revenue that spread over the year does that occur this quarter? No. That - so the way it's working, Chris, is that the ops and admin 29 this quarter was $9 million higher than it would have otherwise been if not for this FX re-val. But that's because the pound and the sterling started the year at - the pound started the year at 135. It ended at 119. And then in the second and third quarter, I think, it went all the way down to like 110 or below, and then - and they came all the way back up. So year the full year, the FX re-val was a $10 million benefit, which was offset by revenue, okay? So it's a wash in terms of impact to earnings. And each quarter, obviously, for it to be a benefit for the full year of 10 coming into the fourth quarter, it was a benefit a lot higher than - because than 10 - because a negative 9 brought it down to 10 this quarter. So for the full year, it's a wash and the quarterly ups and downs basically offsetting revenue. So on a full year basis, it's a wash. Yes, hey. Good morning. Thanks, everyone. I think you made a comment very briefly at the end of your prepared remarks about what you're seeing so far this year. I think I heard that, but maybe you can flesh it out a little bit. It sounds like on the institutional side and also if you look at the public volumes, things have started surprisingly slow. But obviously, that never really speaks to your opportunity set. So maybe you can talk a little bit about what you're seeing and how that compares, obviously, to the fourth quarter? Thanks. Yes. You'd never cease to miss the little kernel one I give a little update. So thank you, Alex for noticing that. And kudos to you. Yes, obviously, since we had a challenged quarter in the fourth quarter for customer market making, I wanted to give some color. And look, it's obviously - I don't think today is January or whatever. So it's obviously early in the quarter. But we have seen an improvement in the opportunity set within our customer work and Making business. It's not been dramatic, but it certainly is meaningfully better than what we saw in the fourth quarter, which is terrific. As you say, the rest of the business in terms of you can then look at kind of what institutional and overall marketplace volumes are. I'm very happy with the way that we've started the year. I will say, and obviously caution everybody, right? It's early in the quarter, and that's really based on, I guess, 15 or so trading days. But I wanted to give some indication, obviously, that we see some improvement in the customer market-making business. And as well, we're seeing improvements in our Commodities and Energies business and in Asian equities where we've had some nice wins early in the quarter. So again, we've seen some improvements in our internalization opportunities on our execution with regard to internalizing flows. So very, very - continue to be very bullish and excited about 2023. And the early indications are that we're going to see a little - see some improvements so far. Excellent. Maybe just one very quick one for Joe, if that's okay. On the debt, I think the trailing EBITDA - debt to EBITDA is, I think, 2.1 times. But obviously, if I annualize the fourth quarter, I think you're somewhere in the mid to high 3s. Can you just remind us in terms of any sort of covenants, again, hopefully, things improve here, but I know people are going to ask again if we stay in this environment, if there is any issues we should be aware of? And we got rid of the cash sweep as well, right? So when we have an outsized quarter, the next time we have an outsized quarter, we're going to obviously dedicate all of it to compounding value by buying back our stock. The maturities are termed out to 2029 you know, that 3 times plus is not an issue. Thanks. Good morning. Doug, I wanted to follow up on the comments about the core or I should say, legacy market-making business. If you could repeat the numbers of what you said, I think, flat year-over-year. But that also includes some of these new initiatives. So I wanted to think about what - how that business has trended maybe over a longer period. And I guess, maybe thinking about it prospectively, what is - how does that - you just gave some context around the start of the year for the customer market-making business, but also maybe talk about that business and how the prospects of that loan from here? Yes. It's a great question. Obviously, we get that question a lot, given the fact that we only report a single segment. So I thought it was important in the context of this quarter, Dan, to give just a little more of a hint of, if you will, how that business is. So yes, what I said in the script, whether it was flat from '21 to '22 and up 11% in the third to fourth quarter, which I thought was significant, right, because we've been doing a lot of work during the year to improve. Look, that is - the beauty of that business is truly scaled and global, and it's multi-asset class. So it's a little bit - the analogy I always use is it's a little bit of like a water balloon or a waterbed. You sit on - I don't know if you remember the water bed [ph] I don't know if you're old enough, I remember them from the '70s and the '80s, right? You sit on one side of it, and it feels great, and then all of a sudden, there's - especially because some of a heavier guy there's a bull where it were to move to the other side and you push that and it kind of goes back and forth, right? You kind of get it. So there's always going to be ebbs and flows in that business. And we have weeks, months, quarters where our energy business is doing quite well and then natural gas will go through a period like it did over the last couple of years, where there's frankly no volatility and the price is pretty consistent and the opportunity set within natural gas and energy declines significantly. And then it comes back, which it has done more recently. And so overall, obviously, we look at that business on the individual asset classes and geographies and we've fully integrated it with some of the intelligence and the quant [ph] expertise of the Knight business, and we now internalize options into equities and commodities and you get how we work. Over the last - we track it, obviously, from when we acquired Knight in 2017 from 2018 through 2022, we've seen significant overall improvement overall in that business. Have there been challenges in various sub-asset classes? Of course, have we introduced options and help grow the business? Yes. The important thing is that capture rates overall in most of those segments have improved. Our - we've maintained our market share, and we continue to be very, very excited about the "legacy businesses". It's not easy to continue to be relevant and highly profitable in those businesses. There is a conga line of firms that used to be in these businesses that are no longer there, but it's really about disciplined execution of improving technology of hiring wonderful people and maintaining an expense base that makes a lot of sense because, as Vinnie Viola said, everything goes into the bid and offer, right? So if you manage your firm in a scaled efficient way, you can continue to be profitable and successful even as bib offer spreads widen and then narrow and widen and narrow. And we've always said that we've built this highly scaled firm to do incredibly well in times of feast, but when there is famines, we still do very well as well. So I'm very, very happy with the progress of that business. And I wanted to give a little more color just in the context of this quarter. Understood. That's helpful. And I guess just thinking about the comments around expenses and knowing that comp can fluctuate, but the more fixed costs being flat, is that - what does that say about your - I guess, your prospects or how you're thinking about the revenue environment for 2023? Do we think about it similarly to kind of what it's been in the more recent periods? Is that how we should think about that expense relationship with the revenue backdrop? No, that's a good question. It doesn't imply that. It does not imply that. It implies that if we had a similar year, I would expect expenses to be flat. I don't - I provide that guidance to just simplify things just because we are in multiple years now where we've kind of met or exceeded expense guidance. So I kind of feel like we can provide that number, if the environment is markedly better, the cash compensation figure is the one that fluctuates a little bit. And there's enough history now you can see the cash compensation ratios for 4 years in a year where we're up in the 2020 and 2021 ranges. I would expect comp ratios at those levels and then this year, the comp ratio, cash comp is 21.5%. So there's flexibility in the compensation ratio. A great portion of our compensation is discretionary. So that's just a guidance based on the current environment, but it does not assume that the environment is going to continue. Hi, good morning. I wanted to flush out crypto and options a bit more. In terms of your build-out road map for those two asset classes, where are you in the build-out? And at what point do you think you'll be fully built out? And then at what point are you going to be in a position, if you're not already, to kind of win the same sort of 606 contracts you have with retail brokers in equities today? Yes. It's a great question. So we began this journey in options, I'll say 2 years ago. But really 18 months ago, it took a lot of building and the building continues, but we had to basically reconstitute the way we approach the market, as I described before, quote-based market as opposed to an options - and order-based market, excuse me. And as you know, there is a plus or of options venues in the United States. I'm embarrassed to say, I think there's 17 options exchanges, but I'm not sure in every day that seems to be adding one. So just having connectivity to each of those and understanding the market structure of each of those, some are price times, some are pro rata, as you know, is - has been a bit of a challenge. So to use the baseball analogy, everybody seems to use on these calls, we're in the very early innings of that process. We have the infrastructure built. We have hired and moved some legacy Virtu people. And so we have a very, very talented team, both in the United States and around the world. But I think there's a lot of runway left. I think to throw out a number, just kind of looking at where we are and the opportunity, I think we could increase that business Ken by somewhere by 3 to 4 to even 5 times what we did in 2022. I think really what we've done here Q4 in '21 and '22 is, I'll just say, just although it's a significant opportunity, but just the Index family. We are dabbling in single name options and the beauty, if you will, of the options market is that you can participate in "retail auctionsâ without having to take all the retail flows. So we are now doing that. We have the functionality for auctions, which leads to the last part of your question as to when do we roll out into being more of a wholesale market maker and options. And the answer is, I'm not sure sitting here today. We know that it's on the horizon. I'm not going to rush it because we had a fantastic year in 2022 in options. I'm very happy. There is a lot of opportunities in Asia. We're now market making the Nikkei and the Nifty50 options family in India. And if you look at the volumes in India, for example, they're extraordinarily large. So there's a lot of opportunity there. And as we built the legacy Virtu firm [ph] Vinnie a bunch of great people from 2008, call it to 2011, '12, '13, we'll use that as a playbook for how we build out this global business. So I continue to be very, very bullish with the opportunity, and we'll prioritize the 605 business relative to other opportunities that we have not lacked for opportunity and work thus far. And so I continue to be very optimistic about our ability to be a meaningful participant in that marketplace. Thank you for that. And does it look like - is there a possibility or a likelihood that 2023 can be the year that you're ready to kind of roll this out? Or is it much more likely that the options business getting to where you wanted to be in terms of that wholesaling business is more of a 2024, 2025 time line? Yes. I mean I would never say never. I'm not sure sitting here today where we're going to have our priorities. I will point out that in looking at the opportunity data in 2022, if you look at like the dramatic increase in options, it really wasn't the Index family, not to denigrate the other business or single name, but that's really where the opportunity is. And as you go where the opportunity takes you, and as I said, there's plenty of opportunity there. So it's something that's on the horizon. Is it within our plans in the next couple, three quarters? No. But I would never say definitively one way or the other, which where we're going to head. And then maybe lastly, is crypto further ahead or further behind the options business, it feels like crypto is a bit more simple. Maybe that's not the least... No, no, it's a great observation, actually. I mean crypto, I want to say it's simple, right? Because obviously, there's - it's - there's a lot of coins and there's a lot of venues. And obviously, there's a lot of fraud and criminality, right? So there is a lot of complications there that you don't see in a highly regulated environment like options. But yes, it's obviously more order-based. It feels a lot more like the FX world where you have you have spot FX, you have forwards and futures, and then you have ETFs or at least in the United States, you don't have ETFs, thanks to the chair of the SEC, but in other jurisdictions you do. So that infrastructure we have set up, obviously, to state the obvious, the criminality at FTX and the shutdown of that venue means that we're not making markets there. And indeed, we pulled back from most, if not all, of the spot venues. And so we continue to be a market maker in futures and in ETFs. And I'll put a plug-in for Jamil and the guys at EDX because we think that, that is the great - will be a great solution, particularly to the Wild West unregulated marketplace, having execution quality that feels and acts like equities with best execution and then ultimately with disclosed custodial and if you will, centralized clearing, that's really going to be the key to exploding or having investors have real confidence in digital assets. So I think EDX, Jamil and the team there really have the right solution, and we're very proud and honored to be an investor in that platform. Thank you, Ken. We have our next question comes from Michael Cyprys from Morgan Stanley. Michael, your line is now open. Great, thanks. Good morning. Maybe just sticking with the options topic. If we look across the industry, volumes continue to remain very robust for options. Just curious your views on that. Why has that held up so well, particularly compared to cash equities? And how durable do you think that is? Do you see any prospects for volumes on the option side to compress meaningfully from here? If we look out 3, 5 years from now, do you think - how meaningfully higher or lower do you think options could be across the industry? Yes. It's actually a great question. It's very perceptive. I think like in a way, actually, you've seen somewhat of a shift of retail or day trading, if you will, from cash equities to options. That's always been the case, but there has been a lot of innovation by my friends at the CBOE, excuse me. There's been good education by brokers. There's now daily contracts, right, as opposed to weekly expirations, and that innovation, I think, has driven some of the volume and you get more leverage and there's more opportunity, if you will, if you're a day trader, a retail investor in options. So again, it's hard to prognosticate. It's more of a macroeconomic question as to where that goes, right? If the economy rebounds, and we don't have record inflation, and there continues to be job growth and people are optimistic, et cetera, then I think you'll see a continued increase in volumes and opportunity there. The thing that was interesting to me, and I said it in response to Ken's last question, was that you saw an explosion of interest in the Index family. And that's really where the opportunity was in 2022. So we kind of got lucky, if you will, Michael, in that we had targeted that as our first place to go as opposed to a single name. And so I think that was up like 40-ish percent in 2022. The volumes there were while single names were actually down pretty dramatically. So I think investors that want to get exposure to broader indices and are making shorter-term investment decisions on those, look at that family of options. Now as I said, that offers even daily exposure weekly or monthly and say, oh, that's a good place to go. And that's kind of really right in our wheelhouse because it's a complicated trading dynamic. Obviously, you have to have a volatility curve that makes sense. You have to have low latency. You have to be - you have to understand the setups in Chicago and New York and all of that, and you have to have the ability to provide a delta hedge that makes sense and it is acute and priced well and whatnot. So that kind of plays very well into the multi-object market making firm that we built at Virtu and our investments in the options infrastructure and our ability to be a participant in a quote environment as opposed to an order-based environment, have really, really bore fruit in 2022. So if you're sensing enthusiasm in my voice, you are very perceptive because I continue to be very enthused about that business longer term. Great. Well, given that enthusiasm, maybe just a follow-up question on the same topic here of options, maybe a little bit more drilling in on the single name side. How many tickers are you making markets in today on the single name side? How does that compare to a year ago? And what hurdles do you face in expanding that to more tickers? How do you think about overcoming that? And what are some of the actions you guys might be able to take? Yes, it's a great question. I mean so the answer is dozens today. And so it's - we clearly have the capability to do it. Look, to be blunt, there's a lot more risk in that side of the business as opposed to an Index side. I mean obviously, Index Options is volatility. You could screw up your curve, you could have an operational issue so you can lose money. But corporate actions and things along those lines make it much more challenging to be a single object market maker in options, particularly if you're going to be - it goes back to my much earlier comments on the service nature of the wholesaling business. As an options wholesaler, you don't get to pick and choose. So hats off to the incumbent, Citadel, Susquehanna, and a handful of others that have built the risk infrastructure to be a two-sided market maker in 1,000 different single object names with a multitude of strikes, a lot of which won't trade a lot, but there's still a lot of - you don't have the ability to pick and choose. And so there's still a lot of risk in that business. So we're going to - this is an obvious answer, but we're focused on the most valuable opportunity and the most addressable opportunity first, and that's what we've done. I don't mean to not give an answer, but it's hard for me to sit here today and say, okay, well, we're going to be 98% complete with that, and therefore, we can shift our focus. We're going to do everything at once the way we've always kind of built Virtu. But the opportunities there are so meaningful and so significant as they are overseas in the Asian markets, I mentioned before that we see - and there's a - 3, 4, 5 times the opportunity in the Index family that there is a single name. So while I think that's a business that we will get into, and obviously, our broker partners would like us to be in that business. Right now, we're focused on the blocking and tackling. And thankfully, it was highly profitable for us in 2022. Yes. Thank you. With all this talk on [indiscernible] back and ask a question about. So with the SEC proposal, I took a hard look at the options market structure. And one of the things that sort of popped out was it's different, like these Citadel and the Susquehanna that you mentioned that are big in options also besides getting flow, but also are market makers on the exchanges and then this whole thing about directed order flow. So I guess the question is, do you think that, that is important to progress an options to be a primary market maker, a designated market make whatever each exchange calls it. Certainly the model at Citadel and Susquehanna has and how easy or hard could it be if you went that route, could you get those same sort of designations if you decide to go that route? Yes. Look, it's a great question. And obviously, we've studied it, and we know we have a lot of friends at the CBOE. We do a lot of business with them and other exchanges where being, as you say, a designated market maker is important. Wholesalers in the options world, will always be the main responders to auctions. Others are invited in. And certainly, if, not if, when we become part of that marketplace, we will need to acquire bins [ph] if you will, become a designated market maker. I have every degree of confidence that we will be able to do that. We've got a pretty good brand name. We've been really good business partners with global exchanges for now for 15 years, and we've always lived up to our obligations. So I don't have a concern that we will be able to do the business development part of this business, and we already have done that, right? And these exchanges and other counterparties want a participant and want a firm like Virtu to be an active participant in it. That being said, you don't wave a magic wand to become a meaningful Market Maker. Citadel and Susquehanna are amazingly competitive, excellent firms that have been doing this for 20 to 30 years. I'm not arrogant enough to suggest that we're going to come in there like guns blazing and take away the market share. We're not going to, right? We're going to be a complement to those firms. We're going to hopefully add value to the ecosystem as we are today in the Index family. And I think that there is room for competition as there is in cash equities wholesaling. I mean one of the complete falsehoods that the chair of the SEC has propagated is that somehow that this is a duopoly between Virtu and Citadel. It's just factually inaccurate. There's a great firm called Jane Street that started in the wholesale cash equities market 2 years ago and now has 13%, 14% of the market order of the marketplace. So Genstar [ph] is just, again, exaggerated, I'll be nice and not said lie [ph] but exaggerated that part of the marketplace. And so these markets are extremely competitive. And the important thing is that we are providing a service to retail brokers. You saw it this week, Rich, with the New York Stock Exchange, right? When the phone rang, based on the news reports I've seen and based on our experience, there really wasn't somebody on the other end of the line picking up saying, you know what, we're going to make this right for you and we're going to make sure that your clients orders were priced and executed at a price that made sense. That's the big lie about our business. He describes it as rents in the industry. These aren't rents. We're providing a service, a very meaningful service, in fact, a bundle of services and being compensated for that service through our own efforts with a portion of the bid offer spread, right? And he either doesn't understand that or doesn't want to understand that. And that's what the data and the narrative will prove. So ultimately, that's not going to change. And that's why it's so important that that firms like Virtu, Citadel, Susquehanna, continue to provide that service in cash equities. And as I've indicated, we intend to do that in options as well. But if I can leave you with one thought, that's the most important distinction, I think, that the chair of the SEC has either intentionally or otherwise limited in all of his political narrative around this marketplace. Got it, Doug. And thank you for the water bedding [ph] analogy earlier. I get it and left good image in my mind. Thanks. Okay. It looks like we have no other questions in the queue, operator. So I appreciate everybody joining us for the fourth quarter call, and we will be back sometime in April, I would imagine with our first quarter results, and I look forward to engaging with everybody then. Thank you very much. Have a great day.
|
EarningCall_1102
|
Good day, and thank you for standing by. Welcome to the Glacier Bancorp Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is recorded. I'd now like to hand the conference over to your speaker today, Randy Chesler, President and CEO of Glacier Bancorp. Please go ahead. With me here in Kalispell this morning is Ron Copher, our Chief Financial Officer; Don Chery, our Chief Administrative Officer; Angela Dose, our Chief Accounting Officer; Byron Pollan, our Treasurer; and Tom Dolan, our Chief Credit Administrator. I'd like to point out that the discussion today is subject to the same forward-looking considerations found on Page 13 of our press release and we encourage you to review this section. I'll start with a few new data points about our community banking markets. The eight Western states, which represent our footprint, are among the most dynamic in the country, include Montana, Idaho, Eastern Washington, Wyoming, Utah, Colorado, Nevada and Arizona. Our eight state average income and GDP growth rate exceeds the national average and the average eight state unemployment rate is below the national average. US News states that Washington as the third best business environment in the United States. In The Tax Foundation's State Business Tax Climate Index ranks Utah eighth in the nation, Montana fifth and Wyoming number one. Net income for the quarter was $79.7 million, an increase of $339,000 from the prior quarter net income of $79.3 million. For the full year, the company had record net income of $303 million, an increase of $18.4 million or 6% compared to 2021. Pre-tax pre-provision net revenue was $103.6 million versus the prior quarter of $105.7 million, a decrease of $2.1 million or 2%. However, pre-tax pre-provision net revenue was up $15.6 million or 18% compared to the fourth quarter a year ago. The loan portfolio, excluding PPP loans, had solid organic growth during the quarter, up $397 million or 11% annualized. For the full year, we grew $1.9 billion or 15%. Noninterest expense of $129 million decreased $1 million or 1% over the prior quarter and decreased $5 million or 4% over the prior year's fourth quarter. The loan yield for the quarter was 4.83%, which increased 16 basis points compared to the prior quarter. New loan production yields were 6.34%, up 93 basis points from the prior quarter. Investment portfolio yields were 1.87%, up 4 basis points from the prior quarter. Interest income of $225 million increased $11 million or 5% over the prior quarter and increased 17% over the prior year fourth quarter. For the full year, interest income was $830 million, a 22% increase over 2021. Credit quality continued to improve to record levels. Non-performing assets as a percentage of subsidiary assets was 12 basis points in the current quarter compared to 13 basis points in the prior quarter. Net charge-offs as a percentage of total loans was 5 basis points. We declared a regular dividend for the quarter of $0.33 per share, which was consistent with our prior quarter dividend. The company has declared 151 consecutive quarterly regular dividends and has increased the regular dividend 49 times. For the full year, we declared total dividends of $1.32 per share, an increase of 4% over 2021. And we entered 2023 with strong capital. Our CET1 ratio, which measures capital against risk-weighted assets is expected to end 2022 around 12.19%, a full 100 basis points above the median of our proxy peer group. So, the most material development in the industry this quarter was the historic increase in interest rates, which created significant volatility in bank deposits. After growing for three quarters, our deposits declined by $1.3 billion, with the largest decline occurring in those accounts with an average balance of $3 million or greater. 60% of the deposit outflows in the quarter were concentrated in just 100 accounts. When the treasury bill rates crossed 4% in early October, it was a significant inflection point, and we began to see an accelerated outflow of deposits, not relationships, primarily to non-banks, mostly for the purpose of purchasing treasury bills. These excess deposits accumulated during the pandemic at ultra-low rates. Core deposit funding of $21 billion, or almost 90% of total funding liabilities, ended the quarter at a cost of only 8 basis points versus 6 basis points in the prior quarter. Noninterest-bearing deposits remained at 37% of core deposits, unchanged from the beginning of 2022. Our total cost of funding in the quarter for total funding liabilities of $24 billion, including noninterest-bearing deposits, increased from 15 basis points in the prior quarter to a total cost of funding of 35 basis points in the current quarter. The increase in the total cost of funding was primarily due to our elevated borrowings from the Federal Home Loan Bank because of the deposit outflow, which impacted net interest income and margin in the quarter. Borrowings increased from $705 million at the end of the third quarter to $1.8 billion at the end of the fourth quarter. We expect deposit outflows to moderate beginning in 1Q and then perform more consistent with historic trends. As a result, we anticipate Federal Home Loan Bank borrowing to slowly decline throughout the year. We plan to fund our loan growth for 2023 by utilizing the quarterly cash flow from our investment portfolio currently in excess of $300 million per quarter. Our margin should grow -- should show growth in 2023 benefiting from the cash flow rolling out of investments yielding about 1.50% and -- 1.5% and being reinvested in new and renewing loans in -- yielding in excess of 6%. While we face an uncertain interest rate environment in 2023, we remain confident in the dynamic Western markets we serve and the capability of our unique business model to continue to deliver strong results. The Glacier team did another excellent job in the fourth quarter and for the full year of 2022. They once again kept their focus on shareholders, customers and communities, which the results clearly show. And that ends my formal remarks, and I'd like to ask Victor to please open the line for any questions that the analysts may have. Thank you. [Operator Instructions] Our first question will come from the line of Jeff Rulis from D.A. Davidson. Your line is open. I wanted to check in about just the use of the borrowings, you kind of walked us through sort of the thought process. But just you've got such a strong deposit franchise and a low loan-to-deposit ratio. Just wanted to see about the timing of -- again, a little more detail as to the use of that? It came at a cost, but -- and appreciate the '23 outlook on running those down and the impact on margin headed up. But anything else to add on the FHLB? Thanks. Hi, Jeff, this is Byron. I can address that. I'd like to start by going back to the third quarter. Recall, we were still growing deposits through the third quarter. That turned a corner though when short-term treasury rate presented such a compelling investment alternative in the fourth quarter. Randy mentioned the 4% number. So, when treasury rates went through that 4%, that's when we really saw a turn with the deposit outflow. We looked at that, and we're not a premium rate bank. We've never been a premium rate bank, that hasn't been our strategy to attract premium rate deposits. So, as we looked at it, we decided not to compete with those treasury rates, because at the time, we had lower cost wholesale funding alternative. And so, it really was a funding cost optimization decision. Now, that math is shifting, especially with the next Fed rate hike where we think wholesale funding rates will be at a level where we can retain deposits at rates below FHLB. So, at the time, we simply had lower cost funding options. Now, as Randy mentioned, we were not losing customer relationships. We are simply seeing an outflow of excess discretionary balances. That outflow was very highly concentrated. It was concentrated in high-balance accounts that accumulated during the pandemic. 60% of that outflow is concentrated in 100 accounts. We know who they are. We maintain the relationship. We know where the funds went. And when we see value in bringing those deposits back, we know who to call, and we think we'll have a good shot at bringing those back in. To reiterate, our core deposit franchise remains very, very solid. In fact, our typical checking and savings account balances, those are balances under $50,000, actually grew in the fourth quarter. So, what do we expect from here? I think, we could see some continued volatility in high-balance accounts. That could offset some of our normal core deposit growth rate. We see the lagging rate pressure, we feel it, and we are addressing it. We do expect deposit rates to go up. We are becoming much more aggressive in retaining those balances. And from here, we do expect deposit flows to normalize. We think we are well positioned to retain deposits. I think you'll see a variety of solutions employed to retain deposits through the rest of this year. I think you'll see some CD specials. I think you'll see some repo specials. You'll see some money market premier rates that are attractive. I think you'll see some targeted outreach, some negotiated one-off rates. All of these things have been very successful for us in the past. And the beauty of our model is that we have 17 divisions with the right tools and the right incentives in place, focused on serving their customers, and finding solutions tailored for their markets while optimizing their deposit structure and funding costs. Thanks, Byron. I appreciate the rundown there. That's helpful. Maybe if I could just jump back to Randy on the capital side, just checking in, your building capital. M&A has been quiet. In the past, you've used special dividends, that's been a bit -- maybe protecting some capital with the macro environment. But anything to touch on, on capital, Randy? Not in particular. As it relates to M&A, we still have the doors open and want to have conversations. There are some headwinds to putting deals together as everybody, as you know, but still having those discussions. Regarding a special dividend, that's completely up to the Board. I would tell you, we put a lot of effort into building the capital and feel like, at this point in the cycle, that's where you want to be, sailing into this with a fair amount of capital, and then, we'll see what unfolds in '23. I'd like to continue on the kind of balance sheet side of things. I appreciate all the color on how you anticipate on funding the growth ahead with the deposit flows moderating and cash flows off the securities book. Just wondering if these funding considerations are helping to guide maybe your outlook for loans bit lower, as well as any changes in demand at this higher rate point in the cycle? So, Kelly, you broke up a little bit there. I just want to make sure I have the right question. Maybe you could just restate it for me. So, the essence was, if these funding considerations are impacting, how you're managing loan growth going forward, as well as I'm sure demand is coming in at this point in the cycle, just wondering maybe if you could hit on both sides of the things, as well as what your outlook is for loan growth over the next few quarters? Yes, good morning, Kelly. From a demand perspective, we've seen that kind of continue to reduce over the past couple of quarters. Fourth quarter was no exception. So, we saw our pipelines reduce again. We saw our top-line production reduce, but at the same time, so did our payoffs. And so, actually, net-net, between the two of them was about the same dollar amount of reduction. All of which reflect of -- I think, of the interest rate environment. Cap rates are still low. So, with rising interest rates, it's a little bit more difficult to make those [indiscernible] to our conservative underwriting guidelines. And just as a reminder, we underwrite not only to loan-to-value and debt service coverage, but also the debt yield. And so, when you've got low cap rates, that typically requires a lot more equity, especially in this higher interest rate environment. So, I think that's been a headwind there as well. Yes. And Kelly, we're not throttling back growth. We have more than enough rolling off the investment portfolio to fund the level of growth that we see organically coming at us in '23. So, we feel like we're well positioned to take care of our customers. Understood. And on the deposit side, I appreciate the color about this being 100 accounts, and you're very well aware of who they are. Can you just remind us about like the typical granularity of your deposit portfolio, maybe average account size and things like that? Because it seems like it was concentrated in just like the larger-balance accounts. Yes. We have -- our average -- so, if you get that down to the average balances, our accounts, we have a lot of -- we have more units than a bank of our size. We have a lot of smaller accounts. And so, we'll get to the average numbers. But that's -- what was the interesting thing here is that they were -- a lot of the outflow was just concentrated in these very large accounts, which we could pretty easily see. Sure. In terms of averages, Kelly, our retail deposit accounts averaged about $15,000 per account, and our business deposit accounts averaged closer to $60,000, $64,000 per account. Great. Yes, that's pretty granular. Got it. And just some point of clarification or trying to put some numbers around first quarter deposit outflows. You, in your prepared remarks, said you expect that to moderate. Is that -- does that kind of imply that we're still going to see some decline in 1Q, it just won't be as great as we saw in 4Q, and then kind of a stabilization thereafter? Exactly. I think you're looking at it exactly right. And back to your point on granularity, I think that's tremendous strength for us, because we have a lot of small dollar accounts. And as Byron pointed out, those actually grew throughout the year, including in the fourth quarter. So, that's an important part of our stable sticky franchise. Thank you. And I'm actually not showing any further questions in the queue at this moment. I'd like to turn the call back over to our President and CEO, Randy Chesler, for any closing remarks. Great. Well, very good. Appreciate it. I know this was a really busy day for analysts with a lot of overlaps, and... I thought there was other people in the queue. So, I'll jump right back in. Can we talk about expenses? They were really well controlled. A lot of the things that I'm seeing are having a lot of pressure on that expense line item. Just wondering as we look out to this next year, maybe if you could discuss any investments or bigger-ticket items that you're making, as well as just any overall comments on how you're managing through the inflationary pressures? And if where we are now is a good run rate to build off of? Yes. We -- Ron and I and the team spent a lot of time looking at expenses. So, I'm going to ask Ron to cover that. Yes. Kelly, really appreciate well controlled, because that's [indiscernible] what it is, and it gets back to the division, the model, local people making decisions that are right for their market, whether it's compensation or other noninterest expense. So, let me start there. So, if you take the fourth quarter, $129 million flat reported, but adjust that for the $2.5 million gain from the sale of former branch buildings and then $800,000 of M&A, you get to about $130.7 million adjusted. And so, the question, I think, is we guided to $133 million, and so we came in substantially below that, and $800,000 of that was the lower compensation expense, and that is a direct result of the control on the hiring. We had a reduction during the quarter of six FTE on an average, it was actually closer to 24. So, the division did a pretty good job, as they have done all year, doing more with less. Just year-over-year, we're down 46 FTE and we've been able to manage through that. So that's been a remarkable thing, and I want to point that out. So, then, on the guide, just the $133 million to $135 million, we would estimate that, that would then go up, say, 2.5% to 3% over the course of the year. So, the math is the math. The thing I would tell you is the -- there's still economic uncertainty. The higher inflation is still out there, I'd say, high. It may be moderating, but it's still coming higher. So, Q1 is seasonally higher. So, I would say, if you took the 2.5% guide, you'd be at $138 million for the first quarter -- $136 million to $138 million, and then it will slowly migrate up from there as we make investments back in our company. Thanks. Appreciate that. If I could turn a little back to the margin. You guys have been obviously really well controlling your deposit costs. I think, it was Byron mentioned potentially running some CD specials. Just given the premium on liquidity that we have now, what are you guys now assuming for cycle today -- betas? -- cycle betas? Sure. Kelly, this is Byron. We previously mentioned mid-teens, and I think we're still there. I think mid-teens is still the right guide for our full-cycle beta on our deposit. Got it. So, just thinking through the pieces, it seems like it's -- the balance sheet is a bit smaller than we had perhaps thought with the deposit runoff. But as you remix into higher-yielding assets from the -- what you've given us on the security side and start to roll off FHLB, do you see this as a bottom for your margin? In terms of margin, we do see a very modest lift this year. The asset momentum that we've previously described is still in place. You mentioned the securities runoff, that cash flow coming off at 1.5 into loan, that's providing a lot of help to the margin. We've got some loan repricing into this higher rate environment. We're seeing meaningful lift from new production rates. And we feel those loan yields will carry momentum beyond the top of the Fed's rate cycle. Now, the near-term headwinds, of course, include the wholesale funding costs that we've talked about, deposit cost increases as we are getting more aggressive in our deposit pricing. However, on balance, we do think the asset momentum will be enough to more than offset the funding costs through the end of the year, with that momentum providing ample capacity to compete for deposits and grow margins. Thanks for the color. Last area for me is just credit. Obviously, metrics are really pristine, but we are starting to get into a more challenging environment. Just wondering, I mean, it feels like there's no direction but up, but what are you anticipating as a normalized level of charge-offs? Are there any areas to where the risk-adjusted returns aren't looking as attractive at this point or maybe areas that you think we could see more softness here in this upcoming year? Kelly, it's Tom. There's no one specific industry or specific geographic location within the footprint that has an outsized area of concern. We're really not seeing any early warning signs than anywhere in the loan portfolio, which is encouraging, especially living through inflation now for the past several quarters at that pace to not really see any early warning signs yet is encouraging. That being said, I think there are certainly a lot of economic headwinds, certainly the inflation and the pressure on consumers and how that will cascade in the commercial borrowers is left to be seen. On the other side of that, I feel our borrowers are coming into this time of uncertainty probably from a position of strength, greater than they've had, certainly, greater than they've had during the last recession. So that's also encouraging. So, in terms of where we think it's going to go in the future, without the early warning signs, we don't really envision any material deterioration in -- at least in the coming couple of quarters. That being said, for the last two years, we've been in a very aggressive campaign, if you will, to work up or work out weaker credits in the portfolio. That effort continues. So, there could be an instance in the coming couple of quarters that if we see an opportunity to exit a weaker credit, we'll do that, if it makes sense. No problem. Victor, let me check back with you to see if anyone else is in the queue and would like to ask a question before we wrap up. Hey. So, Ron, I'm struggling with the expense base. I mean for Q4, I kind of see it as about a $131 million core, if you add back the branch gain and less merger costs. That seems like a pretty big jump into Q1. I know that you said that's seasonally high. Is it possible the -- kind of the progress throughout the year is down from that Q1 high point? Well, Jeff, it gets back to the guide, we were very confident that the -- as I mentioned on the previous earnings call, the merit increases that several of our divisions, a couple of the larger ones put in place, that was mitigated by the reduction in the headcount. But we expect that will not continue. It will reverse. There are still challenges with hiring, but we think that hiring will come back. And then, when you think about our merit increases, they're all going to start here at the beginning of the year. And so, that's the reason we anchored to the $133 million-$135 million range that I gave last quarter. And so, that's why I'm confident when I say 2.5%. It could be 3%. So, I would stick with that guide. And again, first quarter being higher, we've just got some merit increases. We've got the FICA, the traditional things. We've got some restricted stock [indiscernible]. And then, on the noninterest expense, I mean, let me just use as an example, FICA, not FICA, excuse me, FDIC insurance premiums, they're up 40%. And so, we still see a lot of our vendors and we're looking at the contract, but we see that the pressure they're putting on us to pay up, again, thank God, we have the 17 divisions to look at that. Sure. Maybe take it a different way. If I look at, say, you had $519 million in total expenses in '22, if I look at full year, let's strip out the seasonality, with a good growth rate for '23, is it that, like you said, 2.5% to 3% off of a $519 million base? So, I would estimate the range would be, say, $545 million to $555 million, somewhere in that range for the full year, and then that will -- again, we're going to run higher as we traditionally do in the first quarter, and then we go lower from there. So that's the guide I would give you. Okay. Appreciate it, Ron. Thank you for -- I'm slow to pick that up. Maybe just on the fee income side, just a similar question. Obviously, we know kind of mortgage is on its back, but your thoughts on kind of growth from what looks like a pretty low point in the fourth quarter? Any expectations on fees? Yes. When we look at the fourth quarter fees, the mortgage gains was the big driver there of the drop-off. And so -- we had a little bit shorter quarter this quarter. So, those two things are the bulk of that, the change. So, we don't -- it's really -- the big move there is going to be mortgage. And we hope to see some improvement. I don't see it right now. But if that picks up, then we should see the overall fees. But in terms of the account fees, those pretty much look to be in line. We don't see a big change there. All right. Very good. Well, I want to thank you again for all your questions. Again, busy day, and we appreciate you checking in, and Kelly and Jeff, coming back for a couple of questions, happy to answer them. So, we hope everyone has a great weekend, and we again appreciate your participation in the call. Thank you.
|
EarningCall_1103
|
Good day, and thank you for standing by. Welcome to the Bank of Hawaii Corporation Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jennifer Lam, Senior Executive Vice President, Treasurer and Director of Investor Relations. Please go ahead. On the call with me this morning is our Chairman, President and CEO, Peter Ho; our Chief Financial Officer, Dean Shigemura; and our Chief Risk Officer, Mary Sellers. Before we get started, let me remind you that today's conference call will contain some forward-looking statements. And while we believe our assumptions are reasonable, there are a variety of reasons the actual results may differ materially from those projected. During the call, we'll be referencing a slide presentation as well as the earnings release. A copy of the presentation and release are available on our website, boh.com, under Investor Relations. The bank achieved another solid quarter of performance to end the year. Loans grew 2.4% on a linked basis and 11.3% year-on-year, reflecting balanced growth across our corporate, commercial and consumer businesses. Deposits were down 1.3% from the prior quarter, but up 1.3% from a year ago. At quarter-end, our total deposit beta was 11.5% cycle-to-date, reflecting the diversified granular and seasoned nature of our deposit base. By segment, our deposits are 50% consumer, 42% commercial and 8% public. The only half or 47% of our consumer and commercial deposits come from accounts under $0.5 million in account size, and 73% of our deposits have a tenure of 10-plus years or more with Bank of Hawaii. As is our custom, I will now walk through local market conditions, and then hand the call over to Dean, who will delve deeper into the financials, and then Mary Sellers will touch on credit for the company. At that point, we'd be happy to entertain your questions. Now, moving on to Slide 3. You can see that the economy, and namely employment, continues to improve in the islands. November state unemployment rate was 3.3%, marking the second straight month that it's outperformed national unemployment as a whole. Prior to October, state of Hawaii unemployment had been higher than the national average for 29 consecutive months. The visitor sector continues to perform well. While arrivals remain down from pre-pandemic levels as a result of the continued lag in the international and, in particular, Japanese visitor segments, overall visitor days are nearly at par to pre-pandemic levels, as visitors are visiting longer overall and the mix shift of visitors is tilting towards traditionally longer-staying segments. On Slide 5, you can see that RevPAR is performing well ahead of pre-pandemic levels, which has helped push overall visitor expenditures 40% higher than pre-pandemic levels on a year-to-date basis. Finally, values in the Oahu housing market remain stable, with the median home price of a single family home running flat at $1 million in December, while condominium prices were up modestly in December at $503,000. Inventory levels remained tight despite a meaningful slowdown in sales. Our solid loan growth continued in the fourth quarter. Total loans increased by $324 million or 2.4% linked quarter and by $1.4 billion or 11.3% year-on-year. In 2022, we realized double-digit growth across both commercial and consumer loan portfolios with year-over-year growth of 10% and 12.2%, respectively. As Mary will discuss, loans continued to be predominantly real estate secured with low LTVs. The double-digit annualized growth trend has led to significant market share gains in our primary lending market where we hold the largest market share. Our deposits remain a source of strength and value. Nearly 75% of our deposit customers have been with us for 10 years or more and nearly half for 20 years or more. 92% of our deposits are from core commercial and consumer customers and the remaining 8% consists of public deposits that are predominantly government-operating accounts. 92% of our deposits are in core checking and savings accounts with 33% in noninterest-bearing and only 8% in time deposits. As expected, during the quarter, our deposit mix shifted modestly to higher-yielding deposit products with increases in our TDA and savings balances. Despite this, our total deposit costs remained well managed with an average rate of 46 basis points in the quarter. Despite a modest decrease on a linked quarter basis, total deposits increased by $256 million or 1.3% in 2022, while our total deposit betas were well controlled at 11.5% cycle-to-date, which demonstrates our ability to maintain liquidity at a reasonable cost. From an earning asset perspective, net interest income and margin are being supported by strong cash flows and overall asset repricing at higher rates. In particular, the yields on maturities and paydowns of loans and investments in the fourth quarter were 3.8% and 2%, respectively. These cash flows were reinvested predominantly into new loans, which yielded approximately 5.2% in the quarter. With nearly $3 billion of annual cash flows from maturities and paydowns of loans and investments, we have ample opportunity to redeploy funds into higher-yielding assets, particularly with reinvestment into loans, which has been the recent experience. In addition to strong cash flow, another $3.4 billion in assets are repricing annually, which provides additional rate sensitivity. Together, our assets provide a balance between short-term and long-term repricing characteristics. Net interest income in the fourth quarter was $140.7 million, up $14.3 million or 11.4% from the fourth quarter of 2021. Excluding non-core PPP loan interest income, the year-over-year increase in NII was $19.1 million or 15.7%. Compared to the pre-pandemic fourth quarter of 2019, our NII has improved by $16.9 million or 13.6%. The NII improvement over the years is driven by continued strong core loan growth, rising interest rates and managed deposit rates. Linked quarter net interest income was lower by $900,000 or less than 1%. In addition to the impact of the inverted yield curve, we have entered the period where deposit rates and betas are accelerating and deposit balances are decreasing across the banking industry, both of which impacted our net interest income. During the quarter, we added wholesale funding at an attractive rate to supplement our current funding and to provide long-term fixed rate funding to mitigate the risk of higher for longer short-term rates. As we look forward, conditions that we experienced in the fourth quarter remain, continued loan growth and asset repricing will be accretive, while the persistence of the inverted yield curve and higher deposit costs will be dilutive. The outlook for deposit balances and deposit betas remain uncertain. However, as described earlier, the composition of our deposit base affords us greater flexibility to manage our funding costs through the uncertainty. During the quarter, as is our practice, we managed our expenses in a disciplined manner as economic conditions remain unclear. Noninterest expense in the fourth quarter totaled $102.7 million, down $3 million linked quarter. As a reminder, included in the third quarter expenses were severance expenses of $1.8 million. Adjusting for the severance in the third quarter, expenses decreased by $1.2 million linked quarter. This was a result of ongoing efficiencies in a number of areas, which enabled us to reduce the pace of hiring, while continuing to invest in the business. Notably, our investment -- our innovation spend in the quarter was reduced, but did not end, as we continue to position the company for the future. Our practice of disciplined expense management will continue in 2023. For the full year of 2023, expenses are expected to increase by approximately 3%, despite the expectation of continued elevated inflation. An industry-wide increase of FDIC assessment and annual merit increases each represent 1% of the 3% increase. Another 1% has been allocated to our continued investment in the company, albeit at a pace slower than in prior years. Although inflation expectations are still elevated, efficiencies gained from operations and prior investments are expected to offset inflationary increases. As part of this ongoing efficiency effort, we continue to rationalize operations and we'll be reducing staffing in several areas. These actions will result in a $2.9 million severance expense in the current quarter, which is in addition to the 3% core expense guide. It is important to note that these actions will result in annualized savings of $3.3 million. As a reminder, seasonal payroll taxes and benefits expense bump from incentive payouts will be included in the first quarter expenses. This year, the estimated seasonal impact is $4 million compared to the $3.7 million in the first quarter of 2022. This amount is included in the full year expense guidance for 2023. To summarize our financial performance, in the fourth quarter of 2022, net income was $61.3 million, an increase of $8.5 million linked quarter or 16%. Fourth quarter earnings per common share was $1.50, an increase of $0.22 or 17.2%. For the full year of 2022, net income was $225.8 million and earnings per common share was $5.48. As Mary will discuss, we recorded a provision for credit losses of $200,000 this quarter. Noninterest income totaled $41.2 million in the fourth quarter. As a reminder, the third quarter's income was negatively impacted by one-time $6.9 million charge related to the loss on sale of leased equipment and a $900,000 charge related to a change in the Visa Class B conversion ratio, which is reported as a contra revenue item in investments securities gains and losses. Adjusting for these third quarter items, noninterest income increased by $2.7 million linked quarter, primarily due to higher customer derivative and foreign exchange revenue. We expect noninterest income will average approximately $39 million per quarter in 2023, as market volatility and uncertainty continue to weigh on asset management income and higher mortgage rates will continue to suppress mortgage banking income. In the first quarter, there will also be a contra revenue item of $600,000 for an additional Class B -- Visa Class B conversion ratio adjustment, which will be reflected as part of investment securities gains and losses. Our return on assets in the fourth quarter was 1.05%. The return on common equity was 21.28%. And our efficiency ratio was 56.46%. Net interest margin was 2.60%, unchanged from the third quarter. The effective tax rate in the fourth quarter was 22.4%, and the tax rate in 2023 is expected to be approximately 23%. Our capital management -- our capital levels remain strong. Our CET1 and total capital ratios were 10.92% and 13.17%, respectively, with a healthy excess of our regulatory minimum well-capitalized requirements. Our risk weighted assets relative to total assets remain well below the levels of our peers, reflecting our lower risk profile and providing us with ample room to continue growing while maintaining strong capital levels. During the fourth quarter, we paid out $28 million or 46% of net income available to common shareholders in dividends and $2 million in preferred stock dividends. We repurchased 192,000 shares of common stock for a total of $15 million. In addition, our Board increased authorization under the share repurchase program by an additional $100 million, bringing the total remaining authorization to approximately $136 million. And finally, our Board declared a dividend of $0.70 per common share for the first quarter of 2023. Our loan portfolio construct with 97% in Hawaii and Guam assets continues to reflect our strategy of lending in markets we understand and to people we know. These underpinnings, coupled with consistent conservative underwriting and active portfolio management, result in a loan portfolio that is diversified by category, has appropriately sized exposures, and is 80% secured by quality real estate with a combined weighted average loan to value of 56%. Credit performance remained very strong in the fourth quarter. Net loan charge-offs were $1.9 million or 5 basis points of average loan and leases annualized, compared with 3 basis points in the third quarter and 2 basis points in the fourth quarter of last year. For the full year, net loan and lease charge-offs were $6 million or 5 basis points, compared with $5.1 million or 4 basis points from '21. Non-performing assets totaled $12.6 million or 9 basis points at the end of the quarter, down 1 basis point for the linked period and down 6 basis points year-over-year. All non-performing assets are secured with real estate with weighted average loan to value of 58%. Loans delinquent 30 days or more totaled $31 million or 23 basis points, up from 18 basis points in the third quarter and flat with the fourth quarter of '21. And our criticized loan exposure represented just 1.09% of total loans, down 3 basis points from the prior quarter and 111 basis points year-over-year, as we continue to see sustained improvement in the financial performance of those customers who had been most impacted by COVID. Our consistent conservative approach to underwriting is reflected in the consistently strong quality of our loan production and portfolio. In 2022, 67% of commercial production was secured with quality real estate conservatively leveraged. Commercial mortgage production had a weighted average loan to value of 59% and construction production had a weighted average loan to value of 64%. 76% of 2022 consumer production was secured with real estate, again, conservatively leveraged. Residential mortgage and home equity production had weighted average loan to values and combined weighted average loan values of 65% and 59%, respectively. 71% of our home equity production was in first lien position. Similarly, FICO scores for all our consumer production remains strong. Portfolio monitoring metrics also remain very strong. Our commercial mortgage and construction portfolios have weighted average loan to values of 56% and 63%, respectively. Residential mortgage and home equity portfolios have weighted average loan to values or combined weighted average loan to values of 57% and 52%, respectively. 72% of our home equity portfolio is in a first lien position. And monitoring FICOs remained very strong. At the end of the quarter, the allowance for credit losses was $144.4 million, down $2 million for the linked quarter, and the ratio of the allowance to total loans and leases outstanding was 1.06%, down 4 basis points from the prior quarter. The decrease this quarter was driven off UHERO's December 2022 forecast, which reflected lower unemployment rates for '23 and '24 than in their prior September forecast. UHERO's outlook is based upon actual lower unemployment rates realized in '22 and continued strength in tourism with any softening in domestic demand due to a recession to offset by a continued recovery in our commercial visitor base, particularly Japan, coupled with strength in construction given the number of planned federal and state infrastructure projects. The reserve does continue to consider downside risk of a recession, the impacts on inflation and rising interest rates. The reserve for unfunded credit commitments was $6.8 million at the end of the quarter, up $300,000 for the linked period. As we enter into 2023, the forward view on the economy is somewhat cloudy. Economic conditions, while buoyant currently, they possibly be tested in the coming days by the continued effects of tighter Fed policy. Asset values may also be challenged by higher rates. Bank of Hawaii remains well geared for potentially choppier waters. Our credit portfolio is the beneficiary of conservative underwriting standards not just of late, but over the course of many years. Our deposit base is a great source of strength, diversified, granular and long tenured. Our investment assets are both abundant, high quality and highly liquid. I would like to just start off with, I really appreciated all the color and moving part on the expenses and your outlook for the year. But just as a point of clarification, what are you using as your starting point for expenses for relative to 2022? Is it about $413 million, or is there a different number I should be using? There were some one-time charges in 2022. Great. That's really helpful. Next, I would like to -- your loan growth, and this is something you pointed out, has been really strong in the double digit. Just wondering if you look ahead, any commentary on demand and maybe more conservatism that would bring that rate down? Just any color on how we should be thinking about opportunities for loan growth ahead, as well as how you plan on funding that growth, whether it's through wholesale sources or [close off] (ph) the securities book or anything like that would be really helpful. Yes. Kelly, so, you're right, we've been fortunate to have been able to drive annualized loan growth for a number of quarters now. We suspect -- as kind of I tailed off on our formal remarks that we do see and feel things tightening a bit. I think we've got a reasonable forward view on the first quarter loan production wise. But I would suspect that '23 is not likely to be a double-digit loan growth year. I think if we're pushing into the mid/higher single-digit levels, that probably would be a level that reflects overall market conditions. We really aren't changing our underwriting standards and policies, because we pretty much keep those flat through cycles. But I think what may be happening is borrower profiles may be deteriorating a bit as inflation takes hold, as the economy slows a bit, and as interest rates begin to bite a little bit harder into the cap structure. And then, lastly, I'd say that the residential market, which is a big source of value for us, has just been completely impacted by rates and the slowdown in refi. Got it. That's really helpful. I mean, it sounds like in terms of your outlook for margin, that's largely -- the big variable there is on the deposit side, both the betas and just overall flows of deposits and where those come out, your margin was flat this quarter. Do you think we've reached peak margins at this point in the cycle? Or how should we be thinking about that ahead? Yes. I think near-term, we have reached peak margin in the fourth quarter. So, modest decreases, at least in the first and second quarters. Question on the fee income guide of $39 million. If I just look at the wealth size this quarter, mortgage banking this quarter and some higher-than-normal fees maybe in the other line, you highlighted like wealth and mortgage is being the main line items of where there could be some pressure. But are there -- $39 million, it seems a little light to me. Is there -- are there other areas where there is some weakness or some pressure on fee income? Yes. So, I mean, I think, Andrew, the way to think about it is $39 million is probably a good baseline. And then, we have a number of line items that are just a little bit more unpredictable, given the rate environment. So, obviously, mortgage income is not likely to be a big contributor. That historically has been a big component of a $40-plus million fee income quarter. That's just not there right now. The asset management side, I would say, as long as market conditions hold both on the fixed income as well as equity side, we should be able to see a kind of slow and steady growth there. But if conditions change there, those numbers change pretty rapidly, as you know. And then, finally, kind of the big mover is really our swap revenue. And when rates are very low and production levels are knowable and buoyant, that's a very steady and high-performing space for us. As the markets become choppier, a little bit more difficult to figure out production wise. And as people are a little bit more hesitant to just delve straight into a swap transaction, because they're trying to figure out where rates are going to fall out, that number can swing a couple of million dollars one way or another in a quarter. And that's really kind of what's driving our conservatism around the $39 million. We hope that represents more of a downside and with some attendant upside attached to it. Got it. All right. That's really helpful color there. Thank you. And then, Dean, just a question -- I'm just following up on Kelly's question, on the margin peaking, you said pressure over the next couple of quarters. What would alleviate that pressure? Would it be rate cuts? Is it just some lag in asset repricing? Just curious what would alleviate that pressure. Right. So, what we have kind of built into at least our rate outlook, if you will, is kind of the Fed getting to a 5% handle on Fed funds. So, what could help us, which is really not our base case is that they don't raise rates anymore and look to cut rates. But realistically, I don't know if that's really in the cards right now. But that would help relieve some of the pressure on the NIM going forward. Yes, Andrew, I would chime in. You saw our cycle-to-date beta, which I think by markets standards is pretty low. So, I think we still have some latent expansion on the deposit paying side and that may begin to catch up to where the Fed has already pushed market rates. So, I think that could be a tougher environment for us in the next couple of quarters. And then, increasingly -- I guess what I would point to is NIM can come in a lot of different way shapes and forms in this market right now. We're kind of increasingly pushing more towards delta in NII, which coincidentally, I think, could also be off a bit, a touch, in the coming quarters. But really that's our area of emphasis in trying to bolster NII by hopefully some additional deposit growth at reasonable rates. Just a follow-on, I guess, to that last one, Peter, I -- on the beta, I'm just interested in your thoughts. It sounds like maybe Q4 wasn't the total acceleration or a catch-up quarter. I would have assumed much of the rate hikes we've had and the rate-sensitive, customers have kind of rushed to the gate and dealt with that. I guess, your expectation is that, that just continues to drift into the beta, and as we get into 2023, you see additional pressure there? Maybe more succinctly, you don't think Q4 was a catch-up quarter and would expect further pressure from here? I would. I think that -- yes, I mean, there's -- I think when we step back and look at it, it's really quite amazing how suddenly and how quickly rates moved. I mean, basically, it was really mostly a second half of 2022 phenomena. And candidly, our strategy into the teeth of that was to be pretty conservative around our betas and our pricing, because given our market position in the deposit markets we serve, we thought that would frankly just be the best course as we kind of widen out into a little bit more experience and what we're seeing from a rate volume standpoint. I thought that quarter's deposit performance was okay. Frankly, I'd like to get to flat to slightly up and that may require some additional pricing. So that's what -- certainly you may see that on the NIM and hopefully -- our hope would be to see -- would be able to offset that price erosion on NII by volume increases. But I would point out that the NII could very well drift down a bit in the coming quarters. I don't think that would be a overly pessimistic view. Yes. Okay. So, there's definitely a balance -- deposit balance part of the equation. Fair enough. Wanted to also pivot to the visitor count. And I guess as you look at the numbers, sort of a little bit slowing at the domestic and lifting of Japan and international. I guess kind of suggesting settling more towards long-term kind of run rates that may be oversimplifying, but always interested, Peter, in your take on kind of where we're headed and kind of how those trends play out into 2023? Right. So, overall, I'd say that the visitor industry is, I think, kind of hodgepodge its way into a pretty good year in '22. Basically the U.S. market has over performed both by volumes as well as by spending -- arrival volumes and spending. Japan is coming back slowly. So, when I look at November numbers, year-to-date, Japan was down 89%, but for the month of November, they're down in the 70%-s. So, there is some moderating improvement there. And then, I guess what I would say is the other -- Japan is a big chunk of international, which is about a third of our visitor business. The other markets, Canada, Australia, some of the other foreign countries, are beginning to form quite a bit better. So, they may be better than the Japanese experience by, call it, half. So, the overall, the bottom lines of the visitor segment has been generally positive, I'd say, to pre-pandemic levels. That's been led by kind of outsized U.S. domestic. Potentially as that begins to fall off a bit as the economy cools, we're hoping to see that infilled by an improvement in Japanese and other international visitors, but we'll see, it's been a slow rise for Japan. Okay. Thank you. And maybe just last housekeeping. Dean, I missed the -- could you repeat the contra expense on the Visa front? You mentioned $600,000. Is that for the year, by the quarter? Well, I mean, we -- in the third quarter, there was a one -- and I think in the first quarter of last year, I would like to say it's one-time, but it's just dependent on how Visa manages that. Just wanted to circle back to maybe where Kelly and Drew and Jeff were touching on net interest income, but I just wanted potentially to drill down a little bit more on the funding here. Can you talk about how you're thinking about borrowings a massive uptick this quarter? It's still obviously very small relative to your liabilities. But, I guess, point number one, sitting at $410 million, how should we think about that going forward? Because those are higher costing. And then, number two, just on the public deposits, obviously, there was a jump there. Do you have the breakdown on what part of that is time? And then, number three, can you comment on the noninterest-bearing? So, your noninterest-bearing average balances dropped a lot. Can you help us think about that going forward? Was that just an anomaly in the quarter, or just maybe help us think a little bit about that? Thanks. Sure. So, looking at the wholesale funding, it was a combination of several factors that, one was to just supplement the current funding that we have in our deposits. We did want to protect ourselves or at least hedge a portion of the -- our outlook on rates where if the Fed stays higher for longer in terms of Fed funds, these longer-term funding -- fixed rate funding does give us a little bit of advantage there. The average rate on those were about 3.92%, so below Fed funds currently. So, it does protect us a bit there. Going forward, it'll just depend on how deposits balance levels of transition. But we also are looking to the portfolio where we traditionally have that running off. The runoff from that could help fund the loan growth. In terms of the noninterest-bearing, yes, from what I can see, it wasn't unusual that we had a drawdown. There is a kind of a shift to higher-yielding deposit products. Now that Fed funds is at 4.5%, lot of the -- some of the drawdown did go to higher-yielding products. And then, there was some that were just coming off. We had some title companies that had projects that were closing in the quarter that also took some money out. So that was kind of independent of the rate environment. Yes. I mean, it wasn't terribly surprising to us to see money moving out of noninterest-bearing. That's still -- that was last quarter, 34.9% of total deposits. This quarter, 32.6%, so 3 point drop there. Interest-bearing demand was basically flat and savings was basically flat. So, kind of the catch all was in time. And your question about the government deposits, that was pretty much flat in terms of demand and savings on a linked basis and then up on time -- government time deposit, Laurie. Got it. Okay. So, I had your public time deposits at $180 million last quarter. Is the delta increase there in your total public deposits? Is that all time? Or do you have an that number there? Yes. So, total public deposits, last quarter was $1.236 billion, this quarter is $1.706 billion. And public time was $180 million in the third quarter, and $587 million in the fourth quarter. $587 million. Okay. Got it. That's helpful. Okay. And I mean, your loan to deposit ratio is so beautiful. Your loan to core deposit ratio is so beautiful. I mean, any liquidity concerns or how are you thinking about that? No, we don't have liquidity concerns. I think we frankly, we're priced too tight intra quarter and we're kind of hopeful of picking up more deposits in the quarter. And when that didn't transpire, we had to move, obviously, to more wholesale funding sources. So, with the teams both consumer and commercial are working on for the coming quarters is to be a little bit more dynamic from a pricing standpoint to generate more volume levels. Okay. Great. And then, Mary, just one quick question for you. And, certainly, your credit looks great, all the way around. But specifically on the auto piece, can you just help us think about that? We saw, obviously, a pretty nice jump in auto loans this quarter. Was that purchased, or what was that? And then, I guess, the charge-off there, seems like that's just one area of weakness that continues to grow and, certainly, there's a concern more generally within consumer even though your consumer book is so high. Can you just help us think a little bit about that? Thanks. Sure, Laurie. If I look at indirect, our 30-plus this quarter in terms of delinquency was 1.82%. And that's versus 1.38% from the prior quarter. But if I look at 2019, we're still below that at 2.24%. And what we saw in 2018 when our delinquency rate was running 2.28%. In terms of charge-off rates in indirect, we averaged 35 basis points this year and, in 2019, that was 59 basis points and, in 2018, that was 88 basis points. So, in early stage, we did the 30 basis points to 59 basis points, we saw a modest uptick, but still below what we've been seeing pre-pandemic. But we would expect as consumers come under more stress that we would see that our portfolio to normalize a bit. But right now, our less than [620] (ph), everything -- all the metrics aren't showing a huge decline in quality. Yes, we don't purchase portfolios. So, all of our indirect -- all of our consumer is organically driven off of our delivery channels. At this time, I show no further questions. I would now like to turn the conference back to Jennifer Lam for closing remarks. I'd like to thank everyone for joining us today and for your continued interest in Bank of Hawaii. Please feel free to contact me if you have any additional questions or need further clarification on any of the topics discussed today. Thank you, everyone.
|
EarningCall_1104
|
Good day, ladies and gentlemen and welcome to the Fourth Quarter 2022 Hess Corporation Conference Call. My name is Kevin and I will be your operator for today. [Operator Instructions] As a remainder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Jay Wilson, Vice President of Investor Relations. Please proceed. Thank you, Kevin. Good morning, everyone and thank you for participating in our fourth quarter earnings conference call. Our earnings release was issued this morning and appears on our website, www.hess.com. Todayâs conference call contains projections and other forward-looking statements within the meaning of the federal securities laws. These statements are subject to known and unknown risks and uncertainties and that may cause actual results to differ from those expressed or implied in such statements. These risks include those set forth in the Risk Factors section of Hessâ annual and quarterly reports filed with the SEC. Also on todayâs conference call, we may discuss certain non-GAAP financial measures. A reconciliation of the differences between these non-GAAP financial measures and the most directly comparable GAAP financial measures can be found in the supplemental information provided on our website. On the line with me today are John Hess, Chief Executive Officer; Greg Hill, Chief Operating Officer; and John Rielly, Chief Financial Officer. Thank you, Jay. Good morning and welcome to our fourth quarter conference call. Today, I will share some thoughts about the oil markets and then discuss our continued progress in executing our strategy. Greg Hill will then cover our operations and John Rielly will review our financial results. Oil and gas will be needed for decades to come and are fundamental to ensure an affordable just and secure energy transition. The world faces a massive dual challenge. We will require approximately 20% more energy globally by 2050. And over the same period, we need to reach net zero emissions. At the end of last year, the International Energy Agency, or IEA, published its latest World Energy Outlook that offers three scenarios and they are scenarios not forecast for how to meet this dual challenge. In all three of the IEA scenarios, the world is facing a structural deficit in energy supply and significantly more investment is required both in oil and gas and also in clean energies. According to the IEA, a reasonable estimate for the global oil and gas investment required to meet demand growth is approximately $500 billion each year for the next 10 years as compared with approximately $300 billion to $400 billion invested annually in the last 5 years. In terms of clean energies, an annual investment of between $3 trillion and $4 trillion is needed each year for the next 10 years, significantly more than last yearâs investment of approximately $1.2 trillion. Business leaders and government officials must have a sober understanding of this investment challenge, especially since capital is becoming more scarce and more expensive in the current financial environment. The energy transition is going to take a long time, costs a lot of money and require many technologies that do not exist today. To have an orderly energy transition, policymakers must have climate literacy, energy literacy and economic literacy. Our strategy is to grow our resource base, deliver our low cost of supply and generate industry leading cash flow growth and at the same time, maintain our industry leadership in environmental, social and governance performance and disclosure. Our successful execution of this strategy has uniquely positioned our company to deliver significant value to shareholders for years to come both by growing intrinsic value and by growing cash returns. In terms of cash flow growth, we have an industry leading rate of change story and an industry leading duration story, providing a unique value proposition. Based upon a flat Brent oil price of $65 per barrel, our cash flow is forecast to increase by approximately 25% annually between 2021 and 2026, more than twice as fast as our top line growth. And our balance sheet will also continue to strengthen with our debt-to-EBITDAX ratio currently under 1x. As our portfolio becomes increasingly free cash flow positive, we are committed to returning up to 75% of our annual free cash flow to shareholders with the remainder going to strengthen the balance sheet by increasing our cash position or further reducing our debt to ensure that we can fund our high-return investment opportunities through the cycle. Executing this strategy in 2022, we decreased our debt by $500 million, increased our regular quarterly dividend by 50% and completed a $650 million stock repurchase program. Looking ahead, we plan to continue increasing our regular dividend to a level that is attractive to income-oriented investors, but sustainable in a low oil price environment. As our free cash flow generation steadily increases in future years, share repurchases are expected to represent a growing proportion of our return of capital. By investing only in high-return low-cost opportunities, we have built a differentiated and balanced portfolio focused on Guyana, the Bakken, Deepwater Gulf of Mexico and Southeast Asia. Key to our strategy is Guyana, which is home to the Stabroek Block, one of the largest oil provinces discovered in the world over the last 20 years, where Hess has a 30% interest and ExxonMobil is the operator. Since 2015, we have had more than 30 discoveries on the block, including 9 last year, underpinning a gross discovered recoverable resource estimate of more than 11 billion barrels of oil equivalent with multibillion barrels of exploration potential remaining. We are pleased to announce today a significant new oil discovery at the Fangtooth Southeast-1 well, located approximately 8 miles southeast of the original Fangtooth-1 discovery. The Fangtooth Southeast-1 well encountered approximately 200 feet of oil-bearing stand stone reservoirs and was drilled to 5,397 feet of water. Fangtooth was our first standalone deep exploration prospect on the Stabroek Block and this area has the potential to underpin a future oil development. Our four sanctioned oil developments on the Stabroek Block have a breakeven Brent oil price of between $25 and $35 per barrel. We have line of sight to 6 floating production storage and offloading vessels or FPSOs [Technical Difficulty] billion, of which more than 80% will be allocated to Guyana and the Bakken. Our financial priorities are to continue to allocate capital to our high-return low cost investment opportunities, to keep a strong cash position and balance sheet, and to grow our dividend and as market conditions and our return of capital framework provide to increase share repurchases. In Guyana, the Liza Phase 1 and Liza Phase 2 developments are currently operating at their combined gross production capacity of more than 360,000 barrels of oil per day. Our third development, Payara, remains on schedule for startup by the end of 2023, with a gross production capacity of approximately 220,000 barrels of oil per day. Our fourth development, Yellowtail, is expected to come online in 2025, with a gross production capacity of approximately 250,000 barrels of oil per day. A plan of development for our fifth development in Uaru with a gross production capacity of approximately 250,000 barrels of oil per day was submitted to the Government of Guyana in November and final approval is expected by the end of the first quarter. We also will continue an active exploration and appraisal program in Guyana with approximately 10 wells planned for the Stabroek Block in 2023. In the Bakken, we plan to continue operating a 4-rig program, which will enable us to generate significant free cash flow, lower our unit cash costs and further optimize our infrastructure. We have a robust inventory of high-return drilling locations to enable us to grow net production to an average of 200,000 barrels of oil equivalent per day in 2025. Greg and his team continue to do an outstanding job of applying lean manufacturing principles to create a culture of innovation, improve efficiency and manage inflationary cost pressures. We will continue to invest in our operating cash engines offshore in 2023, where we also see attractive investment opportunities. In the Gulf of Mexico, we plan to drill two infrastructure tieback wells and two exploration wells. And in Southeast Asia, we will invest in drilling and production facilities at both the North Malay Basin and joint development area assets. As we continue to execute our strategy, our commitment to sustainability will remain a top priority. In December, we announced one of the largest private sector forest preservation agreements in the world, to purchase high-quality, independently verified REDD+ carbon credits for a minimum of $750 million between 2022 and 2032 directly from the Government of Guyana. Protecting the worldâs force and the important role they play as natural carbon sinks is foundational to the Paris Agreementâs aim of limiting the global average temperature rise to well below 2 degrees Celsius. Avoiding global deforestation was one of the major commitments made at the COP26 Climate Summit, where more than 130 countries, including Guyana, pledged to end deforestation by 2030. The Government of Guyana plans to invest the proceeds from our carbon credits purchase agreement in sustainable development to improve the lives of the people of Guyana, with 15% of the proceeds directed to indigenous communities. This agreement adds to our companyâs ongoing and successful emissions reduction efforts and is an important part of our commitment to achieve net zero Scope 1 and Scope 2 greenhouse gas emissions on a net equity basis by 2050. The agreement further strengthens our strategic partnership with Guyana and demonstrates our long-term commitment to the country and its people, building upon the national healthcare initiative we announced earlier in 2022. We are proud to have been recognized throughout 2022 as an industry leader in our environmental, social and governance performance and disclosure. In November, Hess earned a place on the Dow Jones Sustainability Index for North America for the 13th consecutive year and for the first time was included in the Dow Jones Sustainability World Index. In December, we also achieved leadership status in CDPâs annual global climate analysis for the 14th consecutive year. In summary, we continue to successfully execute our strategy, which offers a unique value proposition, both to grow our intrinsic value and to grow our cash returns, by increasing our resource base, delivering a low cost supply and generating industry leading cash flow growth. As our portfolio becomes increasingly free cash flow positive, we will continue to prioritize the return of capital to our shareholders through further dividend increases and share repurchases. Thanks, John. 2022 was another year of strong strategic execution and operational performance for Hess. Proved reserves at the end of 2022 stood at approximately 1.26 billion barrels of oil equivalent. Net proved reserve additions of 184 million barrels of oil equivalent were primarily the result of the Yellowtail sanction in Guyana and the Bakken. Excluding asset sales, we replaced 144% of 2022 production at a finding and development cost of approximately $14.80 per barrel of oil equivalent. Turning to production. In the fourth quarter of 2022, company-wide net production averaged 376,000 barrels of oil equivalent per day, excluding Libya, which was above our guidance of approximately 370,000 barrels of oil equivalent per day. Strong performance across the portfolio more than offset the severe winter weather impacts experienced in the Bakken during the month of December. For the full year 2023, we forecast net production to average between 355,000 and 365,000 barrels of oil equivalent per day, an increase of approximately 10% compared with 2022 production of 327,000 barrels of oil equivalent per day, excluding Libya. For the first quarter of 2023, we forecast company-wide net production to average between 345,000 and 355,000 barrels of oil equivalent per day. In the Bakken, fourth quarter net production of 158,000 barrels of oil equivalent per day was below our guidance of 165,000 to 170,000 barrels of oil equivalent per day, reflecting severe winter weather impacts in December, which limited our new wells online to only 15 in the quarter. For the full year 2022, net production averaged 154,000 barrels of oil equivalent per day. In 2023, we plan to operate 4 rigs and expect to drill approximately 110 gross operated wells and bring online approximately 110 new wells. In the first quarter of 2023, we plan to drill approximately 25 wells and bring 25 new wells online. In 2022, our drilling and completion cost per Bakken well averaged $6.4 million. In 2023, we estimate industry inflation will average between 10% and 15%. However, we expect to mitigate this impact through the application of lean manufacturing and technology and forecast our D&C cost to average approximately $6.9 million per well or about 8% above last year. For the full year 2023, we forecast Bakken net production will average between 165,000 and 170,000 barrels of oil equivalent per day. First quarter net production is forecast to average between 155,000 and 160,000 barrels of oil equivalent per day, reflecting weather contingencies and the carryover effects from the severe winter weather in December. Net Bakken production is forecast to steadily grow over the course of â23 and â24 and average approximately 200,000 barrels of oil equivalent per day in 2025. We expect to hold this level of production for nearly a decade. Moving to the offshore, in the Deepwater Gulf of Mexico, net production averaged 35,000 barrels of oil equivalent per day in the fourth quarter and 31,000 barrels of oil equivalent per day for the full year 2022. For the first quarter and full year 2023, we forecast net production in the Gulf of Mexico will average approximately 30,000 barrels of oil equivalent per day, reflecting normal field declines and planned maintenance. The Deepwater Gulf of Mexico remains an important cash engine for the company as well as a platform for growth. In 2023, we plan to participate in 4 wells, 1 infrastructure-led exploration well, 1 hub class exploration well, and 2 tieback wells. The infrastructure-led exploration well will be the Hess-operated Pickral Prospect located in Mississippi Canyon Block 727, which is expected to spud in April and will be brought online through existing infrastructure at Tubular Bells. The well will target the same Miocene interval that was successfully drilled at Esox and tied back to Tubular Bells in 2020. The hub class exploration well will be spud in the second half of the year and will be a Hess-operated opportunity in the Northern Green Canyon area in the Gulf of Mexico, targeting high-quality sub-salt Miocene sands in areas where the application of the latest seismic imaging technology has improved the sub-salt image. The 2 tieback wells will be spud in the fourth quarter, 1 well will be at Stampede and the second well will be at the Shell-operated Llano field. First oil from both wells is expected in 2024. In Southeast Asia, net production from the joint development area in North Malay Basin, where Hess has a 50% interest, averaged 67,000 barrels of oil equivalent per day in the fourth quarter and 64,000 barrels of oil equivalent per day for the full year 2022. For the first quarter and full year 2023, we forecast net production in Southeast Asia, the average between 60,000 and 65,000 barrels of oil equivalent per day. Turning to Guyana, where Hess has a 30% interest in the Stabroek Block and ExxonMobil is the operator, the partnership delivered exceptional facilities for liability, project delivery and exploration success in 2022. Net production from Guyana averaged 116,000 barrels of oil per day in the fourth quarter of 2022 and 78,000 barrels of oil per day for the full year 2022, both above our guidance. For the first quarter and the full year 2023, we forecast net production in Guyana to average approximately 100,000 barrels of oil per day. Turning to developments. Liza Phase 1 was successfully debottlenecked in 2022 and has been operating at or above its revised nameplate capacity of 140,000 barrels of oil per day. Liza Phase 2, utilizing Liza Unity FPSO, achieved first oil in February of last year and production ramp-up from start-up to nameplate capacity was achieved in about 5 months, which is world-class performance in the deepwater. The Liza Unity is currently operating at or above its nameplate capacity of 220,000 barrels of oil per day. Production optimization opportunities are currently being considered for late 2023. The third development, Payara, is approximately 93% complete. The Prosperity FPSO is expected to depart from Singapore in late first quarter and commence hookup and commissioning activities following arrival in Guyana. The project remains ahead of schedule and is anticipated to achieve first oil by the end of 2023. Yellowtail, our fourth development, is approximately 40% complete and remains on track for first oil in 2025. The one Guyana FPSO is â hole is completed and is expected to enter drydock in Singapore in April. Topside fabrication activities have commenced and module fabrication sites in Singapore and China and development drilling is underway. The final development plan for our fifth development, Uaru, was submitted in November, and we are currently awaiting approval by the Government of Guyana, which we anticipate by the end of the first quarter. Pending government approvals, our sixth development, Whiptail, is expected to be sanctioned early next year. Turning to exploration. The Fangtooth Southeast-1 well, located approximately 8 miles southeast of the original Fangtooth-1 discovery well, resulted in a significant new oil discovery, and this area could form the basis for a future oil development on the Stabroek Block. The Fangtooth Southeast-1 well encountered approximately 200 feet of oil-bearing sandstone reservoirs and further appraisal activities are underway. We continue to see multibillion barrels of additional exploration potential on the Stabroek Block. And in 2023, we plan to drill approximately 10 exploration and appraisal wells that will target a variety of prospects and play types. These will include lower risk wells near existing discoveries and several penetrations that will test deeper intervals. With regard to upcoming wells, operations are continuing at the Tarpon Fish-1 well in the northwest corner of the Stabroek Block, approximately 43 miles northwest of the Liza-1 well. The well is in the first test of cretaceous age clastic reservoirs in Northwest Stabroek. The well will also test a deeper Jurassic aged carbonate prospect. Lancetfish-1 is a deep play exploration well, located approximately 2.5 miles northeast of the Fangtooth Southeast-1 well that underlies a portion underneath [ph] the field. Drilling operations are underway on the Noble Don Taylor drillship. Beyond that, there is a well called Basher [ph], which will target a deep prospect in the Fangtooth area and a well called [indiscernible] which will penetrate an updip upper campaigning prospect east of Barreleye. Moving to offshore Canada, we plan to participate in the BP-operated FSS-1 well in the Northern Orphan Basin. The well will target a very large submarine fan of tertiary age. The Stena IceMAX rig is expected to arrive on location in the second quarter despite the well, which is located in approximately 4,000 feet of water. BP has a 50% working interest and Hess and Chevron, each have 25%. In summary, our execution in 2022 was again strong, and 2023 will be an exciting year with the Bakken returning to a steady growth trajectory, with an active drilling program in the Gulf of Mexico and with the advancement of our major projects and further delineation of the significant upside in Guyana, all of which position us to deliver industry-leading performance and significant shareholder value for many years to come. Thanks, Greg. In my remarks today, I will compare results from the fourth quarter of 2022 to the third quarter of 2022. We had net income of $624 million in the fourth quarter of 2022 compared with $515 million in the third quarter of 2022. On an adjusted basis, which excludes items affecting comparability of earnings, we had net income of $548 million in the fourth quarter of 2022 compared with $583 million in the previous quarter. Turning to E&P. E&P adjusted net income was $591 million in the fourth quarter compared with $626 million in the third quarter. The changes in the after-tax components of E&P earnings between the fourth and third quarter of 2022 were as follows: higher sales volumes increased earnings by $246 million; lower realized selling prices decreased earnings by $288 million; higher DD&A expense decreased earnings by $29 million; lower cash costs and Midstream tariffs increased earnings by $19 million; lower exploration expenses increased earnings by $13 million; all other items increased earnings by $4 million for an overall decrease in fourth quarter earnings of $35 million. For the fourth quarter, our E&P sales volumes were overlifted compared with production by approximately 1.3 million barrels, which increased our after-tax income by approximately $60 million. Turning to Midstream. The Midstream segment had net income of $64 million in the fourth quarter of 2022 compared with $68 million in the third quarter. Midstream EBITDA, before non-controlling interest, amounted to $244 million in the fourth quarter of 2022 compared to $252 million in the previous quarter. Turning to our financial position. At December 31, excluding the Midstream segment, cash and cash equivalents were $2.48 billion; total liquidity was $5.73 billion, including available committed credit facilities; and debt and finance lease obligations totaled $5.6 billion. During the fourth quarter, we completed the sale of our 8% interest in the Waha Concession in Libya for net proceeds of $150 million, and we purchased 5 million REDD+ carbon credits from the Government of Guyana for $75 million. Total cash returned to shareholders in the fourth quarter through share repurchases and dividends amounted to $405 million. We repurchased approximately 2.3 million shares of common stock for $310 million in the fourth quarter, bringing total share repurchases in 2022 to $650 million at an average price of approximately $120 per share. Net cash provided by operating activities before changes in working capital was $1.4 billion in both the fourth and third quarter. In the fourth quarter, net cash provided by operating activities after changes in operating assets and liabilities was $1.25 billion compared with $1.34 billion in the third quarter. E&P capital and exploratory expenditures were $818 million in the fourth quarter compared to $701 million in the third quarter. Now turning to guidance, first for E&P. We project E&P cash costs to be in the range of $14 to $14.50 per barrel of oil equivalent for the first quarter, which includes a planned workover at the Penn State Field in the Gulf of Mexico. For the full year 2023, E&P cash costs are expected to be in the range of $13.50 to $14.50 per barrel of oil equivalent. DD&A expense is forecast to be in the range of $13 to $13.50 per barrel of oil equivalent for the first quarter and $13 to $14 per barrel of oil equivalent for the full year 2023. This results in projected total E&P unit operating costs to be in the range of $27 to $28 per barrel of oil equivalent for the first quarter and $26.50 to $28.50 per barrel of oil equivalent for the full year 2023. Exploration expenses, excluding dry hole costs, are expected to be in the range of $35 million to $40 million in the first quarter and $160 million to $170 million for the full year 2023. The Midstream tariff is projected to be in the range of $290 million to $300 million for the first quarter and $1.23 billion to $1.25 billion for the full year 2023. E&P income tax expense is expected to be in the range of $160 million to $170 million for the first quarter and $590 million to $600 million for the full year 2023. As of January 24, 2023, we have purchased WTI put options for 75,000 barrels of oil per day for 2023 with an average monthly floor price of $70 per barrel. We plan to increase our hedge position to a similar level as 2022, depending on market conditions. Based on our current position, we expect non-cash option premium amortization, which will be reflected in our realized selling prices to reduce our earnings by approximately $25 million in the first quarter and by approximately $120 million for the full year 2023. Our E&P capital and exploratory expenditures are expected to be approximately $850 million in the first quarter and approximately $3.7 billion for the full year of 2023. For Midstream, we anticipate net income attributable to Hess from the Midstream segment to be in the range of $55 million to $60 million for the first quarter and $255 million to $265 million for the full year 2023. For corporate, corporate expenses are estimated to be approximately $35 million for the first quarter and $120 million to $130 million for the full year 2023. Interest expense is estimated to be in the range of $80 million to $85 million for the first quarter and $305 million to $315 million for the full year 2023. This concludes my remarks. We will be happy to answer any questions. I will now turn the call over to the operator. Greg, I was wondering if you could give us a bit of a teach-in on the deeper sand channels that youâre exploring and have had success at Fangtooth. I know youâre drilling Lancetfish. But give us a sense of â are you still in the campaign, but a little bit of a teach-in on what youâre exploring for? Well, thanks for the question, Arun. Again, as we have said before, if you look at the deeper interval, itâs only 3,000 feet below the upper campaign in which the majority of our discoveries and if you look at that interval, it really underlies a lot of Stabroek Block. And over the past couple of years, weâve had a number of penetrations in that tails of existing wells. But I think importantly, the Fangtooth discovery was our first stand-alone deep prospect and the Fangtooth-1, the first well had 164 feet of pay. In the Fangtooth Southeast well, which is located 8.5 miles southeast of that original discovery well, it had 200 feet of oil-bearing pay. And so we are going to continue to appraise that this year, probably get a DST in it. And as you mentioned, there are some other channels in and around Fangtooth, there is one called Lancetfish thatâs northeast of Fangtooth, and there is a prospect called Basher, which is actually west of Fangtooth and the combination of all that is pretty exciting. And as John mentioned in his opening remarks, it could mean a potential future oil development in there. We will also continue to explore the deep as we kind of go through the next couple of years. But I think itâs very encouraging, and we will just continue to add to the discovered resource and also the significant exploration upside we see. Got it. Just a follow-up, I know, Greg, you mentioned youâll do a DST later this year. But what is it about Fangtooth thatâs kind of moving it up the development queue, perhaps maybe after Whiptail to be the seventh boat on the Stabroek Block? Yes. I think itâs that weâre seeing good quality reservoir and again, oil bearing. So our strategy is to continue to progress the oil developments as quickly as we can on the Stabroek Block. So good quality sand and oil bearing. So itâs coming up in the queue. Good morning. Maybe just going to cash returns real quick here. Youâre committed to returning up to 75% of annual adjusted free cash flow through dividends and buybacks. Can you talk about what determines where you fall within that range for 2023, whether itâs related to oil prices, the balance sheet or maybe anything else? I mean we note that you have a really healthy cash balance right now and your debt maturities in â24 and â27 are pretty manageable. Yes. No. Excellent question, Jeanine. As I said earlier, with this capital budget of $3.7 billion, our first priority is to continue to allocate capital to our high-return, low-cost investment opportunities. Thatâs really priority number one for this year. Along with that, the next priority is to keep a very strong cash position and balance sheet. You heard John saying we bought some puts to provide downside protection, still have unlimited upside appreciation for our shareholders. But I want to protect the downside where itâs a volatile market, and we want to make sure the downside is protected. And then in terms of return on capital, yes, over the year, 75% of that free cash flow will be returned to our shareholders as we did last year. The first priority within that, Jeanine, is to grow our dividend. So our Board meets regularly and will give strong consideration to increasing our dividend during this quarter. Then as the year goes on as market conditions and our return of capital framework provide, then strong consideration will be to increase share repurchases as we did last year. Great. Thank you. And maybe turning back to Guyana here, the Uaru development project, I believe, is anticipated to be around $12.7 billion. Would you be able to comment on the moving pieces versus the Yellowtail cost estimate? For example, how much is related to additional scope versus inflation? And are there other things that arenât included in that $12.7 billion? And should we consider that as the baseline for future projects, which look to be a similar size or maybe even bigger? Thank you. Yes. So the $12.7 billion is consistent with the estimate that the operator submitted as part of their EIA to the Government of Guyana. And that number is going to be finalized as the project progresses. And once we sanction it, we will give the final details. But in any case, the final cost of Uaru reflects a couple of things. It reflects current market conditions and then also additional scope. One example is, is the surf is twice as big as Yellowtail, for example, because it connects a number of further away kind of reservoir systems. But we will give you a final color on that once the project is finally sanctioned. And I think, Jeanine, whatâs also important is Uaru still offers some of the best returns in the industry. So even though there is cost inflation with the resource weâre developing. The fact that itâs low cost, low carbon, it still offers some of the best returns in the industry. Guys, I wonder if I could ask a kind of a longer-term question. So Exxon had signaled a couple of years ago that if the deeper horizon worked, John, I think youâve talked about this a number of times, we could be looking at double the resource potential at the time they were talking 10, so that would be 20 billion BOEs. It seems crazy to think that. But my question is, are you going to have enough time because the exploration phases on the stand that runs out in 2026. And this thing continues to get bigger, weâre already in 2023. What needs to happen for you guys to retain everything that you ultimately could find over the next several years? And what does that mean for development time lines and, I guess, relinquishment of block acreage and so on? Yes, Doug, excellent question. We still see multibillion barrels of exploration potential remaining. Greg made some great context remarks on the deeper horizon at 18,000 feet versus where most of our development efforts and exploration efforts have happened at 15,000 feet. We are still in the early innings of defining the deeper potential, definitely multibillion barrels potential remaining. And to get after that, thatâs why ExxonMobil is doing an excellent job developing this block, has a six-rig program. Three of them are for development activities and three really are for exploration and appraisal. So, we are going to continue to have a very active exploration appraisal program this year and future years to make sure we capture all the high-value resources that we think are on the block. So, just to be clear, John, you think you are going to have enough time in terms of securing the development approvals before â26, or do you have an extension on that to secure the development approvals? No. The reason we are doing the exploration and appraisal program, Doug, is to get ahead of that to make sure we capture all the resources that we can, and we work closely with our joint venture led by ExxonMobil and the government to do that. Thank you. Appreciate that, John. My follow-up, I here want to take this is itâs kind of a two-parter, if you donât mind, because I think you did mention why [indiscernible] but you have also given guidance on Guyana for this year, which has got a lot of kind of cryptic comments perhaps around downtime for debottlenecking Liza and so on. So, there is a lot of things going on in terms of that 3-year, 4-year visibility. So, my question is this. First of all, can you give us some kind of a guide as to what the downtime and ultimate capacity would look like for Liza-2 as we go through this year? Some sort of trajectory, I guess. And then my kind of Part B is, a lot of people are freaking out over the $12.7 billion number that Exxon put in the EIS. Now, we know that the absolute cost recovery is not a big of a deal. But you guys typically have come in lower than that because of contingency. Can you tell us what Hessâ number is relative to that $12.7 billion? Yes. Thanks Doug. So, let me take your first question. So, as I mentioned in my opening remarks, we are looking at a potential debottlenecking sometime in the latter half of 2023 for Phase 2. Now, as we have spoken before, each one of these is going to be bespoke, depending on the vessel. You typically want a year of dynamic data before you engineer the project to understand where the pinch points are on the vessel. As I have said in the past, I think you can expect kind of a 10%-ish uplift in any kind of debottlenecking. I think thatâs in the range of possibilities here as well. Again, we are just in the early stages of engineering that. So, that would maybe come on in the fourth quarter. So, we have included some downtime for that in the guidance for Guyana. I think the quarter four of 2022 basically had no downtime. And as we project forward to 2023, we are really trying to include pigging and the normal maintenance downtime, some debottlenecking downtime in those production estimates for next year and also the tax barrels are a little bit different what John can talk about. And John can also talk about the CapEx for Uaru. So, John Rielly Yes. On the $12.7 billion, Doug, right now, look, we are going to wait for the final section where we come out with our estimates. But you are correct, there was always a contingency in at the beginning of these projects and rightfully so, several years of construction. What we can say is that ExxonMobil has done a fantastic job on every single project, meeting or beating their estimates on cost and on time on execution. So, John has said it earlier, this project will have world-class breakeven, will be world-class returns there in Uaru. We are excited about that. Final details once the government has approved it, we can provide. Hey guys. Good morning. Couple of questions, I think the first kind of is two part is for John Rielly, just to clarify. When you say 75,000 for $70, is that Brent or WTI? And also that when you are talking about in the fourth quarter, the $75 million, the carbon credit purchase, where does it show â where did you show up in the income statement and the cash flow for the fourth quarter? Sure. So, let me do your first question was on the hedges that we put on. We have WTI put options on right now. So, thatâs 75,000. And like I said, we do intend to get to a similar level as last year. And combined between WTI and Brent, we had about 150,000 barrels a day hedged last year. So, again, you should be looking for us to add to this position. But currently, that 75,000 is for WTI put options at $70. And John, for the 120 million on the premium for the full year, is that just for this not in anticipation of the increase in the put option you are going to put? That is correct. That is just for the 75,000 we have. Simple math, if you want to double it to get to 150,000, you could double it, but we will give you updates on that as we increase our hedge position. Then your second question on the carbon credits. So, what we have, that 75,000 â 75 million purchase on the carbon credits, you will see it on our balance sheet in other long-term assets. And when you look at, there is nothing on the income statement because that is an asset being held. And on that cash flow statement, it is in working capital. Okay. And my final question is for Greg. Bakken, can you tell us what is the winter storm impact in the fourth quarter? And also, I understand the first quarter you have been conservative contingency on the weather. But for the full year production, it seems now you have low compared to what we have expected even after taking into consideration of the first quarter. Is the number of wells that you plan for this year end up is going to be lighter than previously, or is there anything that you can share that seems to be low comparing to what I think previously has been discussing? No. So, I think let me talk first about the snowfall for that. The severe snowfall coupled with really low wind chill, significantly impacted our ability to mobilize resources. You just canât put people to work at minus 30, minus 40 wind chill. And so what that did was it significantly increased our backlog of down wells. And then importantly, it delayed bringing new wells online. We projected 25 new wells online coming on in the fourth quarter, that number was 15. So, we lost 10 wells. And if you assume those things come on at 1,100 barrels a day, 1,200 barrels a day, you can see thatâs a fairly significant impact. I think we are in recovery mode. We expect to recover in the quarter from that. It just takes time to build and dig out of that literally. But importantly, Paul, I think the Bakken now is on this steady build, this steady cadence, a steady build to get to that 200,000 barrel a day average in 2025, so there will be this regular cadence. We will probably touch 200 towards the end of 2024. But I think importantly, we will average 200,000 barrels a day in 2025. So, we are on a solid trajectory from here to 2025 and not concerned at all about it. Wells are performing as expected. You are coming in with these IP 180s of 120, EURs of 1.2. Thatâs in spite of going into a little bit less quality acreage. So, the reservoir is performing exactly as expected. These are just weather aberrations as you kind of go through the year. Thatâs all it is. No, not yet and we will guide that as we go through the year, Paul. And as I am always kind of hesitant because fourth quarter is always a little odd on weather, so we wait until we are closer and kind of look forward at weather forecast before we like to project that far out. Hey. Thanks guys. And I just want to follow-up on Jeanineâs question around capital returns. In the fourth quarter, you bought $310 million worth of stock, and I think you did $650 million last year. The share prices have done really well, so congrats on that. Has the appreciation of the share price changed your â how aggressive you want to be around buying back stock? And as we think about this year, recognizing to prioritizing the dividend, should we think that there will be a ratable buyback as well? Thanks Neil. Just going back to what John has said a little early, you reiterated our priorities, invest in those high-return opportunities Guyana and Bakken, maintain that strong balance sheet. So, the first thing, as John had mentioned, we will be looking at the dividend because that will give strong consideration first to that dividend increase. And then in line, we are going to return cash up to the 75% through further share repurchases then. So, as we look at â as you said, with the stock appreciation, we are committed to that return framework, and we will return up to that 75% through both the dividends and share repurchases. And the way we look at it right now is we currently only have two FPSOs on producing in Guyana. We have Payara starting in this year. And remember, every time an FPSO comes on and once itâs fully ramped, Payara is going to be about 55,000 barrels a day, 60,000 barrels a day to us and $1 billion in cash flow. So, then you have Yellowtail similarly in 2025, a little bit bigger. So, 65,000 barrels a day approximately. When thatâs fully up and running, a little bit more cash flow than that $1 billion. Now, we have got Uaru in â26, and we got up to 10 FPSOs to develop all the resources we have found. So, we believe in buying our shares in advance of that significant cash flow growth and NAV accretion that each of these FPSO generates. So, we believe that will deliver significant value to shareholders by continuing the share repurchases. Yes. Thank you, John. And the follow-up is just around post-2023 CapEx, recognizing again that there is a cost recovery element here. And we just try to calibrate our models post-2023. Any moving pieces that you would point us to, to help us think about where we should test those numbers? So, obviously, this is really early, Neil, so thanks for that question. But as you move into next year, just think Bakken steady four-rig program shouldnât be much changes there. Gulf of Mexico, we will see what happens. Greg had talked about the wells we are drilling this year and we will see what â any follow-ons as it relates to that. So, itâs a little early. Southeast Asia may be slowly coming down. You saw it came down a bit in â23 from last year. And then Guyana, obviously, the big spend. So, we will continue to have three FPSOs kind of coming in line. So, Payara will be on, but we will still have three FPSOs that are in the development phase. So, with those, I mean you see with current market, so the current market is a bit up, so you can kind of take up those three FPSOs a bit as compared to what we have this year. And then the one other piece to add is the FPSO purchases, which we expect to have our first FPSO purchase in early 2024. Thanks. Maybe just a couple of quick ones. First off, I appreciate you talked about some of the cost inflation that you have seen and been able to mitigate there in the Bakken. I donât know you have talked about it indirectly with the Uaru number. But what are you seeing in terms of cost inflation on the offshore rig rates are certainly up? I mean as we look at things in Canada and Gulf of Mexico and across your portfolio, what type of inflation are you seeing year-on-year, and where is it worse in the offshore? Well, I think as you mentioned, I mean certainly, rigs are going up kind of the mid to high-3s, approaching 400, I think for offshore rigs, not unreasonable. Now remember, we are largely insulated from that because the â certainly, the first three developments in Guyana are actually already locked in four actually with Yellowtail. So, those costs were locked in. Some of the rig rates flowed a little bit. And obviously, oil country tubular goods were up, but I will say that ExxonMobil has done an outstanding job of delivering improvements to offset both rig cost increases and oil country tubular good increases. So, we are fairly insulated because of the projects we have going on. And as we mentioned, the cost in Uaru will reflect that market inflation, and we will get into details all that once itâs finally sanctioned. But those are sort of the levels we are seeing. But again, we are largely insulated from that in our portfolio because of the nature of Guyana. Great. Thanks. And then maybe just a philosophical question on the hedging, I appreciate the detail on this yearâs hedging. As we think longer term, as production capacity continues to increase in Guyana and that stable cash flow kind of grows, do you expect to reduce your hedging amount over time, or do you view that as just kind of a strategic importance from an insurance point of view? We definitely view it as strategic importance from an insurance point of view. And I think you can clearly expect our WTI hedge levels to remain at similar levels that we have done before, again, the tax and royalty aspect of it. Percentage-wise from on the Brent side as production keeps growing each time we bring on FPSOs, you could see maybe percentage-wise that we could have a lower hedge percentage overall. But again, I think you should expect us to have a good significant insurance protection each year just to protect that downside and again, leave the upside for investors. I just wanted to touch base on something that was mentioned earlier on. You were just talking about experiencing exceptional facilities reliability in Guyana. I was wondering if you could talk a little bit about maybe how that contributed to results? I was just curious if you had modeled some maintenance or slowdown in there that you want it not having to do? No. What my earlier comment was if you look at Q4 in Guyana, there was little maintenance at all in Guyana. And then as we look forward for a whole year, you have to build some of that in. You will have some pigging runs and some facility maintenance. So, we had to build that into the downtime as we kind of look forward for a full year of Guyana production, but Q4 was exceptional, very high reliability. Okay. Great. And I apologize if you touched on this. I dropped off for a minute. But the offshore Canada prospect that you mentioned, I just wondered if you could talk a little bit about the geology of that and how it was identified? Yes, sure. So, we identified this prospect with a number of partners really about the same time that we identified the Guyana opportunity. And this is a very large stratigraphic trap. There is only a one-well commitment. As we mentioned in our opening remarks, the rig will show up in the second quarter. The prospect is very shallow. Itâs about 15,000 feet or so, and itâs only in 4,000 feet of water, total depth 15,000. So, this is going to be a kind of a one-well wonder, and we will see where it goes. But itâs very large. Thank you very much. This concludes todayâs conference. Thank you for your participation. You may now disconnect and have a wonderful day.
|
EarningCall_1105
|
Good morning, and welcome to the Synchrony Financial Fourth Quarter 2022 Earnings Conference Call. Please refer to the company's Investor Relations website for access to their earnings materials. Please be advised that today's conference call is being recorded. [Operator Instructions] I will now turn the call over to Kathryn Miller, Senior Vice President of Investor Relations. Thank you. You may begin. Thank you, and good morning, everyone. Welcome to our quarterly earnings conference call. In addition to today's press release, we have provided a presentation that covers the topics we plan to address during our call. The press release, detailed financial schedules and presentation are available on our website, synchronyfinancial.com. This information can be accessed by going to the Investor Relations section of the website. Before we get started, I wanted to remind you that our comments today will include forward-looking statements. These statements are subject to risks and uncertainty, and actual results could differ materially. We list the factors that might cause actual results to differ materially in our SEC filings, which are available on our website. During the call, we will refer to non-GAAP financial measures in discussing the company's performance. You can find a reconciliation of these measures to GAAP financial measures in our materials for today's call. Finally, Synchrony Financial is not responsible for, and does not edit or guarantee, the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized webcasts are located on our website. On the call this morning are Brian Doubles, Synchrony's President and Chief Executive Officer; and Brian Wenzel, Executive Vice President and Chief Financial Officer. Thanks, Kathryn, and good morning, everyone. Synchrony closed the year on a very strong note with fourth quarter net earnings of $577 million, or $1.26 per diluted share, a return on average assets of 2.2% and a return on tangible common equity of 22.1%. These financial results contributed to full year 2022 net earnings of over $3 billion or $6.15 per diluted share, our second highest in company history; a return on average assets of 3.1% and a return on tangible common equity of 28.5%. This performance was driven by continued strength across the fundamental drivers of our business and a high level of execution across our key strategic priorities throughout the year. We achieved record purchase volume of $180 billion for the full year, which surpassed our prior year's record and was 15% higher on a core basis. Spend per active account was 7% higher for the year, reflecting robust consumer demand across the broad range of products and services for which Synchrony offers flexible financing. We also acquired 23.6 million new accounts and grew average active accounts by 8% on a core basis. The combination of strong consumer spend and some moderation in payment rate contributed to ending receivables growth of 15%. As expected, credit continued to normalize across our portfolio with full year losses of 3%, still more than 250 basis points below our underwriting target of 5.5% to 6%, which is generally the level at which our risk-adjusted margin is more fully optimized. And finally, Synchrony continued to drive progress toward our long-term operating efficiency target, reflecting the combined impacts of our cost discipline, the inherent operating leverage in our highly scalable model and strong revenue growth. Synchrony's ability to deliver consistent growth and strong returns is a testament to our well-diversified portfolio, our balanced approach to product and credit strategies, our compelling value propositions and the strength of our business model. As a result, Synchrony was able to return more than $3.8 billion of capital to shareholders during 2022, $3.3 billion of which was through share repurchase, a 17% reduction in our shares outstanding. When we look back on 2022 and the calibre results we were able to deliver for our customers, our partners and providers and our shareholders, it really all comes back to the dedication shared by the Synchrony team as we realize our ultimate goal: to power commerce by delivering a leading digital ecosystem, connecting our partners and customers through world-class technology, products and capabilities. Over the last year, Synchrony has built upon the core strengths of our differentiated business model by executing on the key strategic priorities that are driving progress towards that collective goal. We continue to expand and enhance our partner programs, including the addition of more than 30 partners and the renewal of more than 50 relationships, including most recently Lowe's, with whom we've partnered for over four decades to drive innovation and value to both their do-it-yourself and pro customers. Synchrony also continued to diversify our products, programs and markets during 2022, deepening our reach and expanding the utility and value we offer to our customers and partners alike. We continue to scale our diverse product suite with the launch of Synchrony's Installment and Pay-in-4 products at a number of retailers and providers, including Belk and Discount Tire. These six pay offerings represent another financial tool that we can offer to qualifying customers while also driving incremental sales to our partners and providers. And whether it's delivering flexible financing offers in a dental practice, connecting a customer with a large partner through a seamless mobile transaction are driving incremental sales at small and midsized businesses. Synchrony meets our customers, partners and providers wherever they are in their digital or retail journey and deliver the right product at the right time. For this reason, we launched a number of strategic partnerships over the last year to expand our distribution channels and broaden customer access to our comprehensive product suite. Through integrations with point-of-sale and business management platforms like Clover, and practice management solutions like Sycle, Synchrony has added hundreds of thousands of small business locations and several thousand provider locations through whom we can seamlessly and responsibly offer access to flexible financing. At year-end, Synchrony had more than 460,000 merchant provider locations and 71 million active customers. So when you think about the sheer size and scale of the constituencies we serve, and the wide range of financing needs we deliver through omnichannel experiences, it should come as no surprise that our dynamic technology platform is at the center of it all. During the last year, Synchrony continued to innovate and scale our digital capabilities to ensure that we can remain at the forefront of the ever-evolving consumer financing landscape. We drove greater mobile customer engagement through a number of initiatives, including both our digital wallet provisioning and the Synchrony app. Accounts provision for digital wallet use in 2022 increased 75% compared to last year contributing to 85% of mobile wallet sales growth. And in terms of our mobile app, we upgraded our [Sy] (ph) pipelines to the latest version, which delivers new features, including a new user experience, freeze my card, e-statements, autopay, apply and Apple Pay push provisioning. As a result, unique visitors and payments within the SyPi channel each grew by more than 20% compared to last year. In today's tech forward world, a best-in-class customer experience is characterized by seamless, intuitive and hyper-personalized engagement. This, in turn, requires a more comprehensive understanding of each customer as we connect them with partners and providers and anticipate which products and services will optimize the experience. For that reason, we are constantly driving deeper integrations, leveraging more predictive and actionable insights throughout our digital ecosystem and developing solutions that are grounded in our customer experience insights. Over the last year, Synchrony achieved over 70% growth in the number of applications using our APIs and more than 80% growth in API transactions, including from our clients and partners leveraging Synchrony APIs to power their digital experience. Our partnership with PayPal is a great example of how together we continue to leverage more APIs to enhance our offerings and drive an even more seamless experience for their customer. In Q1, we launched PayPal Savings, which enabled instantaneous movement of funds between PayPal balances, no withdrawal limits and a savings goal feature to empower customers to set and reach their financial goals. In addition, existing PayPal customers are able to quickly and easily open their PayPal savings account inside PayPal's Super App. In Q2, we launched our new and refreshed co-branded PayPal Cashback credit card with a best-in-class cash-back offering and a fully integrated experience within the PayPal app, powered by native APIs. And in Q4, we enhanced our everyday value proposition on the Venmo co-branded card by introducing free person-to-person payments, the 3% fee is waived for the consumer when they use their Venmo Visa. We are really pleased with what the PayPal and Synchrony teams have been able to execute as we grow and evolve in new and unique ways, empower top of wallet products and best-in-class experiences for our customers. Synchrony also launched our new cardholder service platform across many of our largest portfolios in 2022. This new platform offers customers the ability to service their accounts in one dashboard, and enables a broad suite of account notifications across every aspect of the credit life cycle. These notifications include a range of instant transaction alerts, all enhanced with enriched merchant data and a completely redesigned digital service experience. In addition to text and e-mail alerts, we are able to deliver these notifications and alerts directly within our partners' iOS and Android apps by leveraging our patented SyPi platform, continuing to enhance the customers' experience within our partners' brands. While this new account manager is still in its early stages, we observed some strong trends in response to the launch. 60% of those logging in have more than one account, and 80% of our users stated that their experience was easy or very easy to use and a top driver of their satisfaction. In fact, this more dynamic interface has achieved a double-digit improvement in our transactional Net Promoter Score compared to our previous account management site. This new platform will span the broad set of financial products that Synchrony offers and will enable intuitive, self-service and highly customized and personalized experiences, increased speed to market of features and solutions for our partners and a more effective way for Synchrony to engage and power and deepen our relationships. Accordingly, as we continue to scale and integrate more of our products in the coming year, we believe this enhanced account manager will become an increasingly powerful tool to drive higher quality engagement and deeper value for our customers, partners and Synchrony alike. To that end, we also remain focused on driving greater connectivity across our vast customer and partner basis with the expansion of our Synchrony marketplace. Mysynchrony.com connects customers with information and relevant offers from brands that they trust. These offers are powered by proprietary insights that Synchrony has gleaned through a variety of resources, including online search activity within their shopping category and location to provide personalized offers to the right audience at the right time. As we continue to enhance this level of personalization and launch capabilities, like prequalification within our marketplace over the last year, mysynchrony.com achieved a 25% increase in both new accounts and sales as well as 11% growth in referrals to our partners. This is a testament to the deep customer relationships that our network products foster. Synchrony's ability to leverage our marketplaces like mysynchrony.com or carecredit.com to drive new and existing customer traffic as well as incremental and repeat sales to our partners has been and will continue to be a meaningful competitive differentiator and an important growth driver for our business longer term. In summary, Synchrony is increasingly anywhere our customers looking to make a purchase or a payment. Big or small, in-person or digitally, we can meet them whenever and however they want to be met with a broad range of products and services to meet their needs in any given moment. This ability to deliver the versatility of our financial ecosystem seamlessly across channels, industries, partners and providers alike is what positions Synchrony so well to sustainably grow particularly as customer needs and market conditions evolve. Thanks, Brian, and good morning, everyone. Synchrony's strong fourth quarter results demonstrate the power of Synchrony's purpose-built business model at work. The diversification of our portfolio across industries and spend categories supported by sophisticated underwriting and disciplined credit management enabled continued purchase volume growth that surpassed last year's record level. In addition, the alignment of economic interest between Synchrony and our partners through our retailer share arrangements is performing as intended. Excluding the impact of portfolio sales, our RSA declined as credit losses continue to normalize and funding costs began to rise, enabling Synchrony's delivery of consistent, attractive risk-adjusted returns as we have done for many years. The scalability and efficiency of our dynamic technology platform is enabling operating leverage even as we invest in our business. And Synchrony's strong balance sheet continue to support our customers and partners as their own needs evolve. In combination, these business drivers have continued to uniquely position Synchrony in our ability to deliver sustainable outcomes for our customers and our partners and consistent returns to our shareholders even as market conditions change. Let's now discuss Synchrony's fourth quarter financial results in greater detail. Purchase volume grew 2% to $47.9 billion, reflecting a 3% higher spend per account versus last year. On a core basis, purchase volume grew 11%. This continued strength in purchase volume was broad-based across our portfolio, demonstrating the breadth and depth of our five sales platforms, the compelling value propositions we offer and continued consumer demand. At the platform level, Synchrony achieved double-digit growth in our Diversified & Value, Health & Wellness and Digital platforms and single-digit growth in our Home & Auto and Lifestyle platforms. More specifically, in Diversified & Value, purchase volume increased 15% driven by higher out-of-partner spend in addition to partner performance and penetration growth. The 10% year-over-year increase in digital purchase volume reflected the growth in average active accounts and greater customer engagement. Health & Wellness purchase volume grew 15% compared to last year as we experienced broad-based growth in active accounts as well as higher spend per active account. In Home & Auto, purchase volume increased 9%, generally reflecting strong spend in home and higher prices in furniture. And in Lifestyle, purchase volume was 2% higher, driven by higher out-of-partner spend. Turning to Synchrony's dual and co-branded cards where we continue to experience strong growth. Core purchase volume on these products grew 21% versus last year and represented approximately 40% of our total purchase volume for the quarter. As we discussed in the past, our customers derive great value from our dual and co-branded cards because they combine best-in-class rewards with broad utility. Generally speaking, approximately half of our out-of-partner spend is comprised of nondiscretionary spend by billpay, discount store, drugstore, healthcare, grocery, and auto and gas. And while we observed some minor category shifts during December, for example, from T&E related spend towards more clothing and other retail as well as a reduction in auto and gas-related spend towards more grocery and discount spend, Synchrony's relative mix of discretionary and nondiscretionary out-of-partner spend has remained essentially unchanged. Consistently strong consumer spend, coupled with some moderation in payment rate contributed to 10% higher average balances per account versus last year and 15% growth in ending receivables. Our dual and co-branded cards accounted for 24% of core receivables and increased 28% from the prior year. Net interest income increased 7% to $4.1 billion, primarily reflecting a 13% increase in interest and fees due to higher average loan receivables and higher loan receivable yields, partially offset by the impacts of the portfolio sold during the second quarter of 2022. On a core basis, interest and fees increased 21%. Payment rate for the fourth quarter, when normalizing for the prior year impact of the portfolios recently sold, was 17%, approximately 75 basis points lower than last year and approximately 160 basis points higher than our five-year historical average. The net interest margin was 15.58% in the fourth quarter, a year-over-year decrease of 19 basis points. The primary driver of the decrease was higher interest-bearing liability costs, which increased 168 basis points to 2.86% and reduced net interest margin by 136 basis points. The mix of interest-earning assets also reduced net interest margin by roughly 6 basis points. These headwinds were partially offset by a 92 basis point improvement in loan yields, which contributed 79 basis points to net interest margin, and our liquidity portfolio yields, which contributed 44 basis points. RSAs were $1 billion in the fourth quarter and 4.68% of average loan receivables. The $224 million year-over-year decrease was primarily driven by the impact of portfolios sold in the second quarter of 2022 and higher net charge-offs, partially offset by higher net interest income. Provision for credit losses were $1.2 billion for the quarter. The year-over-year increase reflected the impact of a growth-driven $425 million reserve build and higher net charge-offs. Other income decreased $137 million, primarily reflecting the impacts of the prior year's venture investment gain and the current quarter's higher loyalty costs driven by our strong purchase volume. Other expenses increased 3% to $1.2 billion, primarily driven by higher employee costs, technology investments and transaction volume, partially offset by $75 million of asset impairments and certain incremental marketing investments recognized in the prior period. The fourth quarter employee cost included certain additional compensation items of $21 million, higher stock-based compensation and higher headcount driven by growth and in-sourcing. Total other expense included $12 million of additional marketing and growth reinvestment from second quarter's $120 million gain on sale proceeds. As detailed in the appendix of our presentation, the $120 million gain on sale and reinvestment made in the second, third and fourth quarters of this year were EPS neutral for the full year 2022. Our efficiency ratio for the fourth quarter was 37.2% compared to 41.1% last year. Putting it all together, Synchrony generated fourth quarter net earnings of $577 million or $1.26 per diluted shares. We also generated a return on average assets of 2.2% and return on tangible common equity of 22.1%. Next, I'll cover our key credit trends on Slide 10. The external deposit data we monitor continues to reflect a slow reduction in consumer savings. Average deposit balances at the end of December were down approximately 5% from their peak in March of 2022, but still approximately 1% higher than 2021's average and 12% higher than 2020's average. On an annualized trend basis, the savings decline that began around that March 2022 peak appears to have started to slow in December, primarily in terms of its intensity. Turning to Synchrony's portfolio, credit normalization continued as expected during the fourth quarter. These digits are still performing better than 2018. And delinquency entry rates remain lower than the historical average at approximately 80% of their pre-pandemic levels. That said, as consumer savings rates has decreased, borrower payment behavior is reverting towards pre-pandemic levels with normalizing entry rates into delinquency and higher roll rates in early delinquency stages following the charge-offs. This trend continued in the fourth quarter as payment rate normalization trends expanded from the nonprime segments of our portfolio into the prime and super prime segments, where the average outstanding balances tend to be larger. Relative to period end receivables, our 30-plus delinquency rate was 3.65% compared to 2.62% last year and our 90-plus delinquency rate was 1.69% versus 1.17% in the prior year. And our fourth quarter net charge-off rate increased to 3.48% from 2.37% last year, still remaining well below our underwriting target of 5.5% to 6%, at which point portfolio credit risk is better optimized relative to profitability. Our allowance for credit losses as a percent of loan receivables was 10.30%, down 28 basis points from the 10.58% in the third quarter, primarily reflecting the impact of an asset growth-driven reserve builds, which was more than offset by the impact of receivables growth in the denominator. Moving to another source of Synchrony's strength, our capital, liquidity and funding. Deposits at the end of the fourth quarter reached $71.7 billion, an increase of $9.4 billion compared to last year. Our securitized and unsecured funding sources decreased by $316 million. Altogether, deposits represented 84% of our funding, while securitized and unsecured debt represented 7% and 9%, respectively, at quarter end. Total liquidity, including undrawn credit facilities, was $17.2 billion or 16.4% of our total assets, consistent with last year. We maintain a diversified approach to both our deposit base and our secured and unsecured debt issuances and prioritize a strong and efficient funding foundation of at least 80% deposits. We expect to continue to grow our deposits to fund our growth, and we'll maintain an opportunistic approach to secured and unsecured issuances when market conditions are supportive of efficient funding. We manage our balance sheet to be interest rate neutral. That said, as we continue to grow our deposit base, and given the level of interest rates, consumers are actively rotating from savings to CDs. This has had the effect of extending our deposit duration while making our balance sheet slightly liability sensitive. We will continue to manage interest rate risk through term maturities. It's also important to note through its mutual alignment of economic interest and delivery of a minimum return on assets at the partner program level, Synchrony's RSA will provide some offsetting support to the impact of rising interest rates on our business. Moving on to discuss Synchrony's capital position. Note that we previously elected to take the benefit of the CECL transition rules issued by the joint federal banking agencies. As a result, starting this past January of 2022, and continuing in January of 2023, Synchrony makes an annual transition adjustment of approximately 60 basis points to our regulatory capital metrics until January of 2025. The impact of CECL has already been recognized in our income statement and balance sheet. It should also be noted that the FASB CECL update for the accounting of TDRs becomes effective for Synchrony as of January 2023. This accounting standard update eliminates the separate recognition and measurement guidance for TDRs, which previously followed a separate process using a discounted cash flow methodology to quantify the TDR-specific reserve requirement. Synchrony is adopting this update on a modified retrospective basis as of January 1, 2023. Based on our current estimate, the adoption will result in approximately $300 million reduction to our reserve balance, which we recognize net of tax and equity. The netted impact of the adoption will contribute approximately 25 basis point increase to our capital ratios. From a capital metric perspective, we ended the quarter at 12.8% CET1 under the CECL transition rules, 280 basis points lower than last year's level of 15.6%. The Tier 1 capital ratio was 13.6% under the CECL transition rules compared to 16.5% last year. The total capital ratio decreased 280 basis points to 15%. And the Tier 1 capital plus reserve ratio on a fully phased-in basis decreased to 22.4% compared to 24.4% last year. Synchrony continued our track record of robust capital returns in the fourth quarter. In total, we returned $803 million to shareholders through $700 million of share repurchases and $103 million of common stock dividends. As of quarter end, our total remaining share repurchase authorization for the period ending June 2023 was $700 million. Synchrony remains well positioned to continue to return capital to shareholders as guided by our business performance, market conditions, regulatory restrictions and subject to our capital plan. As we make further progress toward our targeted capital levels, we look to develop our capital structure through the issuance of additional preferred stock and the issuance of subordinated debt. Finally, let's turn to our 2023 outlook for the full year, which is summarized on Slide 13 of our presentation. We expect strong consumer demand for the wide variety of products and services we finance to support continued broad-based purchase volume growth. As excess consumer savings continue to decline, year-over-year purchase volume growth rate should slow. Payment rates should also continue to moderate but weâre still expected to remain above pre-pandemic levels throughout 2023. Together, these dynamics should contribute to ending receivables growth between 8% and 10%. We expect our net interest margin to be between 15% and 15.25% for the full year and follow typical seasonal trends. This outlook is based on a peak Fed funds rate of 5.25% and incorporates the following five impacts during 2023. One, the increase in interest-bearing liabilities cost due to higher benchmark rates and the potential competitive pressures or higher retail deposit betas to address funding needs; two, higher interest and fee yields, partially offset by higher income reversals as delinquency and charge-offs continue to normalize; three, an increase in our liquidity portfolio yields, primarily reflecting the higher benchmark rates; four, the fluctuation of mix of average loan receivables relative to average interest-earning assets as driven by the seasonal growth trends and timing of our funding; and five, the full year impact of the portfolios sold during second quarter 2022. Before we turn to our credit outlook, it's important to note there are a number of uncertainties that could change our expectations and the trajectory of credit normalization. We have greater visibility for the first half of this year and any significant changes in the medium-term macroeconomic backdrop would more likely impact portfolio credit trends in 2024. With regard to our portfolio's credit trajectory in 2023, we expect most of the portfolio delinquency metrics to have reached normalized levels or equivalent to pre-pandemic levels by midyear. Accordingly, the associated charge-offs will reach pre-pandemic levels approximately six months later. The seasonal impact of tax refunds and bonuses in the first half, and the third quarter's acceleration of receivables growth will likely lead to a decline in net charge-off rate for Q3 before credit losses rise and continue the normalization path through the fourth quarter. Given our expectation that delinquency metrics will reach their pre-pandemic levels by midyear, we expect net charge-offs to be between 4.75% to 5% for the full year, still considerably below our pre-pandemic annual loss rate target of 5.5% to 6%. We run multiple economic scenarios to inform our credit outlook as part of our normal business process. Our baseline reserve assumptions include an unemployment rate of approximately 4.2% by year-end. We have qualitative overlays for the current uncertainty and possibility of a mild recession. In this scenario, we'd expect the unemployment level closer to 5%. This is reflected in our fourth quarter 2022 reserve rate, which is still higher than our day 1 CECL rate. Barring any significant changes in the macroeconomic environment, we do not expect our portfolio to reflect our fully normalized annual loss rate target until 2024. Accordingly, we continue to expect reserve builds in 2023 to be generally asset-driven and that the reserve rate will gradually migrate towards approximately 10% as credit normalization brings our portfolio net charge-offs back to that mean annual loss rate to which we've been underwriting. RSA expense will continue to serve as a functional alignment of economic interest with our partners, reflecting the strength of our program performance and purchase volume growth, offset by rising net charge-offs. As a result, we expect RSA as a percent of average loan receivables to be between 4% and 4.25%. Should credit normalize at a slower rate than we expect, RSAs will likely come closer into the high end of that range. And the extent that funding costs or net charge-off rise to the high end or beyond of our current assumptions, we expect the RSA to come in to the low end or lower than this range. In terms of other expense, we remain committed to delivering operating leverage, such that expenses grow at a slower rate than net interest income. Our full year expectation that expenses will run approximately $1.125 billion per quarter to the extent that receivables or revenue growth is not tracking ahead of expense growth for the full year will moderate our spending where appropriate while still prioritizing the best long-term prospects for our business. As we demonstrated throughout this past year, Synchrony's business and financial models are performing as it's designed to do. Our proprietary data and analytics, diversified product suite and dynamic tech stack allow us to reach and improve more customers for the same level of risk while leveraging low customer acquisition costs and driving greater customer lifetime value. Our retailer share ranges are effectively aligning our partners' economic interest with our own, and in doing so, enabling Synchrony to deliver consistent risk-adjusted returns through changing market conditions. And our robust balance sheet is providing funding flexibility as we seek to provide continuity to our customers and partners when they need it most. In short, Synchrony is uniquely positioned to deliver sustainable growth and resilient risk-adjusted returns even as market conditions change and the needs of our customers and partners evolve. We remain on track to achieve our long-term financial operating targets as market conditions stabilize. Thanks, Brian. Looking to 2023 and beyond, Synchrony is well positioned to navigate the uncertainties of the operating environment that lies ahead. As we continue to leverage our differentiated business model to add new and deepen existing customer and partner relationships, further scale our comprehensive product suite, enhance our programs and expand our markets and deliver best-in-class experiences centered around each customer's individual financing needs. Synchrony will increasingly attract new customers and forge more expansive relationships, support our partners' ability to grow through evolving market conditions and solidify our leadership position as the digital ecosystem of choice, all while driving consistent, high-quality growth at strong risk-adjusted returns for all stakeholders. That concludes our prepared remarks. We will now begin the Q&A session. So that we can accommodate as many of you as possible, I would like to ask the participants to please limit yourself to one primary and one follow-up question. If you have additional questions, the Investor Relations team will be available after the call. Operator, please start the Q&A session. Great. Thanks very much. And thanks for all of the detail around the guidance and the performance. I think the -- Brian -- I guess, Brian Doubles, you talked a lot about some of the enhancements to your products. Maybe could you just amplify a little bit as to how you're thinking about Synchrony's role with your partners in this current environment? I mean, it seems like this is an environment in which you're -- and what I hear from the retailers that they're going to need your help more. Just talk a little bit about how to think about the things that you talked about that you're doing and how that's going to help Synchrony and the shareholders? Yes. Sure, Moshe. Thanks for the question. You're absolutely right. I think our partners, in an environment like this, tend to lean on us even more heavily. It's -- there's a lot of uncertainty out there that we've all talked about in terms of consumer trends and behavior and what we can expect from inflation and just kind of the broad uncertainty around the macro environment. And so our partners look at us and they say, okay, what are we doing to drive sales? What are we doing to drive new accounts? And this is when they lean even more heavily on the rewards programs and the credit customers, we've talked about in the past, always is their best most loyal customer. And so in this kind of environment, this is where they really double down and have really constructive discussions around, should we be refreshing the valve prop, should we be doing more promotions, more offers, are there new capabilities and new products that we should be introducing? And we've had really great discussions with our partners, particularly around the multiproduct strategy. So the combination of being able to offer a revolving credit product and installment buy now pay later loan and how those products work together. And one of the things that, as you know, we've been very focused on in that multiproduct journey is creating an easy experience for the customer, but also a really easy experience for a partner. So how do you offer multiple products and use our data-driven analytics to make sure that the customer, their customer is getting the right product, the right offer at the right time. And I think in an environment that we're heading into, that becomes even more important. So going all the way back to our Investor Day, we talked about that strategy. We spent a lot of time on it, and I do believe still to this day that the multiproduct strategy is the winning one. And we're hearing that from our partners. They're highly engaged in it. And I think, over time, it's going to pay big dividends for Synchrony and all of our stakeholders. So thanks for the question. Great. And maybe just to flip this over to Brian Wenzel. As you kind of factor all of that into the financial aspects, where are the areas you think that this could kind of help either already embedded in that guidance or where it could -- things could be better as we go through 2023? Yes. Thanks, Moshe, for the question. As I think about it, that engagement really to drive the compelling value proposition and linkage to the customer can really drive, what I would say, spend probably above what you'd see either in retail sales or in the general economy. So that would help fuel a lower payment rate as well. So I think you can see upside to the asset of 8 to 10, if that gained a lot of traction in 2023. Brian, maybe to just start on the loan growth guidance, can you maybe just unpack some of the drivers behind it. I think you mentioned 30 new business wins. Brian Wenzel, you talked about solving payment rates and also maybe expectations for purchase volume growth. And then I guess any color across which platforms you expect to drive the growth just given the robust growth you've seen along with shifting views on inflation? Yes. So thanks for the question, Ryan. So I think as you think about our asset growth, there's two dynamics that come into play. One is, you will see a slowing payment rate. Now, again, we don't expect the payment rate for the entire business to get back to historical levels during 2023. So that is one that will help you from an asset perspective. But if you believe that the economy is going to get a little tougher, the headwind then becomes, will the consumer pull back on spending a little bit? So I think those two dynamics kind of play with each other and how we think about it. Again, if the economy doesn't -- is stronger than we think, again, I think -- I still think you'll see slowing payment rate, but you'll see stronger sales kind of going in and you could have upside in that scenario to the outlook. Got it. And maybe as my follow-up, Brian, your comments on the RSA dependent on the trajectory of credit. So maybe just to clarify, so we're talking about 4% to 4.5% this year, which is lower than the 4% to 4.5%. I think you talked about it in Investor Day, yet, we're still not back to normalized levels of credit until '24. So my question is, have the goalposts for the RSA move down? What are some of the moving pieces that would have driven that? And is it possible that we could be operating below the 4% level at some point? Yes. Thanks. First, Ryan, just to make sure we're on the same page. The guidance for full year 2023 is 4% to 4.25%. And again, I think you have a couple of things. One, you do have a little bit of the net interest margin coming down that plays through the RSA, #1, with the interest-bearing liabilities cost going up. Two, you have the increase in that charge-off rate kind of coming through. Three, you have a little bit of the OpEx piece coming through. And four, you have growth in the denominator with really receivables. So I think that plays through -- to the extent your question, can it operate below a 4% level? Yes, it can operate at 4% level, but that would be more dependent upon trajectory of net charge-offs and how much of that is offset through net interest margin. Again, given the timing of losses, we're sitting here mid-January, which we have pretty good visibility really through mid-July now. So there is an opportunity for it. Again, we've given you the guidance we think is the best estimate for 2023 as we sit here today. Can you talk a little bit about regulatory risk specifically around what the CFPB might do on late fees, any timing or kind of your updated thoughts? Yes, sure. So look, I think the timing that's been kind of speculated upon out there is pretty much in line with what we assume, which is we might know something here in the first quarter, but I think probably won't have an effective rule until late this year or early next year. So again, pretty much in line with our expectations. We're prepared for that. I think we've talked about in the past that about 60% or a little over 60% of our late fees sit in programs that have an RSA, so that's an offset. Obviously, we'll work with our partners on that. They have an incentive to help us offset the impact if there is one. So we're ready for it. We're preparing internally. We'll see what comes out. But I think we'll have some time between when we have some clarity and probably an effective rule, like I said, late this year or early next year. Got it. And can you talk a little bit about the relative health of the low-end consumer versus prime, what you're seeing? Yes. Look, I think internally, we certainly talk about a K-shaped recovery. I think we're certainly seeing that out. I think, broadly, the consumer is still healthy. I think they still have savings. We're seeing really good spend patterns, great spend on our products, in particular. Last year was a record year in terms of purchase volume. So generally, we feel pretty good about the operating environment. With that said, clearly, there's uncertainty as we move throughout the year depending on inflation and where rates go. So we're watching that very carefully. Our credit teams are highly engaged, and they're monitoring the portfolio to see where we need to make some tweaks and adjustments along the way. I don't know, Brian, if you'd add anything to that? Brian Wenzel, I wanted to dig into some of the commentary on credit quality. You mentioned you're assuming 4.2% unemployment rate, but the qualitative assumption is in the 5% range for the reserve rate. I'm just curious what kind of impact would there be to the charge-off rate if the unemployment rate reaches 5%? And then you mentioned -- or I guess, does this mean that there's no impact to the reserve rate if we migrate to the 5% unemployment? Yes. Thanks for the question, Sanjay. So the qualitative portion, which brings the unemployment, effective unemployment rate up to that, call it, 5% level, again, we look at claims. But that essentially says that in that environment, there probably wouldn't be any form of significant rate-related reserve increases. Again, for the impact in net charge-offs, there is a timing issue here that happens. So the unemployment rate have to move up pretty rapidly in the beginning part of the year to have a factor in the back half of the year, which would impact the net charge-off rate. So if that happens, you're probably more looking at some headwinds towards 2024 from a net charge-off basis, but again, you should have that reserve for in the short term. Yes. I mean, obviously, we were most sensitive to unemployment claims. Obviously, there are other things in the economy that we are sensitive to, but that would be the biggest factor for us to have to relook at reserves. And again, I know there's a lot of questions on reserve rate dipping down. That's a seasonal factor that happens every fourth quarter because of the denominator. I mean we're up in absolute dollars from third quarter to fourth quarter. And again, you'd expect as your receivables come down in the first quarter, that rate to rise. Okay. And just a follow-up question for Brian Doubles. Maybe you could just help us think about how you're managing the business as you're thinking about loan growth, obviously, very undecided on where the economy is going as a whole, I think. And then any flexibility you might have on expenses to the extent that we have a more adverse scenario? Yes, sure. I mean, look, we've talked about this in the past that we try and manage the business really well through cycles. And we try and provide a level of consistency to our partners in terms of how we underwrite. And so if you look at the last couple of years, we're coming out of the absolute best credit environment we've ever seen in the history of the business. And we didn't take an opportunity to underwrite a lot deeper. And I think that's why you saw, again, I think, more consistent loan growth from us than maybe some others, and that's really important to our business. Because if we take an opportunity to really underwrite deeper and take approval rates up, then we know, at some point in the future, we're going to have to pull back on that. And we try really hard not to do that. Again, consistency is really important to our partners. So we feel pretty good about the guide for next year, the 8% to 10% growth. And we think that that's prudent. That's not -- that doesn't assume significant changes in how we're underwriting. Now clearly, if things change, and we see the macro environment play out differently than we're contemplating right now, then we'll go in, and we'll make some tweaks, and we'll make some adjustments. But we feel pretty good about the 8% to 10%. And look, I think the one thing on expenses, you've seen us be pretty disciplined over the years. We had some opportunity last year to make some incremental investments. We did that. Really happy with the return and the payback on those investments, but we stay really disciplined there. And if we head into a tougher environment in '23 or '24, then certainly that's an area that we'll look to pull back on if we have to. My question is relating to capital and capital distribution for 2023. As we think about ending the year at 12.8%, I guess this is a two-part question. #1, does your buyback trajectory get impacted by the macroeconomic uncertainty, even though your receivables growth is set to slow in '23? And secondarily, is this -- is there an amount of cushion that management wants to hold against that 11% target, not necessarily for macro uncertainty, but for potential opportunity use in terms of purchases in case those arise, portfolio purchases in case those arise? Yes. Thanks, Erika. So to your first question on the macroeconomic environment, right now, we're going through the early stages of developing our capital plan that we'll submit to the Federal Reserve in the latter part of March. So we go through that. With that capital plan, we run a number of different loss stresses and severe loss stresses in the idiosyncratic stresses in order to inform us really of what the range of outcomes are and how comfortable we feel with the environment. And again, as we said, throughout 2022, we feel very comfortable in the environment continuing on the capital plan that we laid out and submitted to the Fed last March and got approved in April. So we will use that to inform it. Again, during the year, we go through multiple stress scenarios. So we continue to feel good even under a stress scenario that the targets and the environment that we will continue to operate with a very good capital plan. So we'll do that to inform us. With regard to the level of capital, 11% is our target. Now the first thing to remind you and others of is we have to continue to fully develop our capital stack right through incremental Tier 1 through a preferred or -- and then obviously through Tier 2, whether that be sub debt or incremental preferred. So we have to continue to develop the capital stack to even be able to achieve the Tier -- the CET1 target. And then secondarily, I think every company operates with a little bit of operating range. The real positive part of our business, Erika, is that we generate a lot of capital each year, which we employ back in. And obviously getting down to 12.8%, the growth that we've anticipated when we talked to you back in October, 12%, we came in at 15%. So we're able to fund that growth, and that's really, we think, very attractive returns that will continue to generate capital as we move into '23 and beyond. So yes, there is some type of operating range. But again, the target also has a buffer to it, so you can most certainly go through that buffer a little bit if you wanted to do an acquisition. So that's not a floor, it's just a range in which we operate with, and we'll continue to try to deploy capital in a manner that's in the best interest of our stakeholders. And my second question is a follow-up to an earlier question about the reserve. I just wanted to clarify, fully understand the comments on the trajectory of losses from here. However, on the reserve, if we did end up with an unemployment rate at the end of the year that is closer to 5% versus 4.2%, I just wanted to make sure I understood this correctly, will there be an increase in the reserve rate or -- that's more significant? Or does the qualitative take care of any potential increases from that 4.2% baseline? Yes. Yes, thanks for the question, Erika, and I'll try to be clear here. The 4.2% is the baseline, which we take from Moody's. Effectively, when we run through the model, you're probably more like 4.5%. There are qualitative overlays that bring it effectively to 5% right? Or closer to 5%? So in theory, if you were to hit that, there should not be rate related provisioning. It should just be growth-related provisioning at that point. It's only if your outlook changed above 5%, which you would anticipate more rate-related increases. In your press release, you noted that you had added or renewed 25 programs, including Lowe's, which has historically been one of the largest partners that you have. Can you just talk a little bit about, are you starting to push some of these renewals past 2025, which I know you had a lot of them locked in through 2025? And what's the competitive environment for these renewals today? Yes. So look, first, I would say that we're always looking to renew where we can at attractive terms for us and the partner. So the teams that we have on the ground sitting with our partners every day, you come across things where it makes sense to add some years to the deal investments we want to make, changes in valve prop, et cetera. So our teams are out there every day, finding ways to renew in ways that benefit our partners and benefit us. So we're thrilled to extend with Lowe's. They're one of our oldest clients. I think this extension will take us over 50 years, which is pretty incredible when you think about it. I would say, competitively, just more broadly, it's still competitive, very competitive environment. But I do think, as you start to head into periods of uncertainty like we're heading into now, you do start to see the competition get even more disciplined. And we all know and appreciate that we're not going to be operating at half of our targeted loss rate like we saw in the last couple of years, and you start to see that discipline work its way into the competitive dynamics. So I think that's good. We're a very disciplined bidder in these processes, and it's nice to see that kind of happen across the industry. So we feel really good about how we're positioned. I think in times like this, back to the earlier conversation, you're really competing on capabilities. And that, combined with good price discipline across the industry, is a good thing for us. One question to follow-up on something you mentioned in the prepared remarks. Normalization, you're seeing migrate into prime and super prime, I think I heard you right there. And I just wanted to understand if you were just talking there about the payment rate normalization? Or are you also talking about normalization in delinquencies and your net charge-off outlook? Maybe you could unpack what you meant a little bit more, if you don't mind? Yes. So as Brian mentioned earlier, not many will talk about it, but there is, what I would say, a more K-shape recovery or we're seeing it, where the lower end consumer has been normalizing at a faster rate both, I'd say, from a payment rate behavior standpoint as well as a delinquency and charge-off standpoint. And as you continue to move away from the pandemic and stimulus, you begin to see the other cohorts, which is the prime and super prime, which had already started to normalize, continue to add normalization trends. I think the important part for us, Betsy, is as we take a step back and think about the entire portfolio for a second, if you looked at historical 30-plus and 90-plus-day delinquencies to pre-pandemic levels and applied it to our balances as you step through this year, what you'd see is a very linear normalization of delinquencies for us. And again, that's really the bottom end normalizing a little bit quicker. And now you're starting to see the top end. So -- but if you look at that linear pace beginning in the first quarter last year, I mean, we're about 80% of our pre-pandemic delinquencies and it's moved about 10 percentage points each quarter. So we're not seeing an acceleration in normalization. It just kind of is flowing through and that's on top of a larger balance, but it is normalizing in a manner in which we expected. But again, there is a little bit of a K-shaped recovery where we're starting to feel -- again, moving back, all our vintages from '20 on are performing better than our vintages in 2018. Yes. And that was -- part of the follow-up was around the vintages. So your vintages '20, '21, '22, pretty similar. And I guess the underlying question here is, as the performance is coming in relative to what you had pre-pandemic, how much more room is there for opening up the credit box or pulling in incremental loan growth? Yes. I mean, if you break it apart for a second, Betsy, the '20 vintage and obviously, the early part of 2021, that's performing the best, right, because that's when we put in refinements at start of the pandemic because no one knows what's going to happen. Latter part of '21 and '22 performing between that vintage and 2018. So I think, in all cases, they're doing better, but again, they're slightly different under different underwriting standards. I don't envision, and Brian talked about this, the consistency that we have both in underwriting for origination, but account management that we're going to use that as a growth lever. I think we have a really diverse and attractive set of partners, so we get spend across a multitude of different verticals and categories. And then when you look at the fact that we're really having -- have compelling value propositions and are aligning to our most loyal customers at our partners, we don't have to use credit or growth engine as opposed to others. So I don't envision us using credit and opening up the credit box from here forward. Right now, what we're doing is we're making modest refinements when we see things that concern us, but we're not doing anything across the board because we don't see it across the board in our portfolio. I just wanted to follow up on some of the capital questions. If we did see a rapid increase in unemployment from a base rate of 3.5% to roughly 5% or maybe somewhere around that level as we approach year-end '23, I mean would you start to consider your capital levels to have already embedded that type of unemployment rate or those types of assumptions of economic deterioration just given the stress test? Or do you feel like you need to be a little bit more cautious given the outlook could change rapidly in that type of environment? Yes. So first of all, thanks for the question, Kevin. When we think about our capital plan and the stress test we run, the unemployment rates that we use in those stress tests are significantly higher than 5%. So the 5% isn't concerning on its face value relative to capital and our capital levels. What really we would look at and our risk committee and the Board would look at is, is there a reduced visibility into the macroeconomic environment where you're concerned, or in the case -- or in the case where you're concerned about the level of net income being generated. That's where you would come back to saying, "Hey, listen, should I think about capital differently?" But remember, these stress test models are built under a very severe scenario. And as long as you're inside of that, you should be able to -- you continue on your capital plans and be able to weather it. That's why it is. There's a lot of buffers on top of the minimum requirements. So again, it'd be well north of 5% before we get concerned. Okay. And then in regards to -- maybe a follow-up to that on M&A. I think you've mentioned that the valuations are finally normalizing. Are you seeing any attractive opportunities start to develop, whether it's portfolios or other acquisition potential targets given what we see out there today? Yes. Look, I think you're right. I mean we're finally seeing valuations check up pretty significantly in some areas that we're interested in. Our business development team has a very active M&A screen, so that's certainly something that we look at. You've seen us do small acquisitions where we can kind of leverage our scale, Allegro is a great example of that, pets Best is a great example of that, and we've grown those businesses very significantly since we acquired them. But we're a very disciplined buyer as well. Those were very modest in terms of the capital outlay, but we saw a lot of future growth and earnings potential. Those are the things that we like to do. And so if we can do more acquisitions like that, we'd certainly look to do that, but we're a very disciplined buyer when it comes to allocating capital to M&A. I guess first one is just on the NIM. You talked about deposit durations changing and so forth. Maybe can you just detail to us, is the shift in deposit prices mostly over what your outlook is there? And any characteristic of kind of the duration of deposits now versus where it has been? Yes, thanks for the question, John. So I will deal with the latter part of the question first. So yes, we have seen an extension of the duration a little bit. People have rotated into CDs and we see people into, call it, that 18 month, 19 month duration. So itâs split out a little bit, I wouldnât say materially. With regard to pricing as we move forward, I mean obviously when we gave the NIM guidance here, what we saw in 2022 was really a change in the landscape, right? You had a lot of people trying to manage betas in the beginning part of 2022 and then when they fell at the outflow of deposits during the year, got more aggressive with regard to price. I think you saw a lot of that happen in the latter part of the year. It's been very stable now. So our outlook includes deposit betas getting a little bit worse than they have been from here, particularly on the CDs. So again, this is going to be something that we're really going to watch relative to the Fed's actions at the next couple of meetings and what their guidance is with regard to the terminal rate that they have out there. But we plan for in this guidance to have betas deteriorate in 2023. Okay. That's helpful. And then a second question, maybe can you characterize -- you have some traditional partners, traditional retail partners like Lowe's and so forth and then digital platforms like Amazon and PayPal. Is there anything worth noting about the general trends in the different types of platforms and how that might manifest itself over the course of '23? Yes. Well, so obviously, we serve a very broad range of partners, as you indicated. And clearly, you saw really strong growth in Digital, strong growth in Health & Wellness. We would expect that to continue. I'll tell you where you see the biggest differences, John, is actually in how we engage with those partners. And our solutions inside of those partners differ quite a bit. Venmo and PayPal is a great example where we're completely integrated through our API architecture. And if you're inside of the PayPal or Venmo app, you don't know if it's something that we built or something that PayPal built. It is really seamless to the customer. And that's really important. And I think that really helps make that experience a good one for the customer and helps us drive growth over the long term. And you compare and contrast that with what we're trying to do in the one-to-many space like with Clover and other solutions where we want to make it really easy for our smaller partners to leverage the financial products that we have, and we have to do that by building it once and then scaling it across the enterprise. So you really run the gamut from highly customized, fully integrated API architecture to a one-to-many solution, which just makes it really easy for our partners to offer our financing products. So that's where you see the biggest difference between our partners and the partner set that we have today. I'll tell you, at any given time, you're going to have some partners that are doing really well and just crushing it, and you're going to have some partners that are maybe struggling a little bit. As I said earlier, heading into uncertain times like this, the credit program becomes even more important, and that's consistent across the board. So heading into an environment like this, we feel like we're really well positioned to help our partners succeed. I just want to talk a little bit more about the reserve rate outlook. End of the quarter, 10.3%, day 1 was 9.9% There was a suggestion that it will sort of trend back towards 10% over time, roughly in line with day 1 levels. I think what that implies to me is that as we've gone through the learning process on the CECL models versus day 1, that there has not been a material evolution in terms of sort of loss expectations that the reserve rates will sort of, on an apples-to-apples basis, be consistent with day 1. Is that the right way to think about things? And can we just put that in the context of the normalization over the next 18 months? Yes. Thanks for the question, Rick. So I think if you looked at the assumptions that went into the day 1 CECL model versus the assumptions that are in the model today, they're very close to each other. So I do think that you're in a position where there's not a significant difference right now. Where there is a difference is the macroeconomic overlays that we have in here that are much more significant than what they were on day 1. So as that macroeconomic environment clears, right, either through the losses or through the fact that we were more conservative or things didn't play out the way we thought, you're going to begin to migrate back towards that day 1 level. Now remember, in CECL, at the end of the day, you forecast out for a reasonable and supportable period, right, that you have losses, and then you migrate to your mean. So at the end of the day, that mean hasn't changed for us and our expectations. I mean, obviously, I'd like to say we had a normal period during CECL, but unfortunately, over the last two-plus years, we have not. So again, we'll revisit at some point in the future what the mean loss rate is. But again, that does play into the fact that you will ultimately migrate and they should come back in line absent mix. Got it. Okay. That's very helpful. And I think, like everybody, we're all exhausted of living through unprecedented times and returning to normal would be nice. This concludes Synchrony's earnings conference call. You may disconnect your line at this time, and have a wonderful day. Thank you.
|
EarningCall_1106
|
Good day, and welcome to the W. R. Berkley Corporation's Fourth Quarter and Full Year 2022 Earnings Conference Call. Just a reminder, todayâs call is being recorded. The speakers remarks may contain forward-looking statements. Some of these forward-looking statements can be identified by the use of forward-looking words including, without limitation, believes, expects or estimates. We caution you that such forward-looking statements should not be regarded as a representation by us that the future plans, estimates or expectations contemplated by us will, in fact, be achieved. Please refer to our Annual Report on Form 10-K for the year ended December 31, 2021 and our other filings made with the SEC for a description of the business environment in which we operate and the important factors that may materially affect our results. W. R. Berkley Corporation is not under any obligation, and expressly disclaims any such obligation to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise. Bo, thank you very much, and good afternoon all, and a warm welcome to our fourth quarter call. On this end-of-the phone co-hosting with me is Bill Berkley, our Executive Chairman, as well as Rich Baio, our Executive Vice President and Chief Financial Officer We're going to follow the typical agenda as we have done in the past and I'm going to hand it over to Rich momentarily. He's going to walk us all through some highlights of both the quarter and the year. Once he is through with his comments, I'll pick it up from there, offer a few observations and thoughts of my own and then we will be looking forward to opening up for Q&A and taking the discussion anywhere participants would like it to go. One thing before I hand it over to Rich, and that is just maybe taking a moment to pause and reflect publicly on the year, and we'll be getting into the numbers and the results, but it does seem appropriate, at least from my perspective and our Chairman's perspective to extend some recognition. Thank you and congratulations to our colleagues. I have the good fortune of being the mouthpiece or the one that has the opportunity to talk about the results, along with Rich and Bill Berkley, but these results, these outcomes were achieved because we have thousands of people that are working diligently every day in a thoughtful and methodical manner. So to all my colleagues that happen to be tuning in, I hope you will accept the heartfelt thank you again and congratulations on a job very well done. Of course, and thanks, Rob. Appreciate it. 2022 can be marked as a record year in many areas of the business. The company ended the year with a strong fourth quarter. Net income increased almost 30% to $382 million, or $1.37 per share with an annualized return on beginning of year equity of 23%. Operating income increased approximately 14% to $323 million, or $1.16 per share with an annualized return on beginning of year equity of 19.4%. Our results reflected record underwriting income as well as net investment income. Severe named cat activity continued to challenge the industry, as evidenced this quarter by winter storm Elliott and prior quarter events like Hurricane Ian amongst many others. Our disciplined underwriting approach and exposure management led to record pretax quarterly underwriting income of $292 million, representing an increase of approximately 12% over the prior year. On a full year basis underwriting income eclipsed the prior year by 21.3% reaching more than $1 billion for the first time in the company's history. Pretax cat losses were $31 million or 1.2 loss ratio points in the quarter compared with $48 million of 2.2 loss ratio points a year ago. Net premiums written increased to more than $2.4 billion. The growth in the top line was adversely impacted by approximately 75 basis points due to the weakening U.S. dollar relative to many foreign currencies. On a segment basis, insurance grew 7.2% in the quarter to more than $2.1 billion from rate improvement and exposure growth. All lines of business increased with the exception of professional liability. The Reinsurance and Monoline Excess segment increased to $281 million in the quarter, with growth in all lines of business. On a full year basis, gross and net premiums written grew to record levels of $11.9 billion and $10 billion respectively. The current accident year loss ratio, excluding catastrophes was impacted in the quarter by non-weather related property losses, which drove the increase of approximately 1 loss ratio point to 59.3%. Prior year losses developed favorably by approximately $0.3 million, resulting in a calendar year loss ratio of 60.6%. The expense ratio was flat at 27.8% quarter-over quarter. Record quarterly net premiums earned through -- grew more than 14% in the quarter, continuing to benefit the expense ratio. We do anticipate that our 2023 full year expense ratio should be comfortably below 30%, taking into consideration, investments in technology, rising compensation costs, and new startup operating unit expenses. In summary, our current accident year combined ratio, excluding catastrophes for the quarter was 87.2% and our calendar year combined ratio was 88.4%. Net investment income for the quarter increased more than 40% to a record of approximately $231 million, led by income in the core portfolio, which increased approximately 75%. The combination of our short duration, high quality fixed maturity portfolio, along with record level operating cash flow of approximately $2.6 billion in the full year enabled us to invest at higher interest rates. Our book yield on the fixed maturity portfolio increased from 3% for the third quarter to 3.6% for the fourth quarter, which compares very favorably to 2.2% in the year ago quarter. Our new money rate exceeds the roll-off of our invested assets and we expect net investment income to continue to grow. The investment funds performed well, with a book yield of 5.6%, despite the deterioration in the broader equity markets in the third quarter. And as you may remember, we report investment funds on a one quarter lag. The credit quality of the portfolio remains very strong at a double A minus with the duration on our fixed maturity portfolio, including cash and cash equivalents of 2.4 years. Pretax net investment gains in the quarter of $75 million is primarily attributable to an improvement in unrealized gains on equity securities of $88 million relating to investments in the industrial, energy and financial services sectors The company actively manages its foreign currency exposure. The U.S. dollar weakened in the quarter relative to many foreign currencies, which resulted in a pretax, foreign currency loss of $34 million. For the most part, this loss was offset by an increase in our currency translation adjustment, a component of stockholders' equity. And accordingly, the result was an immaterial net impact on book value. Stockholders' equity increased more than $400 million in the quarter or 6.3% to $6.7 billion. The unrealized loss position on fixed maturity securities improved in the quarter. Book value per share increased 8.1% and 6.1% in the quarter and full year, before dividends and share repurchases. In addition, book value per share increased 1.7% on a full year basis after returning capital to shareholders of $329 million and our full year return on beginning of the year equity was 20.8%. Richard, thank you very much. That was great. So I have a little bit of a list here of topics that I made notes to myself on, because I think there is a lot going on in the marketplace, a lot of moving pieces. And obviously, we as a market participant are navigating through that. So maybe a place to start would be a macro observation. And I know we've touched on this in the past, but I think it's very important to keep top of mind. It's certainly something that we are as an organization are focused on. And that is the reality that yes, this is still a cyclical industry, and the cyclical nature is driven, as we've discussed in the past by two human emotions, fear and greed. And for those that want to drill down into that more we can do that offline. But the simple reality is that, this is an industry that is splintered. And what I mean by that is, once upon a time, most P&C product lines marched throughout the cycle, somewhat in lockstep. And what we are seeing more and more is major product lines, yes, still operating and behaving in a cyclical manner, but they are very different points in the cycle. And we're just seeing that in a more and more pronounced way. And when people talk about where is the marketplace, I don't think that there is one answer anymore. It needs to be more granular. It needs to be where is the property market, where is the comp market, where is GL, et cetera. And one can even get more granular than that. So I want to spend a couple of minutes talking about, through our lens, how we're thinking about major product lines and where those product lines stand in the cycle, and what are some of the realities stemming from that. So perhaps a place to start would be property. Clearly has gotten a lot of headlines over the past couple of years. I think many have been waiting for discipline to finally turn up and it seems like it is arriving. We have seen it in a much more pronounced manner in the reinsurance marketplace. And we've seen it begin to sprout some green shoots of discipline in the insurance marketplace with undoubtedly more to come. As far as the property insurance marketplace, we were a little bit disappointed by the lack of discipline that appeared in the fourth quarter. We are convinced, we're going to see it more and more as we make our way through '23. But the simple fact is, it wasn't there. And we've been scratching our head trying to figure out why, when everybody knows reinsurance costs are going up, both cat and risks. And you would think that as soon as that becomes apparent, one needs to start to factor that into how you price your product. The cost of that capacity is going up. And one also needs to remember that these reinsurance covers are not with traction. They are losses occurring. So as you're writing business in the fourth quarter to the extent you're able to, you really need to be not just contemplating but incorporating into your pricing, what that new reinsurance capacity is going to cost, even if it doesn't take effect till 1/1 because that capacity is going to be supporting the risks for part of the year that you wrote in the fourth quarter or even the third quarter and earlier. The property market from our perspective is poised for material hardening. We, I think are thought of by some as a not a property market. And quite frankly, while we have been and are having more of a liability bend, it would be a mistake to think that we do not have the skills and the appetite for property, when we think it makes sense, when we believe it is a good risk adjusted return. And there is a better than average chance from our perspective, the marketplace is moving in that direction. Clearly, it's getting there on the reinsurance front and more to come again, in our opinion on the insurance front. Maybe pivoting over to workers' compensation, I think there was either a poem or a song or something that went something along the lines of waiting for the world to change. So this is one that I clearly have missed the timing on. I had thought that the world would have figured it out by now as far as where things are going and what people need to be doing from a loss cost perspective. Clearly. I was mistaken. From my perspective, based on what I see, and I believe my colleagues' perspective is that comp is likely going to continue to bump along the bottom throughout '23 and we can look forward to '24 and beyond hopefully for some considerable firming, which again is something to look-forward to. But in the meantime, clearly requires thought and discipline, and quite frankly from our perspective, it's a little bit unnerving that some rating bureaus seem to not be appropriately taking into account or adjusting for the frequency benefit that occurred during the COVID. Additionally we think one needs to be very thoughtful about severity trend as well, and what that could mean in the future, especially on the medical front. Auto is another product-line that we think requires thought and judgment. From my perspective, I don't think that there is a product line today that is more susceptible than auto to social inflation, if you like. And the good news is, there is rates to be had if you go after it. The challenging news is, you better make sure you're getting it otherwise it's very easy these days to fall behind loss costs. I'm going to lump GL, excess and umbrella into one part, which is kind of inappropriate, but in the interest of time, I'm going to do it. I think those are amongst the brighter opportunities at this stage. Clearly, again, one needs to be mindful of social inflation. But the rate is there to be had. I would tell you of that universe that I'm referring to the only one area that is -- I wouldn't say concerning, but is on the watchlist is the large account excess business, the large sort of Fortune 5,000 towers. There has been a huge amount of rate that's been achieved in that marketplace. But one needs to be very mindful as to how quickly that could potentially erode. Other than that, I think there's a lot of opportunity there. Pivoting over to professional liability, I would suggest that it's very much two stories there. I would say, on one hand you have D&O and then on the other hand, you have, by and large, everything else. The D&O market few years ago, took off like a rocket ship with massive rate increases to say the least. And at this stage it is gradually coming down to earth. I would suggest that the parachute may have a couple of small holes in it, but it requires monitoring. That is clearly becoming a more competitive marketplace. Other than D&O, professional liability, we think offers a great deal of opportunity, and we view that as a place for us to continue to lean into. I would suggest, smaller part of the marketplace, hospital professional liability is also an area that requires thought and caution. Finally, reinsurance with all due respect to my friends and colleagues in the reinsurance space, I think the -- perhaps the expression that even a broken clock is right twice a day, well, this is one of those moments when the clock is right. And we will see with time how much discipline really is in the market and how long it remains or what the staying power is. I know that there was a lot of attention put towards property cat and what 1/1 was going to hold. Clearly, it was a firming marketplace. We did participate in that. I would tell you that the U.S. market was at least at 1/1 considerably more attractive than what, I would define as the international market or ex-US. So what does this all mean for us, as we sort of pivot to the mirror and talk about our quarter, before we get into few follow-up on Richard's comments. I think what it means for us is there is still great opportunity. I think what it does also mean is that we need to continue to be focused, disciplined and prepared to pivot, as opportunities present themselves and as they diminish and other opportunities present themselves. It's one of the great things about our organization and the breadth of our offering and our structure. We are a collection of specialty companies where we have teams of people with great expertise focused on their niche. These teams of people understand cycle management and they understand their loss costs and how to deploy and manage capital. So long story short, we think we're in a pretty good place. As always, you're going to see parts of the business growing, other parts of the business perhaps shrinking, as we capitalize on opportunities. Pivoting to the quarter, again I'm not going to belabor this, because I think Rich, as always, did a great job. But a couple of observations on the top line. He talked about the FX impact. I would also suggest rate and rate adequacy continue to be and will always be our priority. As we see new opportunities presenting themselves, I flagged property earlier on, our presence within the E&S space, I think is going to create meaningful opportunity for us, certainly over somewhere between the next 12 months to 36 months depending on cat activity, quite frankly. But again, we will see with time. As far as rate goes, as you would have seen from the release we got just shy of 7 points of rate and we think that that comfortably helps us keep up with trend and more likely than not perhaps we are exceeding trend. One of the things, just on the topic of rate, and I apologize if you find this repetitive, but it's something that does come up from time to time is, confusion that exists between renewal premium versus renewal rate increase. Our definition and our true North, in our effort to make sure we understand loss cost and margin, is the number of dollars that we are collecting per unit of exposure. It's not about the amount of premium that we happen to collect. If I'm running a trucking company, and I have five trucks. And at the renewal, it turns out that my number of trucks has gone from five to 10 and I end up collecting twice as much premium, that's not a rate increase. That means I've got twice as much premium, but I got twice as much exposure. And in theory, I need to get more than that to keep up with trend. So when we talk about rate increase, let there be misunderstanding. We're not talking about increase in premium, even though ultimately, it may have nurtured that. Our focus is on the amount of money we collect per unit of exposure. And we work very hard to make sure that when we are comparing unit of exposure to unit of exposure over corresponding period that we have unpacked that, so it is as close to apples-to-apples as one can establish. Another comment that I did want to make is on renewal retention ratio. Obviously, different product lines, different parts of the business, we target different levels of renewal retention. When we look at our portfolio overall, we look through the renewal retention to sort of float somewhere between 77 and 80, maybe 81 depending on the mix. When we see that renewal retention ratio ticking up above that, from our perspective, it is an invitation to be pushing rate harder. We want to be in the market at a granular level, testing it every day to be getting as much rate as we can to ensure that we are at a minimum at rate adequacy. That's a very important thing that is a priority for us as an organization. One last quick comment on the top line that we've talked about in the past, which, again, I think speaks to quality integrity. Our new business relativity for the year was above 100 or above1, if you will, which means we are charging a bit more for new business than renewal again for the year. Moving on to the losses. Rich covered that. I know there may be some folks maybe at a high level, okay, 60.6. For those of you that subscribe to the [indiscernible], you may be looking at the 59.3. What you may not realize and I'm about to share with you is that we've had some fire losses in the quarter, and it wasn't in any particular operating unit. It was pretty widespread. And that added somewhere between 1 point -- maybe 1.25 to the loss ratio. We saw it both in the insurance business amongst various operating units, and we saw it in the reinsurance business too. So we are focused on that, trying to make sure that there's not something that we're missing here. And to the extent there is, we want to be tending to it quickly. One last data point, which, again, I've qualified in the past, and I'm going to qualify now is not the whole story, but we believe it is a relevant data point is the paid loss ratio. A couple of historical data points that I'm going to give it to you for the -- these are going to be for the full year, that way, you don't need to worry about seasonality or anything along those lines. Paid loss ratio for 2017, 57; '18, 57; '19, 55; '20, 52; '21, 45; '22, 45. You can interpret that and extrapolate any way you want, I view it as a data point that doesn't tell the whole story, nevertheless, a valuable data point. Rich talked about the expense ratio, 27.8. Certainly, the whole team on this end we continue to try and make sure that we are getting good value for the money that is spent. Obviously, as it relates to compensation, we are trying to make sure that we have done a reasonable job on behalf of our colleagues keeping up with cost of living, and I think we've done a good job staying on top of that. And as Rich also mentioned, we have ongoing investments on the technology front, which we think are very important for the future. Could it tick up a little bit from here? Yes. Do I think that we are focused, as Rich said, in keeping it below 30 and remaining competitive, absolutely. And we are constantly making sure that our acquisition cost is thoughtful. Maybe just spending a couple of moments following on Rich's comments on the investment front as he flags duration sitting 2.4, the book yield 3.6%. And I think as Rich flagged and I will flag again, the new money rate these days is north of 4.5%, we're flirting with 5%. So I will leave it to others to fill in the blanks as to what this means for our economic model. But obviously, when you think about the spread between the book yield and the new money rate and what we're able to achieve and you extrapolate that for what it means for our economic model, I think it is very encouraging. One last quick comment on the investment front. While we are not in a rush and we are going to do it in a very thoughtful way, we certainly are considering beginning to push that duration out towards to 2.6, maybe more towards 2.8 over time. But again, we are not in a rush. We're going to do that in an opportunistic way as windows open and close. So since I'm onto most of you folks that as soon as the Q&A is over, everyone starts hanging up, I'm going to just offer a couple of quick summary comments, and then we will move on to the Q&A. I think we had by any measure, a very strong year. And I think that when you look at how the business is positioned, while nobody knows exactly with certainty what tomorrow will bring, we have a lot of pieces laid out in good position for the coming years to be very attractive for the business. I think that is both the case on the investment side as well as on the underwriting side. As I suggested a few moments ago, you can see where the book yield is and where the new money rate is and what that means. In addition to that, you can see the rate increases that are earning through and what that is going to mean for the business. I know that there are some that are wondering, why is it that we have not dropped our loss picks more quickly. And it is certainly something that we look at and we visit and we revisit. But you need to please understand that we are acutely aware to some of some of the unknowns and how leveraged the model is, and we want to make sure that we do not take the cake out of the oven prematurely. So with that, I think people have probably had more than enough of me. Bo, why don't we please open it up for questions please. Hi. Thanks. Good morning. My first question is on the cat reinsurance side. So it sounds like you guys did see some good opportunities at January 1. Can you just give us a sense of how much growth and how big of an opportunity that presented for Berkley? Yeah. I think that, we saw it as an opportunity, but I don't think you should assume that it's reshaping our book of business as an organization. So I think that we are opportunistic. We put more than a toe in the water, but not more than a foot. And that's just because of our view of volatility. In addition to that, we're going to see what type of opportunities there are in the first quarter and the balance of the year, particularly with some shortfalls in certain market participants covers. Did you guys also change your own outbound reinsurance? Do you have a higher retention this year? Were there any changes on your own program? Yes, and you'll get more detail than you're probably looking for in the K. What I would tell you is that our retention did go up. But relative to the scale of the organization and the earnings power in the quarter, it's not particularly material. And then you made a lot of good market commentary on different business lines. You've in the past spoken about, right, 15-plus premium growth, that's obviously come down reflective, right, of some of the trends in the comp and in liability lines. How do you think when you put everything together, and I know that's hard, where do you think the top line growth could trend over the coming year? Yeah. So clearly, comp has its challenges. As far as the comment you made about liability, if you don't mind, Elyse, I'd like to get a little bit more nuanced. I think it was really just predominantly a piece of the D&O or the D&O market, the piece of the professional liability that being D&O that is becoming notably competitive. And then we're seeing more competition in the large account excess space. The rest of the GL and umbrella market we think is reasonably attractive even in the environment with [indiscernible] social inflation, we think that it makes sense to us. As far as your question about growth, we'll have to see how it unfolds. I would tell you that based on the limited data I have on January so far, early returns are encouraging. But my ability to speak at a detailed level beyond that, I just wouldn't want to mislead you. But we see a lot of opportunity, and we're watching the opportunity shift from over time from one product line to another. So I think we have good balance to the shift, but we also are very nimble amongst the different parts of the business. Hi, Rob. Good evening. My first question is, I'm just wondering, if there were any changes at all to how you're thinking about loss trend here in the quarter, both on short tail and long tail lines. I know last quarter, you said at around a similar rate, excluding comp that you're meaningfully above loss trend or I think it was 100 basis points above loss trend. And I thought the commentary this quarter was -- I think you said it comfortably helping you keep up with loss trend and perhaps exceeding trend. I guess, I'm wondering, was there a change in your trend. I think that I probably need to choose my words more carefully. I think from our perspective, by and large, in the aggregate, we are exceeding loss trend at this stage. So if I left you with a different impression, that would have been my mistake. Got it. Thanks. And then maybe a quick follow-up for Rich. Just could you -- I know for the total company, it was immaterial, but on the prior year reserve development, could you provide that by segment? Okay. Great. And then maybe if I just follow one more on -- add one more on. If I think about your commentary, Rob, was pretty interesting on the property side. And I guess I'm wondering, did your view of your own reinsurance costs and retention change your view of the level of primary pricing on the property side during the quarter. Is that -- I guess maybe talk about how that evolved over the course of the quarter. Honestly, I think if anyone was paying attention, you didn't need to be brilliant to figure out that property rates were going to be going up for reinsurance and going up considerably. So I don't think anyone knew exactly down to the dollar or the percent what it was going to be, but you knew it was heading north. And it was just surprising to me that we didn't see more firming during the fourth quarter, given everybody knew where the cost of capacity was. And I guess I could have followed that if people -- if these covers worked in a risks attaching manner. But since they operate in the losses occurring manner, you know that the capacity that you're borrowing from reinsurers, that cost is going up and it's going to be covering the business that you're writing in the fourth quarter. So to me, the reason -- honestly, we thought there was going to be more firming in the fourth quarter. I think it's coming and certainly in the first half of this year. But it's almost like people need to wait for them to be hit over the head with the reinsurance costs really hitting their P&L as opposed to really taking a step back and thinking about how you match up the exposure with the expense. On medical inflation, you had mentioned workers' comp, you need to keep an eye on it. I think you said that there was potential for susceptible to inflation. Are you seeing anything yet on the medical front. I think that we are paying attention to medical care providers and the challenges that they are facing. By and large, most hospitals and health systems find themselves in a very difficult place if you look at, quite frankly, their financials, their economic models. It's not sustainable. So ultimately, they're going to have to figure out a way to improve their position. And they're certainly not going to get a better result or a better outcome from the public sector or the government. So that leaves the private sector that they're going to be looking to get their pound of flesh from to improve their position. In addition to that, while there's been a lot of discussion and a lot of noise, I don't see anything in the immediate term that is going -- again for the private sector going to change the realities of pharma inflation. So when we look out at where things are going, we think that there is a challenge ahead, and that is going to play a meaningful role in driving workers' comp claim costs. In addition to that, we think, as I suggested, rating bureaus they seem to not be backing out the COVID frequency effect. Do you think the same thing is happening in commercial auto, there's too much reliance on the last couple of years, and that's why it's gotten more competitive. That's why you tapered your business there? I think there are a lot of challenges with commercial auto. I think certainly, one of them is people paying attention to frequency trend. But I think severity trend is for society, for the industry, is really the bigger issue. And when you look at the -- how emboldened the plaintiff bar is at this stage, I think the commercial transportation industry has a bit of a bull's eye on its chest, and we -- who ensure them need to take that into account. And when you drive up and down I-95 at this stage, you see more billboards for plaintiff attorneys than you do for fast food. So that's probably not a great sign. Yeah. Obviously, it's a lagging indicator, but we continue to see auto premiums coming in at quite a healthy level, and we remain encouraged by that and what that means for our business and what that means at a more macro level to your point, for the health and well-being of the country. That having been said, we, I'm sure, just like you are paying attention to what type of Ts (ph) the interest rate hikes have for the economy and by extension, our clients. Hey. Good afternoon. First one I have is just a follow-up on workers' comp. I guess we've seen some reasonably large numbers in terms of potential decreases in NCCI. I'm just trying to understand how much pressure we should be thinking about there? I know your book is a little more nuanced than that, and there's a lot of excess and so forth. So I just wanted to understand from you all because it sounds like you still have a view of loss trend that certainly sounds like maybe from your comments is at least positive, let alone may be materially positive versus just big price downs that we're seeing kind of coming out of NCCI. So can you help me think through that? And what kind of impact that may have on the business going into 2023? Sure. I mean from our perspective, we think the -- we're using a very broad brush here. And I think we need to be mindful of that. And we operate the business with a very, very fine brush. So there's a bit of a difference. I think at a macro level, we need to be conscious of the fact that there have been rate decrease after rate decrease after rate decrease and a lot of that decision-making is based on information that people collect through the rearview mirror. And to make a long story short, we just think that you can't wait to see the problems in the results. You need to anticipate that. And I think we're very focused on that. So I think a lot of state rating bureaus, NCCI I think that they just need to be, we need to be as an industry careful that we are conscious of what is going on out the front windshield, not solely consumed by what's in the rearview mirror. Got it. And then the second one was sort of a follow-up on some of the growth questions that you guys have received. I mean is there anything to read into the buyback you did this quarter? And seems like E&S property, maybe some of the property kind of coming out of standard lines and the foot in the water on reinsurance in real tangible ways that you can deploy capital. But is this an indication that that maybe you're not seeing as much capital deployment opportunity as you would have liked, and we might actually get a little bit more back in buyback over the next year. I think the answer is that we do see a lot of opportunity before us. And we are conscious of the capital needs in order to support that. I would suggest to you, I would not read too deeply in based on what I can see so far, granted it's just very early in Q1, and I don't have a lot of data but I would encourage you not to read too deeply into the fourth quarter as far as being an indicator for opportunity going forward. . And again, we have a view as to a variety of things, both how we see opportunity going forward. We also have a view as to what the capital that's required to support that. And finally, we have a view as to what we think the value of the business is. And we put that all together and we try and make decisions from there. Good evening. A couple for me. First one, just trying to parse out what's happened with the loss ratio this year, at least in my model, because I'm confused because in my model with this quarter baked in the underlying loss ratio looks kind of flattish, '21 to '22. I mean I was hoping, Rob, maybe you could unpack like -- there's obviously noise, but how much did you -- did loss picks go down or whether it was just -- what give you kind of -- what was your view of what the core margin expansion would have been this year, if not for noise. I would have hoped that we could have done a little bit better. But as I alluded to earlier, the fires created some non-cat noise, which we are trying to make sure that we understand and that, that is not a permanent part of our loss activity. So as I said just earlier, that was probably worth more than 1 point, not more than 1.5 points. Got it. And then yes, so a follow-up on the fires. We've never really seen that type of non-cat volatility here. And I guess my interpretation of that was your per risk reinsurance program that attaches pretty low, but a little more than a point is close to like $30 million. So it was a lot of... So it was a frequency -- it was a frequency of severity on a gross basis. And honestly, we -- it wasn't concentrated in any one of our operations. And I'm not a big believer and good luck and bad luck, which is why we are digging. Look, earning references, -- what you guys do is hard. It's a very competitive process with a lot of transparency and it's quite attractive. You're not the only ones who want to write that business. I think about four quarters ago or maybe five, you said that you felt that, broadly speaking, your book got to the rate accuracy you wanted, and you're now pivoting to the growth phase and exposures on a backward-looking basis, did you grow as much as you wanted to with the opportunity set as you thought it was? I look at the premium growth this quarter, the lowest quarter of the year, it's been better throughout the year. But it seems like it's kind of pacing with your pricing trends on renewals, and there is a new business baked into there as well. Have you been able to grow with the nasty that you hoped a year or 15 months ago when you sort of announced that of it? Well, Josh, to be perfectly frank, you remember what I say, better than I remember what I say. Nevertheless, I'm sure you're correct. And obviously, we all look out and we try and anticipate and we try and figure out what does that mean? I think in hindsight, you always say to yourself, well, I could have done this. We could have done that. Maybe we want to squeeze a little bit more juice out of the orange and hopefully, that's a learning opportunity to find new mistakes to make in the future as opposed to repeating old ones and no one's effort to optimize. To make a long story short, I think in many pockets of the organization, we did really well and trying to make the most of it. I think there are some pockets of the organization where we did really well quite frankly, being disciplined and letting business go. As I suggested earlier in the call, we have different cycles going on -- same cycles but different products at different points in the cycle. I think one of the pieces that we anticipated but not fully, call it, whatever, 15 months, 18 months ago, I think that we did not fully appreciate what was going to be happening with loss trend, particularly inflation. We were talking about social inflation, and I think we had our finger on that pulse. I think economic inflation, we saw it coming, but it proved to be even more than we had expected. So I think those would be two things that when I made that prediction, those were realities we had to factor in even more along the way than I had when I had suggested it. But I think there are parts of our business, particularly our E&S businesses and others and many of our specialty businesses that I think have done a great job getting a lot of traction. On the other hand, I strongly applaud, for example, our colleagues that are focused on workers' compensation and the discipline that they have exercised. Yes, when you look at one of the pages in our release, you see the comp line growing, but that's really driven by payroll. If you look at the number of accounts, that product line has really shrunk for us because of my colleague's discipline. So directionally, it played out the way for a lot of product lines, I would have anticipated degree wise, there are places where I thought the ports (ph) was going to be hotter and there are places where I thought it was going to be colder. So okay the prediction game is hard to do. You made the point earlier that you run with a lot of leverage. And I just want to dovetail that on what you were seeing before. And you got to be careful, but [indiscernible], there's some people who -- if you're loss ratio deteriorates by 200 basis points, I imagine there would be a lot of unhappy people on this call. But if in doing that, you were able to grow your portfolio 15%, 20% more than you otherwise would have done so, that seems to me a pretty good trade in the long run. Am I right about that or is growth just transient? I think that the point that I was trying to make is, when we think about our loss picks, we need to be very thoughtful and measured because when you make a loss pick, the assumption, there's a lot of sensitivity. So if you are overly optimistic, even if you're modestly optimistic that is very leveraged and that could be a problem. And that's why we, again, do not want to declare victory prematurely as we see things season out, we will start to recognize our accuracy or potentially some caution. And given the good ROEs, is there any reason to relax a little bit on the discipline. That's going to sound bad, but [indiscernible] a little bit more business even if it makes the loss ratio to deteriorate a bit because it will make sense for the long-term growth of the company. Josh, what you're pointing to, I think, is one of the hardest things to do in this business and it's striking the balance, if you will, between optimization of rate versus exposure growth. And it's something that we look to do, not just at a macro level, at a very granular level and optimizing that. So I'm sure in hindsight, there will be parts of the business that we will look back on and say, I wish we had leaned into it a little bit more. But in the meantime, I think we're just trying to make the best judgment we can every day. Hi. Good evening to you as well. I don't want to put words in your mouth, Rob, but I think what I heard you say was in the right market, you may look to lean more into property, both in insurance and reinsurance, if the rates are adequate. If that is the case, can you maybe help us or indulgence us with your thinking about this because on the one hand, I would think it should certainly improve the loss ratios and returns. On the other hand, one of the things I think differentiates Berkeley is a very, very stable loss ratio and underwriting margin. And I would think that underwriting margin probably would incur greater volatility in that scenario. How do you think about that trade-off and the opportunity set? Yeah. So we're very focused on risk-adjusted return. And we think volatility, as you point out, is an important part of thinking about risk. Do I think that we are going to dramatically shift the risk profile of the organization to become a heavy cat exposed writer? No. But do I think that there is opportunities within the property market where rates are going to get to a point that they haven't been in some number of years, and the risk return balance makes more sense than it has? Yes, I do. And to that end, are we going to be prepared to participate in a more meaningful way than we would if it was a less attractive market? Yes, sir, we will. But do I think you should think about we're going to dramatically shift our risk profile and how we think about volatility. No, sir. I don't think you should. Okay. And then I think in response to a previous question, you talked about increasing your premium retention, just given the dynamics in the reinsurance market. Can you also maybe talk a little bit about any structural changes that you may have had in your reinsurance program, whether it's lower ceding commissions or higher retention rates or move to [indiscernible], what other changes can you call out here? Yeah. I think ultimately, on a net basis, it's going to prove to be something very similar for the business and by extension for our shareholders. As I said, the retention moved up incrementally relative to the scale of the business and the earnings power of the business on a quarterly basis, forget about on an annual basis. So again, I think that you should not expect that in the event of a cat, we have a dramatically different risk profile. And that, again, is that's by design. And maybe a follow-up to that. Are there lines of business where your appetite is somewhat curtailed by the fact that reinsurance appetite or structures have changed. Fortunately for us, we have a lot of long-term relationships on the amongst reinsurance partners. And I think that they are conscious of the fact that we are an organization that is a collection of people of expertise and discipline. And I think people understand that we are gross line underwriters. Hey Rob. How are you doing? Just a couple of ones here for you. Excellent. God Couple of brokers you've been citing the lack of M&A and kind of transactional stuff going on this quarter versus the fourth quarter last year is a reason for strong organic growth. Are you all involved in that business? Could that perhaps have been part of kind of a difficult comp headwind for someone of your like professional liability in other areas? Yes. So to the point that you're raising, we kind of -- we do plan the transactional space. I perhaps mistakenly lump that in there with D&O. They oftentimes go hand-in-hand. And yes, I think that part of what we're seeing in the D&O market is a competitive environment, but even more so, it's just a reduction in demand. During the heyday of D&O a couple of years ago or over the past couple of years. That was really in part not just driven by losses and discipline on the underwriting side, it was the IPOs and the specs were enormous. That level of activity And on the transactional side, I think as we all have an appreciation, the level of M&A activity has slowed dramatically as well. So yes, there's a bit more competition there, but even more so, it's the reduction in demand than the addition of supply. Got you. And then I guess my second question is, are you seeing any call it increase and kind of competitive from the standard markets vis-a-vis the E&S markets? Or does it continue to flow that way towards the E&S and out of the standard markets. We still see a pretty healthy flow of business coming into the E&S market, both on the casualty side on parts of the professional market and it's building momentum on the property side as well. I think I may have made the comment in the past, and it's still very accurate today. The standard markets, particularly the national carriers, if it is in their appetite, it is jaw-dropping how aggressive they are. If it's outside of their appetite, then it's a great opportunity for the rest of us that are happy to run around to pick up the crumbs that fall off their table and price them as we see fit. But the standard market, their appetite, ebbs and flows and moves in different directions, we continue to see a reasonable flow of business but if it's still within their strike zone, look out, to step out of the way. I would tell you, one area that we have seen, perhaps, moving back towards the standard market, which isn't a huge deal for us, but it's worth noting, is product -- large account products liability. Why? I have no idea, but the standard market, particularly national carriers, seems to have a thirst for it. And I think we all know how that's going to end. A couple of brief questions because I know it's late. One, am I reading too much to be worried by the fact that the expense ratio [indiscernible] 30%. You've been well below that for a while. I don't think it was 30%. I think what Rich and I perhaps failed to articulate was it's going to be comfortably below 30%. I don't know if we're going to be able to keep it below 28%, we'll have to see what happens with our earned premium, we'll have to see a variety of things, and we're making investments. But I think that our expense ratio will remain competitive and remains a focus, and we'll be comfortably under the 30% as Rich said. Okay. That's helpful. Second question, I guess, broadly, like I know on the insurance side, we've been talking about social inflation for a while. And I'm wondering with regard to the actual insurers, is there any push for them or by them to get higher limits to contend with social inflation? Yes. I think the short answer is, yes, but -- so if you are an insurer, you're sitting there saying, "Well, I'm concerned and my agent or broker is perhaps advising me to buy more capacity because of the environment. But at the same time, the cost of capacity may be going up. So it's a matter of what can I afford? One of the things sometimes we're seeing people do think about an SIR or a large deductible as a way to try and figure out a way to move dollars around as to what they're buying. But I think that there is a broad awareness in society. I think distribution is advising. But I think, ultimately, it's really a matter of what people can afford. And I think it's an important point because what you're touching on is something that society doesn't always really appreciate. And that is social inflation. And what that means for claims activity, it's not paid by the necessarily the insurance company long term. The insurance company this turns around and raises the rates. Ultimately, the bill is paid by society. Okay. No, I completely agree with that just both with the observation and the perception of it. And final question, if I can. If we pick you square to read the 10-Qs and 10-Ks anyway, can we start getting reserve development by segments on the call? Yes. I'll talk like -- I'll talk to somebody who makes these decisions. We probably have like a dozen lawyers that are deciding what we can and can't say. So the answer is, well, I appreciate the gesture of the [indiscernible], and it will be in the queue and to the extent that anyone dying to know what it is, assuming that there's no lawyer that pulls their hair out, Rich will have it available. Okay. No. I completely agree with that. Just book with the observation and perception of it. And final question, if can. If we think you squared recent 10-Qs and 10-Ks. Anyway can we start reserve development chemical. Yeah, I'll talk to like I'll talk to somebody who makes these decisions. We probably have like a dozen lawyers that are deciding what we can and can't say. So the answer is, we'll I appreciate the gesture of the pinky sweater and it will be in the queue and to the extent that anyone dying to know what it is, assuming that there's no lawyer that pulls their hair out, Richard will have it available. Hey. Good evening. Thanks for fitting me in. I guess just -- I think this was touched on in maybe Brian Meredith's question. But I guess in terms of the lack of discipline, that's your, I think, a term you used regarding the rate environment recently. I mean could some of that be do it -- just competitors simply feeling that investment income is a much bigger plus than it was before. So it just simply makes sense. And maybe I'm wrong, but even on the work comp side, there's an element of carriers being able to dictate rate a bit around the state bureau suggested rates. So just curious if you think that's a theme that we should be thinking about as we're thinking about pricing into '23. Mike, I just -- I don't see us getting back anytime soon to -- if I'm understanding it correctly, call it, cash flow underwriting or something that's a stepping stone to that. I think the reality is that not everyone's investment income is taking off exactly the way ours is because a lot of people, quite frankly, had a much longer duration. So from my perspective, do I think over time, if rates stay up at the levels they are or higher, do I think that can eventually have an impact? Yes, I guess it could. But I don't think that's what we're seeing today, if you want to talk about, for example, workers' compensation. I mean if you really want to get granular about workers' compensation, the fact of the matter is the people that are doing the irresponsible things are the same people that did the irresponsible things the last time we were in a trough. Sometimes they're in the same place, sometimes they're in a new place. But it's the same people that I don't know if they don't understand or they don't care, but they're creating mayhem in the market. We've kind of seen some version of the movie before, and we'll just wait it out. Understood. As a follow-up also to a previous question on the impact from higher reinsurance rates. And I heard you say probably not too material given the overall size of the organization. Just want to make sure are there any nuances we should be thinking about? Like are casualty seeding rates changing and we should be thinking about that? Or is there still kind of more of the book in terms of your reinsurance purchasing that could come later in the year that we're still kind of TBD. We buy many contracts, and they renew throughout the year. I think it's how you should look at that. I think for our reinsurance and retros, did we pay a bit more? Yes, we did. Do we have every intention of passing that increased cost along? Yes, we absolutely do. And as far as our insurance and our cat costs, it's the same story. There are some cases, clearly, where we're paying a bit more, and we have a choice, whether the company allows that to erode our margins or whether we pass that on. And it is our intention to pass that along in the cost of our product that we sell. Okay. And lastly, thank you for the paid loss ratio comments. And just curious if you've been surprised at where the paid loss ratios have been settling out lately? Or are you -- or as Berkeley, since you guys have been sounding the alarm on social inflation for a while, maybe there's kind of a mix or just resifting you guys have been doing to help keep those paid loss ratios from getting back to, I guess, pre-pandemic or longer-term levels? Look, Mike, we don't have it down to a granular level that -- or basis points, but directionally, it has unfolded as we had anticipated. And we'll have to see what that means over time. But again, directionally, it is unfolding as we had anticipated. Okay, Bo. Thank you very much. We appreciate everyone's participation this evening, and we will look forward to catching up with people in give or take, 90 days. Have a good evening all. Thank you. Thank you, Mr. Berkley, Again, ladies and gentlemen, thank you for joining W.R. Berkley's fourth quarter and full year earnings conference call. We'd like to thank you all so much for joining us. We wish you all a great evening. Goodbye.
|
EarningCall_1107
|
Welcome to the Getinge Q4 2022 Earnings Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. Thank you very much, and welcome to today's conference. I have our CFO, Lars Sandstrom with me as well, who will support during part of the financials presentation. Okay, we can move directly to Page number 2, please. So before we dig into the facts and figures regarding our performance and outlook, I just wanted to briefly touch on what I think is a really important subject that was highlighted in a good way in the last edition of The Economist. And this is the fact that we nowadays get much less output from healthcare, despite spending much more and also despite having more people than ever working in healthcare. All of this, of course, boils down to having problems with doing the right things and doing them right, what we usually call effectiveness and productivity. So the low productivity in healthcare is nothing new. I think the problem right now is that it seems that it has decreased a lot recently, which is of course, impacting patients. It's impacting clinicians and also, of course, companies like ours. So some of the examples of the short-term problems here, though, is that we see more patients with severe symptoms with â you can see that the COVID quarantine in different parts of the world has led to a weaker immune system. It also led to people staying away from hospitals, which means that illnesses are diagnosed at a later stage and people show up with more â at a more severe stage that requires the different approach to treatment. We can also see that the productivity is lower meaning that we have slower throughputs. We can see that the engagement among people working in the system is lowering as well. The burnout ratio is shooting up among clinicians, which means that we have a loss of competence and a loss of capacity, as well as even if there are more people working there, it still means that there's a lot of operational challenges in the system. Our people have worked hand-in-hand on the front-line with the people in the healthcare system to try to deliver as much care as possible. But it has been a challenge during the whole of 2022 and the last quarter was no difference in that regard. What is urgently needed, I think, is that, we need to be able to more efficiently manage patient queues, staffing and other flows within the hospital which will lead to better working environment for healthcare professionals. We also need products that gets â that allow patients to leave the hospital faster and in a healthcare condition than what is the case right now. And we need products that are easier for healthcare professionals to handle as well. There needs to be a easier learning curve to go through for new people working in this environment. We have a lot of good solutions for this. That's not the purpose of this call, but I just wanted to paint a bit of a background picture when it comes to our industry. So with that, we can move to Page number 3, please. We start with the key takeaways regarding performance for the fourth quarter of 2022. We saw net sales and order intake declining organically by 5.3% and 6.7%, respectively. This was mainly a result of continuing external challenges. This means that hospitals have not yet recovered to pre-pandemic levels for elective surgery, and they are also generally experiencing lower productivity than before the pandemic as I mentioned a moment ago. We can also see the treatment needs related to seasonal influenza was lower than expected and lower than in past four quarters. It also impacted our orders of sales negatively. In addition to this, we also have a company challenging comparative figures in products for COVID-19 treatment and also for vaccine productions. We are also continuing to experience the supply chain challenges, which negatively impacted net sales by at least SEK400 million in the quarter. This is mainly in capital goods and Acute Care Therapies now, so the challenges have narrowed somewhat compared to the past, but in terms of magnitude, they are similar. We had lower sales volumes and unfavorable mix effect and also generally increasing cost pressure which contributed to lower margins in the quarter. To counteract these effects, we are continuing our work on price adjustments, ongoing productivity improvements and also more thorough rationalizations where needed. Getingeâs free cash flow and financial position remains very strong, very low level of net debt, so keeping us in a good shape to take on additional opportunities ahead. And finally, the Board of Director proposes an increase of the dividend to SEK4.25 per share. We can then move over to Page number 4, please. So if we take a brief step back here and look at some of the other key events in the quarter, when it comes to our offering and the customer perspective, one of the products that we launched in the quarter was Livit Flex. This is a system for bioprocess control that enhances the effectiveness in pharmaceutical development. We also launched ULTIMA 815, which is an Optional Injection Dryer, and this enables quicker and more environmentally friendly processes in laboratories. And in addition to this, I also want to mention that Getingeâs Flow-c anesthesia machine was approved for sale in China during the quarter. When it comes to sustainability, the journey towards carbon neutral production continues at a fast pace. One example of this in the quarter is that the solar panels at our production facility in Turkey started producing energy during the quarter. Also, I mentioned that Getingeâs vascular grafts, so the artificial blood vessels received EU MDR certificates and the production facility in France was awarded with the business areaâs fourth EU MDR certificates for its quality control. The production facility in Solna, in Sweden, also received EU MDR certificate for the Servo-c ventilator. During the quarter, we also announced that the U.S. Food & Drug Administration included Getingeâs subsidiary Datascope as an additional facility in the companyâs existing consent decree. This is due to findings from previous FDA inspections and a warning letter related to operational compliance with the company's quality management system and processes. We have also had a few items affecting comparability in the fourth quarter. As you all know very well by now, we have continuous improvement approach to everything that we do. And this is because we want the business and the people in the front and the business to be agile and forward thinking, and normally we work with [indiscernible] and continuous improvements. In some cases though, we need to take somewhat larger structural adjustments. And in this quarter, we decided to do so in order to adjust our cost base and increase productivity further in slightly bigger steps than normally. So consequently, we have made a provision of SEK195 million and the cost savings from this will gradually impact the P&L during 2023. The full impact will happen from 2024 and onwards. We also made right times related to capitalized development products in Acute Care Therapies. And this is a consequence of the impairment test that we do on a regular basis. This is not something that's expected to have a material impact on our forward-looking expectations on growth. Also, I mentioned that in the quarter we decided to build a new production unit in Derby in UK. The new facility is facility that will replace the one that we acquired from Quadralene in 2020, and it will serve as a new hub in the UK by colocating sales, manufacturing and logistics. This investment will also result in higher production capacity for consumables offering in terms of disinfection products for sterile reprocessing. Just as a reference here the income from chemicals increased by 10.7% in 2022. So significantly above the growth rate of most of other categories, and it also comes with a higher margin than average in Surgical Workflows. We can then move over to Page number 5, please. So as I mentioned earlier, order intake decreased by 6.7%, and net sales by 5.3% organically in the quarter. Orders were down in Americas and in EMEA. The comparison here is impacted by last year's strong order growth in ECMO and BetaBags due to the Omicron breaker at the time. We could also see, though that orders picked up quite strongly in Asia Pacific this year, and this is mainly due to COVID flare-ups in China in December. On net sales, we had a flat development in Americas, to a large extent due to continued strong development in Surgical Workflows. This is something we are very encouraged by giving that it's an very important part of our strategy for this business area. Net sales in Asia Pacific was negative in all business areas in the quarter, mainly due to previous lockdowns in China. As this has changed now, we expect things to start to normalize in 2023, and as I mentioned before, we saw quite nice growth in orders in China. We can now move over to Page number 6, please. When it comes to the outlook for 2023, we are expecting a weaker first half of the year as a result of continuing challenging comparative figures for significant parts of Acute Care Therapies and for Life Science, whereas the second half of the year is expected to be stronger. And this will result in healthy growth for us in the second half of the year and an anticipated organic sales growth of 2% to 5% for the full-year. We can then move over to Page number 7, please. So if we look at some of the details when it comes to order growth, we can see that Acute Care Therapies had a minus 4.4% organic development in the quarter. The lower order organic order intake in Acute Care Therapies was primarily attributable to advanced ventilators and ECMO therapy products in EMEA for the first two months of the quarter. The quarter ended with a strong order intake in mainly China as a result of the higher rate of COVID-19 infection spreading. The order intake for products for planned cardiovascular procedures increased slightly compared with 2021. We then look at Life Science, we had a minus 32% organic development on the order intake and the order intake for Life Science declined significantly in Americas and EMEA. This is due to challenging comparative figures in sterilizers and also a continuing falling demand for COVID-19-related products. On a positive note, the service business continues to grow, and this is a very good sign as we clearly can see a positive relationship over time between good service business and an overall healthy business for us both from a financial standpoint, but also from a customer loyalty perspective. And finally, Surgical Workflows, here we saw a 3.2% organic improvement and the order intake in Surgical Workflows increased as a result of the positive trend in Digital Health Solutions and Infection Control. And as I mentioned earlier, the positive trend in North America is continuing something that we are very happy about. We can then move over to Page number 8. So looking at the sales perspective in Acute Care Therapies, we were down 9.8% organically and the net sales here in ACT declined in all markets due to challenging comparative figures in ECMO therapy products, and also a shortage of components, which impact the delivery capacity, mainly related to Cardiac Assist within Acute Care Therapies. Net sales increased in products for elective cardiovascular procedures, but it has not yet reached pre-pandemic levels. When it comes to sales of capital goods, this was negatively affected by the continuing shortage of components. In Life Science, we saw a minus 3.6% organic development. This was a result of challenging comparative figures in product related to COVID-19 vaccines. The positive trend though in sterilizers and washerdisinfectors and also the service business continued in the quarter. Recurring revenue for Life Science declined as a result of lower volumes of consumables related to production of COVID-19 vaccines. And in Surgical Workflows, we had a 0.9% organic improvement and the increase in Surgical Workflows was due to operating room and Digital Health Solution products. And again, the performance in North America was particularly encouraging for SW. Net sales in Asia-Pacific fell mainly as a result of lower activity in China. The strong order intake in prior quarters and Americas contribute to a more increase in net sales for the quarter. And we saw an organic increase in recurring revenue as a result of the positive trend in service and in consumables. Currency had a SEK911 million or an 11.4% positive impact on net sales for the group in the quarter. Organic net sales of capital goods declined by 4.9% in the quarter to a large extent due to supply challenges. The decline in consumables is related to lower sales of ECMO and products for treatment of ECMO and BetaBags, which is part of our sale transfer offering and something I mentioned before. With that, we can move over to Page number 9. Looking at the development of gross margin, we can see that our adjusted gross profit increase by SEK3 million to SEK4,153 million in the quarter were a positive FX effect accounted for SEK469 million. For the group as a whole, the adjusted gross margin declined by 3.1 percentage point. This is an effect of unfavorable mix, supply constraints, reduced absorption in our factories and also cost inflation. These effects were partly offset by price increases, some productivity enhancing measures, and also support from currency, but obviously not fully. For Acute Care Therapies, the adjusted gross margin declined to 58.4% due to lower sales, unfavorable mix, shortage of components and also cost inflation. This was to some extent offset by positive FX effects, price increases and productivity improvements. When it comes to Life Science, the adjusted gross margin declined by 5.4 percentage points, mainly as a result of lower volumes, of unfavorable mix, some supply chain strategies also here, and also non-recurring warranty costs and under-absorption in some of our factories. The favorable currency effects contributed positively to the margin to a much more extent. Surgical Workflows adjusted gross margin fell by 1.8 percentage points. This was primarily a result of cost inflation and of FX, and this could be partly offset by continuing productivity improvement. All right. Thank you, Mattias. Adjusted EBITA declined by SEK406 million compared with the same period last year, while margin decreased to 15.5%, mainly due to negative effects from GP and OpEx, which ties back to the lower volumes, unfavorable mix effects and supply chain-related costs and challenges overall. Adjusted for currency, GP had a 3.4 percentage point impact on the EBITA margin due to the reasons just mentioned by Mattias. Organically, we had lower SG&A than previous year, but negative effects, revaluation effects in other OpEx is impacting us quite negatively. Cost inflation is somewhat higher activity was partly offset by reduced variable pay to employees. All in all, this brings us to reduce operational leverage, leverage on OpEx and the 2.3 percentage point impact on the margin year-on-year. Higher activity in R&D, where some come from development maintenance, EU MDR, but also from acquisitions. Currency had a negative impact of 0.4 percentage points on the margin. And adjusted for currency, D&A didn't have any impact on the margin in the quarter. All in all, this resulted in an adjusted EBITA of SEK1,317 million and a margin increased to 6.1 percentage points. Worth mentioning here, its also the restructuring efforts made in the quarter, as previously mentioned by Mattias and where most of the effects are expected to come gradually in 2023. Then let's move over to Page 12, please. The free cash flow amounted to SEK708 million for the quarter and SEK2.3 billion for the full-year 2022. And working capital for the quarter was mainly a result of high material costs and supply chain disruptions, which resulted in less inventory reduction normally given the season. We expect this to normalize gradually during the year. Working capital days continued to be well below 100, and we are now at some 96 days, down 43 days from the peak in Q2 2018. And going forward, we expect working capital days to increase somewhat mainly related to the increase in high material costs during the first half of the year. And we are on trend on operating return on invested capital with 14.6% on the rolling 12-month basis, and that's still well above our cost of capital. And then let's move to Page 13. The change in net debt year-on-year was positively impacted by the cash flow, taking us to SEK2.6 billion and if we adjust for pension liabilities, we are at SEK0.1 billion. This brings us to leverage of 0.4x EBITDA and if adjusted for pension liabilities, leverage is at 0x. Cash amounted to [five months] SEK7 billion at the end of the quarter as well. All right. Thank you. So when it comes to summarizing the key takeaways for the fourth quarter of 2022, we can see that organic development on net sales and orders were negatively impacted by external challenges that I mentioned in the beginning of the call. Our margins in the quarter have been impacted by lower volume, by unfavorable mix effect, some continuing supply chain disturbances and also inflation. We've been able to partly offset this with the price increases and continued productivity improvements. We've continued to have healthy free cash flow and a very strong financial position. When it comes to some of the more forward-looking parts here, we expect the challenges to remain. We can see gradual improvements in parts of supply chain, in parts of the operating environments in hospitals and so on. But we expect this to be only a gradual improvement during the year. This takes us into an outlook for 2023, where we expect net sales to grow 2% to 5% organically, and with a stronger second half of 2023 than the first half. Finally, then I would like to take this opportunity to thank our customers, our employees, who have worked hard for a very, very long time now, sometimes under very difficult circumstances to deliver vital care to patients around the world. I look forward to 2023 with a continued deep commitment to helping both customers and patients in the best possible way. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line of Erik Cassel from ABG. Please go ahead. Hi. Good morning, Mattias and Lars. I thought I'd start off with some questions on 2023 and your guidance. I mean the 2% to 5% kind growth guidance, it's a pretty wide range. But I understand the uncertainty given how backend loaded your year should be. But could you maybe explain what needs to happen for you to be in the upper part of that range? That's not included in the low end. Is there a some sort of larger swing factor that you see? Yes. There's no larger swing factor. I think we need to see a continued normalization, primarily when it comes to the operating environment in hospitals, so they can focus on getting elective surgeries back to where they need to be above pre-pandemic levels. And we need to get rid of some of the supply chain disruptions that we still have primarily related to our Cardiac Assist products. Okay. Thank you. And then in previous quarters, you've been able to provide some guidance for full-year margins based on where volumes are heading. I guess that there's a lot of moving parts, but is it possible to share how you're thinking about profitability in 2023? Yes. I think as you alluded to yourself, it is a very uncertain environment to navigate in right now, first of all, from a volume perspective. And as you know, we are very, very volume sensitive with the operating leverage that we have. So we are refrained from giving any guidance. I think we feel good about improving from where we are, but with, I mean, few basis points. So we decided not to give any official guidance here. So volume is a key factor. We have some mix effects that are going to have an impact as well. We continue to see inflation providing some uncertainty to the development as well. And of course, we will offset this with the continued price work. That's a key thing for a key team for 2023, and also some of the productivity improvements that we were already on and some of the enhanced measures now that we've implemented in the fourth quarter as well. So if you summarize all that up, we expect some small improvement, but we refrained from giving detail guidance. Okay. I fully understand. And then last question for me. On the orders in China, what was the magnitude of the total order take that you received now in Q4 and Q1 and is everything expected to be delivered during Q1? And then also if there's any ongoing discussions for more orders going to China or if you're done with that now? Yes. We don't disclose details by country. We saw a heightened level of order intake from China, primarily when it comes to ventilates in the quarters. We are in the process of delivering this. I mean, there's ongoing discussions and â about additional business, but it's not something that we will speculate in right now. I don't think you should assume any big step up in orders of sales because of this. It's a slightly heightened level December, last year and Q1 this year. But I think on overall level for full-year 2023, nothing really material. All right. Good morning. Thank you for taking my questions. So first one, the margin in Life Science segment declined significantly here in the quarter even adjusting for the one-off there. So how should we think about more normalized margins for the segment heading into 2023, more of a sort of a post-COVID scenario? How should we think about the levels in relation to where we ended up for the full-year? Yes. Hi there, Rickard. When we look at last, as you mentioned now, yes, we had some one-offs here in the fourth quarter. If you look at bottom [indiscernible] in the decline there, I will say half of it is roughly around the impact from the one-offs. And going forward, I think, since we will have somewhat slower share of sales on the consumer side compared â and that will of course impact us going into 2023, but we still have a very good order book when it comes to the rest of the product. And that's together with the easing out of the supply chain issues that we actually have and the work we do to right size part of the Life Science organization now with the current demand, especially on the BetaBags. We should get back to not the pandemic so to say levels, but there should be an improvement coming back. All right. Thank you very much. And I want to dig a little bit deeper into China. So you have previously mentioned that losing market share to local players in Surgical Workflows segment, but we have also seen the first approval of a Chinese developed ECMO solution rather recently. But as you mentioned, we've seen orders that pop here entering Q1 as well in Acute Care Therapies. Can you talk a little bit about the dynamics in China heading into 2023 and beyond? Would be interesting to hear a bit more on the competitive landscape development, what you're doing to secure your sort of and protect your market shares overall, that'll be very helpful. Thank you. Yes. We do see heightened demand both on ventilators and also ECMO therapy products right now to China. As I mentioned on the call, we also had an approval of our anesthesia machine for China as well. So we think that in the short-term, we definitely remain competitive. We're monitoring the development of new entrance as well. But we have a very strong position with really strong clinical performance of our ECMO solutions, very much liked by customers. So we feel that we have a pretty robust position from that standpoint. Now, when it comes to the medium and longer-term, we expect this market to be back to a double-digit growth market. I mean, we have several categories where we are really strong, if you look at, for example, our vascular interventions portfolio and so on. So we remain generally positive towards our possibilities in China. We expect to be about 10% growth in the longer-term. It is a decline from where we've been. We've been more like 15%, 16%, pre-pandemic, but it's still will remain a good market and a clear number twofold. Perfect. Just a super quick final one. Can you quantify or give some magnitude on the cost saving initiatives in 2023? So when you look at what we have, the decisions and restriction we have done now in the fourth quarter, there will probably be some more coming here in the coming quarter. And then we expect that to gradually come through let's say half, 50%, 75% of that coming in during 2023. Then what you should also remember is that we have an underlying cost inflation that we are fighting against here. So restructuring and continuous productivity work is what we are looking â need to offset some of that impact. Yes. Thanks so much for taking my question. The first one would be on ECMO. Can you just talk to the level of [indiscernible] that you see and given now obviously that Q4 was softer with some kind of increase in demand from China? Is it reasonable to assume that ECMO can actually grow again, high single-digit in 2023? And then secondly on ventilators, can you just confirm where you came in in terms of ventilator phase in the full-year? I think you talked about 6.5 to 7,000, just try to get confirmation of that. And also here, is a chance you go back to the pre-pandemic baseline now with the incremental demand from China. And the last question is just in terms of housekeeping. Is there any kind of color you can provide us in terms of restructuring costs that we should expect for the full-year? Also, can you give any kind of color on capitalization on the â in the full-year this include 35%. So I'm just trying to understand if anything here is not worthy. And finally, also on a full-year basis you could see half in reduced and variable employee costs. Can you give us any kind of sense for the magnitude of the full-year? Thank you very much. I have five questions. We'll try to take them one by one. When it comes to ECMO, we do expect to return to growth. I wouldn't say maybe high single-digit, but at least single-digit growth in ECMO with our expectation depending on how things pan out to the year of course. When it comes to ventilator sales, we ended up with 7,300 machines last year. We don't expect any big upswing this year with our expectations is basically flat. One thing I want to highlight always the work on the installed base, we had really good traction when it comes to developing the service business and developing more consumables business from this. So I think it gives maybe sometimes the wrong picture to just look at number of machines when it comes to ventilators. When it comes to your question on restructuring, we don't guide forward-looking. We have a few more things that I think we can implement during the year, but we will not provide details now on the cost impact of this. We think and hope that the main things have been put into place, but there will be some additional measures. On R&D, I didn't quite hear your question. Actually, Lars heard it. I think, you asked about the level of capitalization. I think you can expect the similar level, maybe slightly higher. We see that we have quite a few projects running now in capitalization phase. And then that was where increasing during 2022. And I think on this level where we are now is where we are running into next year. And on the last question on variable pay, it's also not something that we've provided granular details on and we refrained from now as well. The only thing I want to say is that the system with variable pay in the company is set up to balance out the kind of performance, fluctuations that we've seen [indiscernible], we believe that it's kind of serving its purpose. Thank you. Two questions for me. First of all, I wonder about the mid-term margin guidance and how you feel about that given that the starting point is now lower and you have more or less lost the year. So that's my first question. And then wonder if you could in some way maybe quantify a little bit what you mean with weak first half. Does that mean negative organic growth or do you think you could start to grow at least a little bit already in Q1 â second quarter and also what that means when it comes to more and again maybe earnings development year-over-year? Thank you. Yes. I think on your last question there on what we looked on, I think what we talked about, weak, it is a little bit connected of course to the comparables when we compare the first half 2023 versus 2022. I think we will probably be slightly positive that is what we see in the first half and then improving gradually after that in the second half. And when it comes to your first questionnaire around the mid-term, as I understood it on the EBITA margin, you said that we lost a year coming out now with 15.1% and what you think going forward on that. Is that correct. Yes. I guess margin now is probably lower than what you expected to be in a year-ago and the one when you announced that guidance? Yes, that's true. And I think it's for the reasons we have mentioned during every quarter this year, or what we see and what we now say going forward is that we see that on the supply chain issues, we should see gradual improvement come forward that would ease up a lot of the service is interesting absorption and also of course, volume. We have lost quite a bit of volume this year. We go out the area, we've lost SEK400 million in the quarter as we mentioned here. So by getting that part [indiscernible] and also together and we decided improve product mix, so it means to 2023, especially then going into the second half, that will help the margin going forward. And then as we mentioned, we have cost inflation continuing to heat us and that we work with improvements together with the continued focus on improving the five picture here in 2023. That is why we say that we give the stable guidance on the [indiscernible] 2023, but it is a bit tricky actually to â it is very much depending on demand and if you see volume picking up better, then we have significant that helps of course quite significantly, but that's why we're a bit cautious here. Hello. Yes. Thanks for taking my questions. I had a couple. One was just around the broader CapEx environment you're seeing within the hospitals. I know you mentioned that the elective procedures are not back up to sort of normalized level yet. Just in terms of the spending and priority, I'd just be kind of curious where you're seeing hospitals spend that money, is it in the products you are getting, is it in the kind of larger capital equipment machines? That was my first question. The second one is just on supply chains. Can you just give us some sense of where you're seeing the biggest bite points in your supply chains, which particular components are you sort of struggling most to get hold of and what gives you conviction that's going to get better? Is that just a sort of broad-based improvements to that specific suppliers you're having trouble with that, you've got visibility that's getting better? And then the last one, if I can, is just around the comments you made around the installed base and service. Can you just give us some sense of the capture rate you have of your installed base against maybe some sort of smaller independent service providers and where that stands versus a couple of years ago and where you think you can get that to? Thank you. Yes. Thanks. When it comes to the broader CapEx environment, we think it's rather positive still. We do see a continued investments in both operating room equipment. We've seen some investments when it comes to CSSD environment as well. So customer seems, I wouldn't say surprisingly, but it is positive that they're not holding back as much as one could have feared I think in this environment. Compared to our equipment, but others, I don't really have a great insights on some of the other capital equipment categories where we are not to [indiscernible] to refrain from providing any information there. When it comes to supply chain, it has narrowed quite a bit to very specific components in certain product groups. I think there is a broad-based improvement, but we have some specific issues, especially related to our Cardiac Assist product category. So that's really where the main issue is product growth. When it comes to the capture rate, we don't provide capture rates, but I think we are the prime supplier and partner when it comes to serving the install base. It's more often the hospitals themselves than the service rather than going to third party actors in this case, I would say. So we're pretty â we feel good about the penetration rate. It has started to improve since the big increase of installed base during 2020 and 2021. And like we highlighted some, a couple of years back even, we can see that there is better and better traction both when it comes to service offering, when it comes to consumables for some of the therapies that we offer, and also more and more interest in some of the connected solutions for managing these. Yes. Thanks a lot for taking my questions. Starting off on the margins. Again, I perhaps misheard you there. Did you say that you aim to â the grow sort of â the margins in first half of this year, are they going to be slightly positive before improving much more in the second half, or did I misinterpret that? Okay. Perfect. And then just following up on the margins as well, we started to see at least, on perspective of ECMO starting to decline by Q2 in 2022, where you saw the larger headwinds. Where would you say in terms of customer destocking, et cetera, where are you on that trend line entering Q2, you think? Is it possible that that ECMO could actually hold up decently in Q2 already? Is that the way we should look at it? I think we have limited visibility on stocking levels. We are very confident that they've gone down compared to what they were a year-ago, there's no question about this. But when it comes to guiding, we've said for the full-year, we expect an improvement, but not a dramatic improvement. When it comes to quarterly or half year guidance, we refrained from giving any details. Yes. Fine. And then just lastly coming back to EBITA margins, so it's clear that you aim to improve them, it's a lot of swing factors obviously. But is the expectation feasible â the expectation of growing 2% to 5% on topline, is it feasible to see you expanding those margins in any sort of scenario depending on where you end up in the net sales range? Or would it be much tougher for you, if you end up at just 2%? I think it's reasonable to expect an improvement cost becomes much easier in the upper end of the range. Mix though, I think is more probably â more important factor here than the absolute number when it comes to the margin improvement. Hey guys. Thanks for the questions. Maybe just to push a little bit on phasing. I know you said sort first half revenues slightly up, but just so we are in the right spot for the first quarter should we expecting Q1 sales and also margins to be down year-on-year? Secondly, just a housekeeping, just wonder what the FX impact you're expecting both on topline and margins. And then finally, just in terms of your cost inflation, is your underlying cost inflation, I suppose mostly around salaries. What are your assumptions on that front please? Thank you. Yes. On your questionnaire we are getting, now we are dissecting the half year as well. I think what we said, it'll be â as we said, gradually improve during the year with the first half being less good than the second half of course then gradual mix bit weaker in Q1, and then gradual improvement also in Q2. That is what we think. And then when we look at FX, when we have a significant weaker corona now during 2022 and we don't forecast currencies, but technically then that's going forward, we will have pricing positive impact in the beginning of the year on topline. And then it saves up during the rest of the year. And then when it comes to bottom line, it is limited impact. If there is a big change in closing rates, we have a reevaluation effect and that is [indiscernible] the full cost, but if we take that away, it'll have limited impact for next week. Yes. Sorry, wage inflation there as well. We don't expect anything else than anyone else here. I think, we have had gradual increases during last year mainly in U.S. which are normally quicker to adopt to a new reality. And then, of course, comes Europe now this year and we don't expect to be best or worse than that, which Europe and, you know, big broader cost base in Germany province and Sweden when it comes to people. I suppose what I'm getting at is if your topline is 2% growth, but your wage inflation is 4% to 5%, it's difficult for us to model much in the way of margin expansion? Thank you for taking my questions. Most of them has already been answered or asked, a couple of ones. When I see that â when I assess the hospital and supply chain environment, especially in the U.S. it seems like Getinge is not â is facing a much tougher headwinds compared to many of your peers, especially your U.S. peers. And looking at the hospital sector, they had a very tough first half last year, but then improved quite significantly even though staffing shortages is still a lingering headwind. So what I'm just trying to get around, if the geographical mix, U.S. ex-U.S. is negative for you in this current environment compared to your, especially your U.S. peers, that's what my first question. And then I don't know if maybe you have already talked about this, if you could say anything about price volume during 2023 and let's say if that you end up in the middle of the 2% to 5% guidance, how much of that is volume and how much of that is price? And then lastly, you are alluding to that you have quite a number of long contracts that has not been renegotiated yet. Can you talk a little bit about your average length of those contracts and if these contracts will have a positive effect in 2024 instead of 2023? Thank you. All right. Thank you. When it comes to the U.S. question, I think in general, if you don't look at our competitors, most of them have closer to half of their sales in the U.S. and very often the incumbent, so to speak, benefits a bit in difficult environment. So there's probably an element of that. Having said that though, I think when it comes to for example, Surgical Workflows, we've done well in the U.S. This is a category where we've focused for a long ride, getting the right products, having the right vehicles, supporting customers on the ground, and we clearly see the results of this as well. And it's also categories where we are largely unconstrained when it comes to supplies. So the other part for the U.S. performance for us is heavily impacted by Cardiac Assist and the supply chain problems we've had there. We've had some restrictions when it comes to ECMO product supplies as well. So that also factors into the overall picture when you compare our performance in the U.S. to lots of competitors. So I think those are the main explanatory factors. When it comes to price and volume for 2023, we have an ambition to hit at least 3% or 3% price increase in 2023. And we make guidance though, it's a mix of volume increase and price increases. So we have to make our own estimate of how success we were with the different components there in both operations. And when it comes to longer term contracts, yes, we have several of those as well, but we're not providing any overlooking information on how they expire and what the potential price impact could be. The average ambition for the group is 3% for 2023. Okay. Thank you, Mattias. Just a quick additional question before I get back into the queue. When it comes to the mesh settlement, what's your best guesstimate now when you will pay out? What's left of that settlement? Will it be during 2023? No, not yet. We can't give you a number. We expect this to be within what we have accrued for acquisitions. Okay. But many costs, as I understand it has been taken along the time regarding, if you compare to the initial reservations that you made. So the end amount will probably be significantly less than if you add the two reservations together? Well, yes, lawyers and the legal costs are high, but maybe not so high. Assume I still look to [indiscernible] and when it comes to the payments, we don't really intend to share the number at the end of the day since this is, we want this to be not an opportunity for anyone to get attracted by anything here and store. So that is â you will see it in the cash flow when it comes and it's within the provision we have taken. And that I think we will stay on that communication. There are no more questions on the telephone at the moment. I would now like to hand the conference back over to Mattias Perjos for any closing remarks. All right. Good. Thank you. Nothing else to summarize, I think from my end. We have gone through materials and happy that we have exhausted the queue questions as well. So thanks everyone for dialing-in today. I wish you good rest of the day. Thank you very much.
|
EarningCall_1108
|
Thank you for standing by, and welcome to the Q4 2022 AGF Management Limited Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there'll be a question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded. Thank you, operator, and good morning, everyone. I'm Jenny Quinn, Vice President and Interim Chief Financial Officer of AGF Management Limited. Today, we will be discussing the financial results for the fourth quarter and fiscal 2022. Slides supporting today's call and webcast can be found in the Investor Relations section of agf.com. Also speaking on the call today will be Kevin McCreadie, Chief Executive Officer and Chief Investment Officer. For the question-and-answer period with investment analysts following the presentation, Judy Goldring, President and Head of Global Distribution, will also be available to address questions. Turning to Slide 4, I'll provide the agenda for today's call. We will discuss the highlights of the fourth quarter and fiscal 2022, provide an update on the key segments of our business, review our financial results, discuss our capital and liquidity position, and finally close by outlining our focus for 2023. After the prepared remarks, we will be happy to take questions. Thank you, Jenny, and thank you, everyone for joining us today. Fiscal year 2022 saw continued market volatility. Despite the challenging macro backdrop, we had another solid year. I'll begin with some highlights. We reported AUM and fee earning assets of $41.8 billion at the end of Q4, down just 2% from 2021 despite the market volatility. Our mutual fund business reported net sales of $251 million in the quarter, marking the ninth consecutive quarter of positive mutual fund net sales. For the year, we achieved mutual fund net sales of $765 million despite the industry being in net redemptions of $41 billion. Supporting our positive mutual fund flows was our strong investment performance. As you know, AGF measures mutual fund performance by comparing gross returns before fees relative to peers within the same category, with the first percentile being the best possible performance. We target an average percentile ranking versus peers of 50% over any one year and 40% over three years. At the end of Q4, the average percentile ranking was 41% over the past one year and 30% over the past three years, with a number of our top selling funds remaining in the top quartile. In recognition of our fund performance, AGF Global Select Fund won the Lipper Fund Award for the three, five and 10 year performance in the global category. Our strong performance was attributable to our disciplined investment and risk management processes, the cautious tone we had about the market since the fall of 2021, and our tactical approach in the cash level on the use of liquid alternative assets in our funds. Looking at the past three years, the market has experienced a drawdown with COVID, the subsequent recovery and the drawdowns in the current monetary tightening. In the midst of that market volatility, we continued to deliver strong investment performance and our product lineup remained resilient. Turning to our financials. We reported diluted EPS of $0.32 for the quarter. On a full year basis, we reported diluted EPS of $0.96. During the quarter, we completed a substantial issuer bid where we took up 3.5 million shares for a cost of $24 million. We ended the quarter with $59 million in cash, $220 million in short and long term investments, and $22 million in long-term debt. Our capital position remains strong and we are well-positioned to continue to weather the macro uncertainties and have capital available to return to shareholders and strategically invest to generate recurring earnings. Finally, we paid a quarterly dividend of $0.10 per share for the fourth quarter. Starting on Slide 6, we will provide updates on our business performance. On this slide, we break down our total AUM and fee-earning assets in the categories disclosed in our MD&A and show comparisons to the prior year. Mutual fund AUM was essentially flat year-over-year. I'll provide some more color on our fund business in a moment. Institutional, sub-advisory and ETF AUM decreased compared to prior year, mainly due to markets. We continued our strategy to expand the U.S. SMA business. We have onboarded a number of our strategies onto three leading turnkey asset management platforms, Vestmark, SMArtX Advisory Solutions LLC and Envestnet, as well as other leading wealth management platforms. Our U.S. SMA relationships continue to generate positive flows and AUM is expected to grow gradually over time. Our liquid alternative products continue to attract interest from investors who are looking for a strategic or tactical hedge for their portfolios. Managed by our quantitative team in the U.S., our Market Neutral Anti-Beta strategy is designed to generate positive returns in volatile markets and preserve capital in a downturn. At the end of last week, the AUM for this strategy has doubled to over $900 million from just over a year ago. Finally, we continue to see interest from institutional investors across multiple strategies and jurisdictions, which bode well for future sales. Our Private Wealth businesses continue to demonstrate resiliency with AUM only decreasing 1% year over year. Our Private Capital AUM and fee-earning assets were $2.1 billion. It is our goal to grow and diversify our private markets business and to be one of Canada's emerging leaders in private market investing. We are focused on expanding our existing relationships and continue to explore other unique opportunities to grow our Private Capital business and product offerings. Turning to Slide 7, I'll provide some detail on the mutual fund business. The mutual fund industry continued to experience net outflows, worsening to net redemptions of $28 billion for the quarter ended November 2022. Despite the industry trend, our mutual fund businesses remained positive and recorded $251 million of net sales in the quarter. This includes the win of $230 million allocation from a strategic partner that we disclosed last quarter. Excluding the net inflows from institutional clients invested in our mutual funds, retail mutual funds were in net sales of $76 million for the quarter. AGF's outperformance to the industry is attributable to our strong investment performance, our strong brand, the diversity of our sales channels, and our team's continued efforts to build key relationships with our clients and partners. Thanks, Kevin. Slide 8 reflects the summary of our financial results for the fourth quarter with sequential quarter and year-over-year comparisons. EBITDA before commissions for the current quarter was $30.2 million, $3 million lower than Q3 2022. EBITDA this quarter included higher income from Private Capital, which is offset by higher expense levels. Net revenue for the quarter was $70.5 million comparable to Q3. SG&A for the quarter was $51.5 million. Excluding severance, SG&A for the quarter was $49 million, which is $2.8 million higher than Q3 due to timing of activities and higher performance based compensation. AGF Private Capital contributed EBITDA of $8.5 million in the quarter, which is $1.9 million higher than Q3. EBITDA from Private Capital managers this quarter included $1.2 million of carried interest revenue, recognizing strong performance in one of our long-term Private Capital investments managed by SAF. EBITDA for Private Capital LP funds was $7.1 million, which is $1.2 million higher than Q3. AGF participates as an investor in the units Private Capital LP funds, benefiting from valuation increases and distributions from the funds which can vary. On the long-term basis, we expect returns of 8% of 10% from investing in Private Capital LP. On a full year basis, EBITDA before commissions was $138.6 million, a $11 million higher than prior year. Net revenue for the year was comparable to prior year. SG&A for the year was $194.6 million, which includes $4.4 million of severance. Excluding severance, SG&A in 2022 was $190.2 million, which is in line with our guidance provided on the Q3 call and $2.4 million lower than prior year, mainly due to lower performance and stock-based compensation. EBITDA from Private Capital was $28 million, $9.2 million higher compared to prior year mainly due to higher contributions from our long-term investments. And then EPS was $0.96 for the year, which is 75% higher from prior year. Our net income and EPS were bolstered by the elimination of the deferred selling commission purchase option, which came into effect June 1, 2022. The elimination of the DSC will provide a temporary lift to our net income and free cash flow. However, this lift bellwethers over time. Turning to Slide 9, I will walk you through the yield on our business in terms of basis points. This slide shows the net revenue, operating expenses and EBITDA before commissions as a percentage of average AUM for the fourth quarter with sequential quarter and year-over-year comparisons. To provide a more normalized yield to yield that we earned, we have excluded AUM and related results from the Private Capital business as well as other income, DSC revenue, severance and corporate development costs. The Q4 net revenue yield is 75 basis points, which is 1 basis point lower compared to prior quarter and flat compared to prior year on a full year basis. As a reminder, net revenue basis points will fluctuate depending on the percentage of our mutual fund assets and the product and series mix within those assets. Q4 SG&A as a percentage of AUM was 52 basis points, 3 basis points higher compared to the prior quarter. As previously mentioned, expenses were higher this quarter due to timing and higher performance based compensation. On a full year basis, SG&A was 49 basis points, 1 basis point lower than prior year. This resulted in an EBITDA yield of 23 basis points in the quarter, compared to 26 basis points in the prior quarter. Full year EBITDA yield was 27 basis points, 1 basis point higher than prior year. Turning to Slide 10, I will discuss free cash flow and capital uses. This slide represents the last five quarters of consolidated free cash flow on a trailing 12-month basis, as shown by the orange bars on the chart. The black line represents the percentage of free cash flow that was paid out as a dividend. Our trailing 12-month free cash flow was $70.3 million, and our dividend payout ratio was 37%. In the same period, we have returned $72 million to shareholders. That includes dividends, share repurchases under our NCIB, and the $24 million substantial issuer bid completed in November 2022. This is monetization of our investment in S&W in the fall of 2022. We have returned $150 million to our shareholders. Our cash balance at the end of November was $59 million, and we have $220 million in short and long term investments. We have $128 million remaining on our credit facility, which provides credit to a maximum of $150 million. We are comfortable increasing our net debt-to-EBITDA up to 1.5 times to the right opportunities arrive. Our remaining capital commitment to our private markets business is $43 million. Itâs not included in this as our anticipated commitment of $50 million to an upcoming third fund managed by Instar. Capital commitments may be funded from excess free cash flow. But keep in mind, there will also be further recycling of capital as monetization occur, which will help to fund future commitments. Taking all that into account, we currently have excess capital available. Redeploying that excess capital to generate recurring earnings is a key strategic priority. We will have further updates on this in coming quarters. Thanks, Jenny. In 2022, AGF celebrated its 65th anniversary. The firm's longevity is a testament to our history of innovation, disciplined investment approach, and an unwavering commitment to our clients. This year, it was another solid year for us despite the challenges facing the markets and the industry. In such environments, our AUM and fee-earning assets remained resilient. We continued to outperform the industry and recorded the ninth consecutive quarter of positive mutual fund net flows. This is the longest streak of mutual fund net sales we've seen in the past 20 years. We delivered strong investment performance through our disciplined processes and focus on risk management. Diluted EPS for the year was $0.96. Our SMA business gained momentum in 2022, and then we have onboarded a number of our strategies on to several leading U.S. SMA platforms. Ash Lawrence joined us as Head of Private Capital to lead the growth of our private markets businesses. We welcomed employees for our new head office at CIBC Square, which marked the official start of our hybrid work approach. The space provides our employees with a flexible workspace, enhanced collaboration and greater communication while continuing to advance the reduction of the firm's office footprint by approximately 22%. As we navigate the uncertainties in the market, we remain focused on building on the momentum from the past few years, managing the risks and our results and creating value for our shareholders over the long term. As we look ahead to 2023, we are announcing SG&A guidance of $202 million. Our SG&A guidance does not include costs related to corporate development and excludes severance. At AGF, the most important asset is our people as they play an integral role in the firm's success. AGF is committed to being an employer of choice, which means looking at responsible practices and initiatives to attract, develop and reward employees. We continue to be thoughtful and disciplined in our approach to expenses, while also investing for growth, especially into our Private Capital business. SG&A for 2023 reflects these investments as well as the inflationary market environment. As a reminder, our SG&A includes variable compensation. A significant improvement in sales or investment performance could result in higher variable compensation expenses. We have a strong balance sheet to strategically invest and redeploy excess capital to generate recurring earnings and return capital to shareholders. We continue to evaluate our pipeline of capital deployment opportunities. However, with the current market environment, conditions to complete a transaction continue to be challenging. As we head into fiscal 2023, we remain focused on our strategic priorities, which are to deliver consistent and repeatable investment performance, maintain sales momentum and generate net inflows, build a diversified private markets business, beat our expense guidance and continue to invest in key growth areas, and enhance our corporate sustainability programs. Finally, I want to thank everyone on the AGF team for all their hard work. We will now take your questions. Hi. Good morning. This is Chi asking in for Gary. Kevin, can you talk a bit about how you're achieving your three-year fund performance percentile? It's been a choppy market since the last few months, so how have you maneuvered for that? And can you also expand on your outlook for 2023? Yeah. Thank you, Chi. Yeah. Obviously, if you think about the last three years, we've had, as I mentioned in my remarks in the call, the drawdown from COVID, massive recovery in the same year, and then pretty strong year in '21 followed by the drawdown in '22 on the idea of Central Bank tightening. Now begin that on all sizes what I look at, and I think it's a testament to frankly that we've got a disciplined view of things. In the market, last year was one where we had to be more tactical and probably more defensive, so that positioning helped. And so, when I look at December, which was also equally a tough month to remember, we gave everything we got back in the end of November back in the market in December. And we continue to improve on those track records. So, I feel pretty good about the performance because that sets us up obviously now for the next couple of years of sales. And probably more importantly, we didn't have any, what I call, blowups. So the cardinal sin in this industry is where you -- in a negative market like last year, you have performance that's even worse than the market, and then you are on defense. So we have, obviously, none of that to deal with. So we can really play offense and talk about how we've helped investors through this. As far as where we go in 2023, obviously, we have some more volatility ahead. But obviously, the worst of the monetary tightening is behind us. I mean, what we know about our industry is that our company's asset management industry goes down first with the market because obviously that's where we're sensitive to, and we all move in the recovery while you're in a recession. So, I think it's going to be volatile year, but a very different year. Obviously, the tone of the market will set the tone of the investor sentiment around investing this year, but I think obviously we're through most of the worst of it. So I think a volatile year, but probably one that sets up sort of better back half. Thank you. My second question is on the flow side. So you'll continue to see some decent momentum to start a new year. What are you hearing from your distribution partners as we head into the important RSP season? And what products they are most interested in? Thanks, Chi. This is Judy Goldring. We continue to see strong flows going into our global equity and fixed income has picked up significantly as well. And so we are expecting to see sort of across the broad portion of our offering sort of interest across the different channels. And I think we remain certainly optimistic or cautiously optimistic around the upcoming next couple of quarters. And Kevin, did you want to add something on market? Yeah. No, I think that Chi, as I've said, if we stay with a lot of volatility, obviously that will impact flows. But to the extent that -- again the industry losses here in Canada is something that looks close to $50 billion last year in outflow, that's sitting in cash and GICs. As the market firms or at least starting to flatten out, some of that will come back. Obviously, the big month for us all is the -- is February for the RSP season. And so to the extent that investors feel like the worst is behind and we could see some better year on that front. So I'd say -- and then probably the second thing is related to product specific. Global has been in place for people. We expect those flows to continue. Most of our suite is more globally oriented and I'd say that the other place will be fixed income. We're really well positioned as well. As investors probably won't have a repeat of three negative quarters of fixed income returns last year, you can really get yield now. And so, I think that suite of products will do well in this environment as we move forward. Thank you. And just my last question on the private notes (ph). Can you elaborate on the fair value adjustment this quarter? It seems like -- also seems like the private old (ph) amount on your balance sheet, that's creeped up sequentially. So maybe provide a bit more color there. And lastly, may be just some timing and thoughts on the $5 billion mark? Thank you. Thanks, Chi. This is Jenny Quinn. So our investments in our long-term investments increased 100 -- from $176 million at Q3 to at the year at $199 million. So, three things happening in there. We had a $23 million increase, which was $17.6 million in capital calls for the quarter, and then we also recognized a $2.1 million adjustment in fair value. And then, finally, we had a reclassification of routes to distribution income of $3.5 million. So those are the three pieces that are increasing it from the $176 million to $199 million. So a small piece of that is the fair value, most of it was distribution income. Yeah, Chi. It's Kevin. Let me touch on the $5 billion, and we still are committed to that target. Obviously, as we said, towards the later part of last year with the environment around us, getting transactions done was difficult and continues to be difficult. But we still feel pretty comfortable we'll get there this year in 2023. And the environment being one we're again, things we're looking at. Sellers want yesterday's multiple and we want to pay todays multiple, that takes a while to solve, but the pipeline of things we're looking at is very robust. So we feel pretty comfortable in that mark. Hi. Good morning. Just maybe to start on the SG&A guidance. Is that up slightly? I think you said $202 million for the year. Is that up slightly from the preliminary guidance provided last quarter? Hey, Graham. It's Kevin. Yeah. I mean, we've looked at going through our budget cycle and obviously when we had strong investment performance, strong sales performance. And I think about us being an industry leader, we have great talent and to keep that talent, as we want to be pretty certain around that in terms of securing where we're going with it. And I think, at the same time, when we look around, we have a lot of inflation as we all know. And so we've tried to be really competitive around that to take care of our employees. So that is probably the biggest chunk of it. And second to that I'd say is the build-out of the Private Capital business is also in there. So there is a spike to where we were on this year's guidance from where we were a couple of quarters ago. Okay. Perfect. Helpful. Primerica, just maybe looking for an update there on what the fund sales look like in terms of what classes of funds because I know you have a bespoke, I think, F class type fund that you've created for them. Is that what's driving the sales or are they going into A class funds? Just maybe some color there. Graham, this is Judy. We launched a specific comprehensive suite of 19 funds exclusively for Primerica, so their flows go directly into those funds. And as you know, a principal distributor relationship and we're seeing in terms of the flows are going in across the various offerings that we have on our platform. And so we're supporting -- we're supporting that business and we're seeing some good momentum in that channel. Yeah. And Graham, I'd also add to it. It's Kevin. We don't talk about specific clients, but I would tell you this. We can't tell how well that would be doing without the backdrop of this market behind us, right, which we know is hanging over that. But having said that, we're very pleased with where we are with that relationship and that launch. So again, as cloud of the market clears, we'll get a better look on that. Okay. And just to be clear, Judy, are those funds like an F class type structure with no trailer fee associated? Okay. And I guess building on that, any implication then for what you're sort of expecting over time, as sales move into that class of fund, is that going to have an impact on your overall management fee rate and your trailer fee rate in terms of basis points? How should we be thinking about how that evolves? Yeah. So there's no transferring of the funds from historical or legacy PFS assets. This is purely net new assets going into this comprehensive suite of funds that we have. So as they -- as PFS evolves their business, they are successfully transitioning out of the DSC model structure that was in place previously and moving into this new principal distributor relationship. And they've been doing it quite successfully. Yeah. So over time, Graham, what you'll see is, we still think there is a basis point or two a year in terms of our -- now basis points on revenue. As obviously these funds -- the legacy funds stay in place, the new funds will come on at a lower rate because of that model. But that will shift over time. So, I think 1 basis point or 2 basis points a year. Okay. And the trailer fees, should we expect those to be moving down as well over time? Because I know there's kind of puts and takes there as DSC falls off, they pickup. But then if you're putting on new funds and have no trailer associated and that's going to have an impact as well. So, any color on how we should be thinking about that? Hey, Graham. It's Jenny. So, again, just think that it really comes down to the next of the assets. So, as we will get assets coming on schedule, which will bump-up that trailer rate, but then as these scale across the board of the AUM, it will offset that. So we would expect it to decrease slightly over time. So you might want to say 1 basis point a year over time. Okay. That's helpful. Judy, you're on, I think, three SMA platforms now in the U.S. Can you just quantify what that was in fiscal '22 in terms of net new assets from those platforms? Yeah. We have very much focused in the U.S. on the SMA opportunity. We see that as a great opportunity to run three platforms and then, as Kevin mentioned in his opening remarks, for on the TAMP platforms as well. And across the board on the SMA specifically in Canada and the U.S., we've seen growth of those assets over time and we now have about $500 million. So we've seen great progress and I think we're seeing continued success. The $500 million is just specified as U.S. And in Canada, we're seeing some additional flows in the SMA platform as we focus on that channel up here as well. And Graham, the SMA platforms in the U.S. are actually ahead of where we are in Canada, but we'd expect platforms here to pick up as well as people get more vehicle agnostic, right, meaning it could be a fund, could be an ETF, could be an SMA. But obviously the platforms in the U.S. are well ahead of where we are in Canada. Okay. Great. One more if I could get a little greedy here. I noticed that you said Ash Lawrence presented to the Board a strategic plan for the private assets platform. Is there anything incremental there that we should be aware of or any update? Yeah. I mean one of the things that it will bring to the table is, obviously, when we get through a deal here, we recognize that part of the business gets bigger, we'll have to get better and more complete disclosure on some of that. So look for us Ash to be present on these calls as we move into time as well. But really no change to where we had set out with the Board in mid-year. I think he should have been executing them. Okay. Thanks. Good morning. Just back to the mutual fund flows, I think you alluded to certain products that we're experiencing pretty healthy demand environment. Just wondering if you can help us understand the breakdown of those mutual fund flows in the quarter by asset class or maybe the split between long term and money market? I'd just like to drill down a bit and try to understand the composition of those flows a little better. Yeah, Nik. We have very little money market, so most people come to us for a long term. So, I would say, money market has been kind of the non-issue for us, whereas you're seeing some of the other players, the banks are seeing money come out funds into money market or GICs, that won't be an issue for us. But it's been broad based. It has been across -- again, we're more global than most, so that has been a better place to play. So -- and then, performance has been broad based and broad based really strong. So flows are probably more global equity-driven, but picking up on the fixed income side as well. So I'd say, it's not a specific fund or category that I would point to. I'd say it's been pretty solid across the board, but definitely don't think about it as money market. That's not the driver. Okay. Good. And then I think just a point clarification. I think you had highlighted that quarter-to-date mutual fund sales were still positive. Are there any chunky allocations that were won in the I Series supporting that quarter-to-date result or is that a pretty clean number? So just -- yeah. I know there's sometimes, some confusion. We do adjust our mutual fund sales just for non-recurring institutional net sales or redemptions that are in excess of $5 million that have been invested into our mutual funds. And so when you -- we did announce the $230 million win, which is positive flows for a strategic partner in November as well, there was a smaller redemption of about $56 million that came out during the quarter. And so, as a result, our net sales number, that is true, flows in retail is about -- is $76 million. Got it. And then I was just thinking more along the lines of subsequent to quarter-end. I think you just -- that the quarter-to-date sales were positive. I was just wondering if that would have been adjusted for I Series as well. Yeah, no. And just to clarify, that that's December 1 to January 20, we saw $62 million in sales and that's not been adjusted. There is no adjustment. Hi. Good morning. Just first question was on the 2023 SG&A expense guidance. I know you mentioned it excludes separate severance and corporate development. On the corporate development thing, is that just things that might be things around M&A and those sorts of things or there other things that you would classify in corporate development that would be outside of that scope? Yeah. I know it's just transaction-related things where we do transaction on something this year. So you're right, Geoff, it's real M&A-type stuff. Okay. And just my other question was just on the institutional side of the business. Can you share what the net flow number was for Q4? What you're seeing like in terms of the committed pipeline in terms of other new sales or potential redemptions? And just in general, the outlook as you can see it over the next few quarters? Sure. It's Judy. So if we look back over the last sort of six quarters, we've seen strong flows of that $500 million from a variety of different clients, institutional clients in our SMA platform. When we are looking forward, we're continuing to see strong RFP activity. At this point, there's no committed sales pipeline at this juncture and very nominal small committed redemptions of about $85 million in the next quarter. But we are seeing a significant pickup in the RFP activity, largely in the global equity and U.S. growth space along with our sustainable mandates. Thank you. And I'm not showing any further questions. Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. AGF's next earnings call will take place on March 22, 2023. You may now disconnect.
|
EarningCall_1109
|
Good morning, and welcome to Valley's Fourth Quarter 2022 Earnings Conference Call. Presenting on behalf of Valley today are CEO, Ira Robbins; President, Tom Iadanza; and Chief Financial Officer, Mike Hagedorn. Before we begin, I would like to make everyone aware that our quarterly earnings release and supporting documents can be found on our company website at valley.com. When discussing our results, we refer to non-GAAP measures, which exclude certain items from reported results. Please refer to today's earnings release for reconciliations of these non-GAAP measures. Additionally, I would like to highlight Slide 2 of our earnings presentation and remind you that the comments made during this call may contain forward-looking statements relating to Valley National Bancorp and the banking industry. Valley encourages all participants to refer to our SEC filings, including those found on Forms 8-K, 10-Q and 10-K for a complete discussion of forward-looking statements. I have a few comments to make this morning, and then we have Tom to provide insight on the quarter's loan and deposit results. Mike will then discuss the financial results in more detail. In the fourth quarter of 2022, Valley reported net income of $178 million, earnings per share of $0.34, and an annualized ROA of 1.25%. Exclusive of non-core charges, adjusted net income, EPS, and ROA were $183 million, $0.35 and 1.29%, respectively. In 2022, we generated net income of $569 million and adjusted net income of $650 million. This represents a significant increase from 2021, as a result of strong organic loan growth, the acquisition of Bank Leumi USA, and the benefit of higher interest rates that were realized for the majority of the year. I am extremely proud of Valley's consistent financial performance throughout my tenure as CEO. Our profitability metrics and earnings per share have increased steadily across a variety of economic and competitive backdrops. Despite the negative impact of interest rates on equity in 2022 and completing the largest acquisition in our company's history, our focus on tangible book value resulted in year-over-year growth. In fact, our stated tangible book value has increased 36% since 2017. This compares to a 14% increase for our proxy peers over the same period and a 14% increase for Valley between 2012 and 2017. Our value creation, as measured by tangible book value plus the dividends we have paid has totaled 72% since 2017. This is over 1.5x our proxy peer median of 47%. We have generated real franchise value on both an absolute and relative basis. Within the context of our sustained financial success, I want to focus this morning on what I see as our key accomplishments over the last five years and how the evolution of our company positions us for the years ahead. From a balance sheet perspective, we have done a tremendous job diversifying our funding base. At the end of 2017, approximately 92% of our deposits were held in retail branches. By focusing on commercial relationships and both niche and digital deposit channels only 70% of our deposits are from the branch network today. From a geographic perspective, 78% of our total deposits were in New Jersey and New York branches in 2017. Today, that number is down to just 48% of total deposits. Finally, despite a challenging few quarters, CDs and borrowings comprise just 23% of funding today versus 31% five years ago. Our focus on geographic diversity and a holistic approach to commercial relationships has benefited the asset side of our business as well. In 2017, 78% of our loan portfolio was in New York and New Jersey. Currently, less than 60% of our loan portfolio is in these states. The ongoing addition of higher-yielding and increasingly adjustable loans has helped to better align our asset and liability betas. In our view, this increased balance should help to reduce the net interest margin volatility that we have experienced in prior cycles. Ultimately, our sustained credit excellence provides a stable foundation upon which the aforementioned transformation could occur. Our premier asset quality will continue to be the hallmark of our organization. This credit strength is a result of both stringent underwriting criteria and a focus on holistic relationships with wealthy and sophisticated commercial clients. Heading into 2023, we have not identified any underlying trends, which would indicate meaningful stress on the loan portfolio. In any event, we believe that our experience during the height of the pandemic indicates the exceptional resilience of our borrower base. In aggregate, the balance sheet transformation that we've undergone has been a direct result of our company's strategic evolution and targeted M&A activity. We have focused on business and geographic diversification, premier customer service and establishing a sustainable organic growth engine. Our hiring efforts and tactical initiatives have aligned with these outcomes, and we feel well-positioned to navigate the near-term operating environment headwinds that we face today. Over the long-term, we will continue to focus on diversification and sustainable growth. We believe the progress made over the last five years will drive our continued success and ultimately benefit our associates, customers and external stakeholders. Slide 6 illustrates the quarter's 15% annualized loan growth. While quarterly loan originations remain below peak levels, net growth continues to benefit from slower payoffs and more sustained activity on the residential and consumer side. Our commercial loan growth remains well diversified across asset classes and geographies. We continue to experience significant repeat business from our longstanding and sophisticated commercial borrowers. We anticipate that customer demand will wane somewhat in 2023 largely due to the impact of higher interest rates. Still, we are well-positioned from a competitive perspective to capture high-single-digit loan growth for the year. Our continued focus on attracting and retaining top talent and preserving service excellence positions us well despite a potentially more challenging backdrop. On Slide 6, you can also see the 99 basis point increase in average new origination yields to 6.2% during the quarter. We remain successful in passing rate hikes through to our customers and anticipate further expansion in origination yields in the near-term. As a reminder, approximately 40% of our loan portfolio is fixed and another 20% re-prices over a period beyond 30 days. These buckets should provide a re-pricing tailwind that will continue to support increasing portfolio yields as rate hikes slow. Before moving on to the deposit side, I wanted to provide some additional color on the quarter's net charge-offs. Approximately $21 million of the quarter's charge-offs were related to a single C&I loan. Both Legacy Valley and Leumi has participated in this larger syndicated credit. Our combined loan exposure has previously been classified as non-accrual, and the remaining exposure is fully reserved for as of 12/31/2022. This is a discrete credit event, and the vast majority of our portfolio continues to perform extremely well. And as Ira mentioned, our underlying credit trends remain very strong. Turning to Slide 7. You can see that deposits grew at an annualized rate of approximately 21% during the quarter. While the quarter's net growth is largely funded by brokered alternatives, we are pleased with our ability to effectively defend our traditional deposit base in this challenging environment. While we saw non-interest deposit pressure across business lines, the largest single driver of the quarter's reduction occurred in our technology deposit area. Despite the volatility in this business, which has been exacerbated by certain environmental challenges, we continue to add customers and accounts and anticipate above average growth over time. As a reminder, our technology deposits contribute approximately 5% of our total balances. As we indicated last quarter, we are experiencing competition for deposit sources across the franchise. Specifically, on the commercial side, the same wealthy and sophisticated customer base that supports our strong and consistent credit performance has been actively requesting competitive deposit rates. This has incrementally pressured our betas and deposit costs. Our retail network has been responsive to our CD offerings, and both digital and canvas deposits saw solid growth during the quarter. We are keenly aware of the price competition that we face to defend and grow our deposit balances. A variety of channels remain available to us, and we will do our best to take advantage of the most cost effective alternatives to support our continued loan growth. Slide 8 illustrates Valley's recent quarterly net interest income and margin trends. Net interest income increased approximately $12 million or 3% from the linked quarter. This reflects continued loan growth and expanding loan yields, which were partially offset by more robust interest-bearing deposit growth and funding cost pressures. While our fourth quarter fully tax-equivalent net interest margin declined 3 basis points to 3.57% from the third quarter of 2022, our PPP adjusted margin remains 47 basis points above the fourth quarter of 2021. During the quarter, a 69 basis point expansion in our asset yield was more than offset by a 78 basis point increase in total funding costs. The asset yield increase was driven by both the re-pricing of our floating rate loans and a significant increase in the yields on newly originated loans. During the quarter, we funded loan growth and our non-interest-bearing deposit runoff primarily with higher cost time deposits. As you saw on Slide 7, we calculate a cumulative year-to-date deposit beta of approximately 34%. As we noted last quarter, deposit competition has accelerated rapidly, and we have had to offer higher rates to attract funds to support our significant loan growth. While we continue to benefit from asset re-pricing, this is likely to be more than offset by higher funding costs in 2023. Moving to Slide 9. We generated just under $53 million of non-interest income for the quarter as compared to $56.2 million in the third quarter. The reduction was primarily the result of lower swap income. This was partially offset by stronger revenues from our trust, wealth and insurance businesses. We anticipate that our 2023 fee income could grow at a mid to high single-digit pace using the fourth quarter annualized number as a starting point. On Slide 10, you can see that our non-interest expenses were approximately $266 million for the quarter or approximately $256 million on an adjusted basis. Most expense lines were well controlled during the quarter, and the modest increase from the third quarter levels was partially the result of higher counterparty collateral fees related to certain hedging activities. Continued revenue growth helped drive our efficiency ratio to 49.3% from 49.8% in the third quarter. We anticipate sustaining a sub-50% efficiency ratio in 2023 and believe there will be opportunities to drive efficiency lower from our current level. Turning to Slide 11. You can see our asset quality trends for the last five quarters. Tom detailed the single loan relationship that drove the spike in net charge-offs for the quarter. We believe this was an isolated incident and are pleased with our aggregate 5 basis point net charge-offs to average loan rate for 2022. As a result of continued improvement in our underlying credit metrics and stability in the economic forecast, our allowance for credit losses as a percent of total loans declined to 1.03% at December 31 from 1.10% at September 30. As a percentage of non-accrual loans, the allowance increased to 170% from 162% at September 30 and 150% one year ago. On Slide 12, you can see the tangible book value increased approximately 3.4% for the quarter. This was the result of our strong earnings and a modest improvement in the OCI impact associated with our available-for-sale securities portfolio. Tangible common equity to tangible assets improved slightly as a result of the same factors. Our regulatory capital ratios declined modestly during the quarter as a result of our strong loan growth. We anticipate that growth will moderate in 2023, resulting in higher regulatory capital levels a year from now. We lay out additional 2023 guidance items on Slide 13. For simplicity, we based our forecast on 2022 full-year results, which only included three quarters of impact from Bank Leumi. Based on our current pipeline and expectations for a modest pullback in demand, we anticipate 2023 loan growth of 7% to 9%. This would result in net interest income growth of 16% to 18%. We anticipate approximately 10.5% to 12.5% growth in expenses using 2022 reported less merger charges as a starting point. This would imply a full-year efficiency ratio at or below the mid-49% level posted this quarter. I wanted to start drilling down on the margin a little bit. Appreciate the guide and the outlook, and obviously a strong kind of end to the year. I'm just curious, though, I mean, I imagine you guys are assuming some more beta pressure on the funding side in the first half of the year. But as we think about the thought process around a relatively stable NIM for 2023 and asset yield improvements being offset by funding improvements, are you guys also factoring in continued outflow on the non-interest bearing side? Or how are you guys thinking about mix? Because obviously, Ira, your point is well taken about how much the business has structurally changed, but is there still some kind of normalization to be had just from the environment that we're coming out of? Yes. And I think it's a good question, and I'll turn some of the mechanics over to Mike. But I do want to re-highlight once again the macro change that we have in the funding base today and especially just out of that retail footprint. I know, historically, the Northeast has been high on an absolute basis as well as high on a beta basis. And to now have 48% of our deposits just in the New York, New Jersey region versus 78% before is dramatically going to change what the overall beta performance is. But Mike, you've got some more details, I believe. Yes. I think the thing to really keep in mind is we saw $900 million roughly rotate out of non-interest bearing into interest-bearing between third and fourth quarter. And our expectation right now as we look into 2023 is that, that will continue. And hopefully, it bottoms out into the high 20s type range. The reason that we think that is, we bank a fairly sophisticated wealthy customer base. And obviously, we pass the line where they're going to leave excess deposits in non-interest bearing. Also keep in mind that with that $900 million that rotated, we also had about $700 million of "excess" put that quotation marks deposits that we put on in the fourth quarter in anticipation of the Fed's -- two additional Fed actions increases in the first half of 2023. So we're getting out ahead of that a little bit. And obviously, those have a higher beta attached to them. And I do want to really just add to one of the things that we have done is continue to grow the commercial book as well. If you look at a year-over-year basis, we've seen business checking accounts increase 11%. And obviously, those have a lot of operating accounts associated with them. So there is -- there really isn't as much excess deposits in some of those. So while there is pressure, I do believe some of the changes and focuses that we've had in the strategic areas are really going to unload to the benefit throughout 2023. Great. So taking that kind of all into context, I mean it's fair to say that at this point, when you guys are kind of guiding towards a stable-ish NIM, you could kind of conservatively assuming that some of the headwinds that occurred in the fourth quarter continue to occur in 2023. And Mike, I think when you think about -- this is Travis, when you think about our 7% to 9% loan growth guide and when you kind of take the fourth quarter run rate on NII and you figure out where the guide that we're giving you is for 2023, you'll see kind of closer to 4% NII growth. So we're anticipating some amount of margin compression. And don't forget too, the first quarter, obviously, we'll have additional headwinds. Like the day count issue is going to cost us a couple of basis points there as well. So I don't think we're guiding necessarily to a stable margin. I would say that if you factor it all together, there's a little bit of pressure that's baked in here, and it's because of the factors that we've talked about. Perfect. Okay. Great. Thanks, Travis. And then secondly, Ira, on the efficiency ratio and -- I guess just kind of a philosophical question, but I mean, do you think sub-50 is kind of the new table stakes? I mean, as you guys try to manage your business from an investment standpoint and an ROI standpoint on -- in terms of like incremental margins of new business customers and stuff? I mean, is this -- I guess the question is, is this kind of just the way we should be thinking about your business kind of base case moving forward kind of irregardless of where rates are? Yes, I guess, I'll just leave it there. Curious what your thoughts are. I mean candidly, we should not be disappointed if we went above 50% on a consistent basis. I believe even our forecast for this year continues to invest in strategic initiates that are really going to continue to drive franchise value for us. I think we focus on expenses probably too much in certain areas. If you go back to when I took over as CEO, we have 3,325 employees and $29 billion of assets the first quarter thereafter. Today, we're sitting with $57 billion of assets, 3,826 employees. So we've added 501 employees over the five years and grown the bank $28 billion. There's tremendous focus here on efficiencies, process and making sure that we're getting the most out of every single dollar that we spend on the expense side. I think -- but to your point, we have to build franchise value. We are investing in our future in certain businesses that we think are going to continue to really grow and so outsized performance. So it is a balance for us. But managing the macro number, I think, is something that's really important to everyone here within the organization. Helpful. Perfect. And then just sneak one last one, and then I'll drop back. Just the trust and investment fees were stronger than I was looking for, at least in the quarter. And I was just curious if you could maybe remind us what the fee structures there look like and depending -- like are they market-dependent? Or are they more fixed? So just any color there would be great just so we have an idea of what to expect once we make some assumptions for next year. Yes. Mike, I think the fourth quarter pickup was partially related to Dudley, which has some seasonally back-loaded revenues. So that flows through that trust investment insurance line for their advisory fees. I do think our forecast for 2023, we assume that there's some continued improvement in that line in total because should the equity and debt markets normalize, I think we would look for some improvement in our market-based revenues. So I think that's reasonable, but we don't anticipate a significant -- obviously, we're guiding to mid to high single-digit growth on the fee side. So it's not astronomical. Okay. And the Dudley, is that seasonal revenue something that would -- you would expect to occur kind of on an annual basis towards the end of the year? Thank you. And one moment for our next question. And our next question comes from the line of Steve Moss with Raymond James. Your line is open. Please go ahead. Good morning. Maybe just following up on Mike's question here, just going a little further into the weeds. Curious, where is loan pricing these days? I think when you -- it's Tom, Steve. When you look at our yield in the fourth quarter, we increased that 100 basis points to 6.2%. On a monthly basis, we were just under 6.5% for the month of December. We continue to push our spreads up to counter the cost of our deposits. It really will differ by asset classes, more so than anything else. And as Ira mentioned earlier, we're 60% adjustable. So we'll continue to benefit by the rise in short-term rates on that 40% of our portfolio tied to SOFR prime and LIBOR. Okay. That's helpful. And then just on the deposit side, you mentioned growth in, I think, tech and cannabis here. Just kind of curious if you can give a little more color on the trends there, maybe size it up. And how much is maybe non-interest bearing versus interest bearing? Yes. It's a deposit-driven business for us, and we are focusing on the multistate operators. We now do business with 10 of them. We grow accounts in double-digits on a quarter-to-quarter basis. We are -- I don't have it exactly, but we're primarily non-interest bearing on our deposit accounts. And one thing -- this is Travis, we lumped cannabis in with a couple of other niche deposit businesses. So for us, there'll be cannabis, HOA, national deposits and digital. And those four businesses in aggregate added $900 million in deposits during the quarter, which helped to offset some of the other traditional kind of commercial deposit runoff. And so that goes back to the Ira's conversation about the transformation of the bank. Absent those businesses, which are relatively new to Valley, we'd be looking at a different deposit picture. Okay. That's helpful. And then last question for me here. Just curious, any color you can give on the construction loan that was moved to non-performing status type geography, things of that nature? Yes. Sure. It's Tom again, Steve. It's a single loan based in New York City. It's a for-sale construction project of six units, three are contracted to be sold. We're awaiting a TCO to close those sales. Upon the three sales, we will be paid in full. Thank you. And one moment for our next question. Our next question comes from the line of Jon Arfstrom with RBC Capital Markets. Your line is open. Please go ahead. A question for you on the CD growth during the quarter. Ira, you mentioned it used to be, I think 31% five years ago. Do you guys see any limits to that CD growth? Should we expect more of the same in the next quarter or two? I think you will see slightly higher levels, assuming that we have loan growth that's in excess of what our expectations are in the guidance. And then brokered CD market is very liquid for us, and we'll use it as a tool to fund up the balance sheet and manage our loan-to-deposit ratio. But as Travis commented earlier, what's really important is the growth we're seeing in these other niche sectors, along with the fact that we did do another CD promotion in the fourth quarter that raised just about $1 billion as well. And while those are higher-cost deposits, as I said earlier, trying to link it back to my earlier comment, we expect those deposits will become cheaper, assuming that the Fed's expected rate increases occur in the first half of 2023. And Jon, I mean, I just can't reiterate enough the different levers that we have today that we never historically had. When we talk about where we used to generate fund income, you always have to come out of the branches. It came out of the FHLB or came out of the brokered CD market. Those were the three choices we had. Today, to even to support the 15% loan growth, we have a litany of additional levers today. And we have the flexibility that if we wanted to go to the retail CD market because we think that's attractive, then that's where a portion of it could come from. We have the ability to extend duration on certain things that we've never had before. So the flexibility that we have today is astronomical compared to where we were before. And I do believe over a period of time on a relative basis that that's going to help us manage our funding cost to a much better degree than what we're historically able to. And when you look at the asset side of the balance sheet, which they should be looked at in conjunction in the floating rate assets that we've been able to put on, it really helps dictate the types of funding that we want to do across the entire organization. We don't necessarily look at one side of the balance sheet just in isolation. Yes. Yes, that makes sense. I mean it's a unique period, Ira, right? It's -- we're in a period of maximum deposit pricing pressure right now and I understand that. And keep in mind, we had 60 -- I think, as Mike was alluding to, we had a 60-plus basis point runoff early, right, because of the asset sensitivity. So there was an expectation here that we're going to see some increase in the funding cost to come along with that. But like you said, Jon, it's unique, it's interesting right now. But there's massive franchise value that we're able to build by adding 50% loan growth and be able to find the funds to really support that. Yes. Okay. Just one quick one on this topic, and then I have one other one. But you mentioned the tech vertical, the decline in deposits there. Was that a surprise? And what drove that? Was that simply making a decision on rate? Or was that something else in there? And what was the magnitude of that? I won't give you the magnitude of it, but I will tell you what caused it. What caused it was one customer in their portfolio that went IPO. And as a result of that, the bank that took the IPO received the deposits that we previously had. And that should come as no surprise. That is the lifecycle of what happens inside of that tech business. But overall, our tech balances from the time we started to now are basically flat when you've seen most everybody else in that space have declines. Which I think is a good thing. I mean, if you think about what you've seen from an industry perspective, you've seen tech deposits come down because of cash burn and needs at the overall individual portfolio companies. This was a great event. If you think about it from a client perspective, that there with you IPO and really still even in this market generate some sizable returns from an investor base. And I think it demonstrates the differentiation of what our tech business looks like maybe versus what some of the others do from an industry perspective. Yes. Okay. Good. And then maybe this is for you, Mike, I'm not sure. But buried in the release, there's a comment about talking about reserves, a lower quantitative factor in the reserves. And I'm just curious what was behind that. Was that related to the charge-off? Or was that something else that drove that? And then just if you could give us some thoughts on the provision as well, that would be helpful. Thanks. Yes. You're really in the weeds on that one. But the quantitative -- for the most part, the quantitative adjustment was not an adjustment based upon economic assumptions because we kept those the same. So that's probably what you really want to get at. It's more a function around nuances in various loan pools that we use; kind of management overlays is the way to think about it. And then if that's good, on the provision question, all else being equal, we definitely believe that we will be able to -- all else being equal, we'll be able to maintain our current allowance coverage ratio of 1.03%. But it's also important to note that from the time that we did CECL to where we're at now, we're actually up 14 basis points. So we started CECL at 89 basis points. We're at 103 today. And by our math, the peer group is roughly down 20 basis points. So while you've seen massive releases and reductions, we've been the exact opposite. And clearly, we could have done that if we chose to in the fourth quarter, and we chose not to because I think it's prudent going into this economic environment to try to preserve our allowance or our provision as best we can. And maybe just following up on that, I mean just to put it in simplest terms; we didn't believe the reserve when many of our peers did. So it's not unlikely that we're not going to have to provide as much if the economy does go into recession compared to where the peers were. But just it doesn't feel like you guys are -- you're being cautious, but you're not necessarily seeing the erosion that maybe we're all fearing is coming later? I think when we were being cautious for the last five to six quarters, where our economic conditions still had a much more significant weighting towards a recession than what everybody else did. I find it unfathomable that people would drain their reserve 20 basis points below CECL for the last -- coming out of a pandemic and put it down to their P&L. It makes no sense to me. So now where I think that we've been more conservative, it's absolutely more likely that we're not going to have to build to the level that everybody else is. They should have never dropped down below CECL, from my individual perspective. Thank you. And one moment for our next question. And our next question comes from the line of Steven Alexopoulos with JPMorgan. Your line is open. Please go ahead. I wanted to start -- so first, following up on the NII guide, the up 16% to 18% in 2023. Within that guidance, what is the deposit beta assumption by the end of 2023? Sorry, I just want to clarify, like, so when you look in just for a simplistic terms, because Mike said it absolutely right, the simplistic terms like we wanted to give you the metric that would be comparable to the way we present the deposit beta in our investor deck. So if you look at that and you roll that forward to the fourth quarter of 2023 based on our rate assumptions, that that cumulative deposit beta would be 50%. There is one rate cuts, but it's very late in fourth quarter, so I don't think it will be very impactful. Got it. Okay. And then in terms of the funding strategy, in terms of funding the loan growth in 2023, I'm hearing somewhat mixed messages, right? You have these lower-cost niches, which helped this quarter. But you're relying more on brokered CDs and other CDs. How do you see the mix evolving through 2023? And is it going to skew materially towards these higher costs? Or do you think you could keep about the same mix, but because of the growth you get out of the lower-cost verticals? So in our comments, we made a comment around non-interest bearing rotation that could possibly reduce that number as a percent of total deposits down to something in the high 20s. So I think the answer to your question is yes. We expect a further rotation out of non-interest bearing. I think that we expect a continued growth in those niches based upon different aspects that happen with interest rates throughout the year that will help fuel the loan growth that we expect and fund that loan growth. But to the extent that those are shortfalls and we don't have enough funding, I think brokered is probably the first place that we'll go. And we've been doing that. So I think it's just a continuation of demonstrating what we've been doing. Okay. So if we put this together and think about the NIM being under pressure, at this point from the 4Q NIM, do you think it's sort of down fairly consistently quarter-over-quarter through the year? Is it more pronounced in the first half then you get to some level of stability in the second half? Yes. So I think the pressure right now -- nobody has a crystal ball. This is really hard to try to figure this out. I think the pressure will be more pronounced, there may be some lag, but I think it will be more pronounced in the first half of the year. And then you'll see a plateauing, hopefully, if in fact, the future rate curve is actually realized. And then you'll see a plateauing and then maybe later -- as we said earlier, later in the fourth quarter, you get a slight reduction that won't be meaningful because of the timing of that cut. Yes. As you think, Steve -- but just keep in mind, if you're looking at it on a relative basis, right, I think the day count is really going to impact where we are from 4Q going into 1Q. So I think our comments are acknowledging that when you think about the pressure we're going to see just in the first quarter. So not all the pressure is really from a funding base but just really that day count piece as well. Awesome. Got it. And then just one separate question on credit. There's obviously a lot of market concern on commercial real estate given the rise in cap rates. And I'm just curious, looking at the detail that you could provide on Slide 15 of the deck, one, do you share the markets concern over commercial real estate more broad? And maybe could you drill down if you are concerned? Is it a particular geography or product? I'd love to hear your commentary on that. Thank you. Yes. Steven, it's Tom. We certainly share the concern of segments of the markets in real estate. We still continue to see robust growth of people moving into the southern markets, especially Florida. A lot of our real estate growth is coming down in that Florida market to support that migration of people down there. As you well know, we are a very diverse granular book of business. We don't have a sizable concentration in any segment. Looking at our real estate portfolio, our average -- weighted average loan-to-value is 62%. Our debt service coverage is 1.75. So we do look at this very closely. Our cap rates, we've always stressed at higher cap rates than our competitors. Our average cap rate is around 6.42%, but you'll go through different categories and asset classes. And as an example, when multifamily cap rates were being -- were in the 3%, 4% range, we were stressing at 5.5%. That allows us to obtain what will consider lower leverage growth in our markets and keeps down the weighted average LTV and debt service coverage. And we underwrite to cash flow. We don't underwrite to collateral value. Thank you. And one moment for our next question. Our next question comes from the line of Manan Gosalia with Morgan Stanley. Your line is open. Please go ahead. Hi, good morning. Had a question on CDs. You noted that customers have been responsive to your CD offerings. Can you expand on what terms you're putting on? I know you were selling them out in the past. So has there been any change in the duration mix given that we're closer to the Fed holding rate steady or potentially cutting? And if you could also help us with how much of the CD portfolio will likely -- is likely to re-price in the next couple of quarters? Yes. This is Mike. So our retail CD promotions that basically started in the middle part of 2022 and continued into the fourth quarter have all been around 12 or 18-month duration. So we're not going out long on the curve because obviously, related to the answers we gave to earlier questions around our expectation for rates is that we do expect rates to come down in the very end of 2023 and obviously spill over into 2024. We're also trying to build a fairly flat maturity schedule so that we don't have any one quarter where you have a lot coming due. So generally 12 months to 18 months and we've been very fortuitous on those offerings so that while at the time they might have been a little bit on the high side -- the high beta side, when you look back now where we are with rates after the 425 basis points of Fed increases, you now look at those as being fairly good funding for us, actually fairly cheap in some cases. Now the one we did in the fourth quarter was obviously on the more expensive side of that. And that's public. So I can definitely tell you where that was at. That was at 4.5%, and it raised just under $1 billion. Got it. Very helpful. And then apologies if I missed this, but I think last quarter, it sounded like you were tightening lending standards a little bit. Can you talk about how you -- what you're doing this quarter? And how you feel about [indiscernible] going in? Yes. Yes. I'm sorry. We consistently look at our lending standards and our criteria. And we again tighten those standards early on in the pandemic. And to remind everyone, 70% of our business is to our existing customer base that have been through the ups and downs in the economic cycles. So we manage our the -- we never compromise standards to grow. We maintain our standards. And as we talked about before, we typically use higher cap rates to evaluate our loan-to-values. Thank you. And one moment for our next question. And our next question comes from the line of Matthew Breese with Stephens. Your line is open. Please go ahead. A couple of quick ones. First, what was the accretable yield for the quarter? And what's the outlook for accretable yield in 2023? Yes. So Matt, we said the third quarter was $8.5 million on the loan side. That ticked up about $3 million this quarter. And we anticipate -- I think we said that $8 million to $10 million is a good run rate on a quarterly basis, and that remains kind of our guidance. Okay. And then what is -- just give us some outlook for the securities portfolio in 2023 and whether or not you see much of any growth. Or should it match kind of overall balance sheet composition stay the same? Yes. So as a reminder, it represents a little less than 10% of our earning assets. So it's not a material driver of income. Nevertheless, that portfolio is very high quality. And remember, the majority of that is held in held -- or held for maturity. So 75%-ish is out there, 25% is only held in the AFS portfolio. I don't really expect a lot of changes. I guess the biggest change you've seen probably this is an industry change has been that any kind of payouts have ground to a halt. And so you have very little coming due that way. What we will add is in the highest-quality ranges and probably in the lowest risk-weighted asset ranges. And we'll keep pace, obviously. We have -- as a reminder, we have a lot of public fund money in this bank as well, and government banking as a niche for us is an important niche. So we do have to have collateral for that business. So we will continue to maintain at a minimum what we have. Got it. Okay. And then, Ira just would love your thoughts in 2023 around M&A. Previously, the message was, look, we got a ton of stuff to do organically. There's plenty of opportunity on that front. Felt like M&A would have to be incredibly spectacular for you to do it, but my read was probably not. Just wanted some updated thoughts there. I would probably say you could copy and paste back into the comments for this quarter as well. I think we're very fortunate that we are likely an acquirer of choice, a partner of choice for many people that are out there today, which is wonderful, I think, based on the experience and successes that we've had. Maximizing and focusing on tangible book value is something that I've always talked about from day one when I became CEO, and that really continues. And today, when you look at the economic environment, I think it's very difficult to do an M&A transaction that isn't necessarily just a resource strain, but really drain the tangible book value as well, and that's not something that I'm comfortable with doing. Outside of that, I do believe that we have such tremendous opportunities on an organic basis that we should continue to focus on those resources. We still need to continue to convert and get some of the synergies associated with the Bank Leumi deal, and there's tremendous opportunities with that. So like I said, probably copy and paste, Matt. Understood. Lastly, just thank you for adding the expense guide for 2023. I appreciate that addition to guidance. That's all I had. Thank you. Thank you. And one moment for our next question. And our next question comes from the line of Frank Schiraldi with Piper Sandler. Your line is open. Please go ahead. Good, good. Thanks. Just on the niche businesses, I think, Tom, you talked about sort of the way you approach that, you lump in the cannabis, the HOA, the national deposits. And then, you mentioned a growth rate in the quarter. Just wondering, as we think about those businesses maybe ramping up, I'd assume that we could see greater contribution on a quarterly basis going forward. And then just also curious, is that largely low to no cost deposits within that umbrella? Yes. When you look at the individual components, certainly, we've been ramping up the HOA, and that's largely non-interest bearing deposits. We talked about the national deposits business. That's primarily an interest bearing program and process there. The tech will have a large portion of non-interest bearing, but we'll have interest bearing mix in there also. And the plan on tech is really to broaden the users and have reliance in addition to domestic VCs will go along with the Israeli VCs that we're doing business with today. There are other -- cannabis again will be multi-state operators, primarily a non-interest bearing program. So yes, the plan is to ramp up our specialty or niche businesses, focusing on the deposit side of it. And then on the technology deposits, you mentioned there's been some volatility there. But overall, I guess it's sort of flattish with where you acquired the business in terms of balances, it sounds like. And so do you -- can you give any -- put any parameters around how volatile it has been? I think you said 5% deposits right now and where that's gotten to over the last couple of quarters? And do you see it just continuing to be volatile here in the short-term? That's a great question. Other than the IPO event, the very discrete event that we talked about, it's not actually been that volatile for us. We know from talking and listening to industry folks that in other portfolios, it can be incredibly volatile, but ours has not been. Now granted, we've only had three-fourths of a year of experience with it. So you got to take that for what it's worth. Okay. And do you lump in there -- is that like a Bank Leumi umbrella? I mean, do you lump the private banking that you got from that acquisition in with those technology deposits? Or how has that growth rate been for you guys? Okay. And have you seen a contraction in that business? Or do you have any -- the size -- the relative size of that business at this point? Yes. So I think we've said this before, the international business is from a deposit perspective, is larger than the domestic business. And the domestic business is going to grow. This is one of the synergies that we identified as part of the Leumi acquisition. We'll grow because of the private banking business that we have on our side, the legacy side of the business, I should say. The international private banking business has had some reduction in deposits. The good news is, remember, that's both a deposit and an AUM business. And for the most part, their value add has been structured notes. And obviously, the market has not been conducive to that. So we've been able to retain those clients by moving a vast majority of them into treasury securities. And then in a different interest rate environment, I would expect some of those as they mature to come back on balance sheet. And just one thing to add. In the last six months, we've had over $250 million of referrals from the Legacy Valley customers into the domestic private bank for assets to manage. And it's a constant flow of consumer loan business that comes out of that private bank portfolio into Valley. Got it. Okay. And then just lastly, sorry if I missed it, but could you give any more color on the participation? I thought I heard you mention that you weren't to lead, and I think you mentioned Leumi in there as well. But just wanted to make sure I heard right with the partial charge-off. Yes, certainly. So this is a customer that began banking with us in 2006, so almost 17 years. We began with a $7.5 million share and a total $25 million credit facility or 30%. Company performed well over the years. The credit facility grew to $160 million since that 2006 inception. We always manage our exposures, and we increased our exposure from 7.5% to 19% but reduced our overall from 30% to 12%. The company sells cardboard boxes for shipping produce. Their customers' customer had a concentration to Russian entities. The embargo has put a very big strain on your customers' ability to pay them. We saw that early on, took early action. We put this on non-accrual early in 2022. And we reserved the 100% of the loan during 2022. This represents about a 50% charge-off of our outstanding loans. Isolated, we do constant reviews of all of our receivable-backed loans, received as any stretching of payments on those. And as Ira mentioned earlier, our credit metrics remain strong. It's probably important to note that Leumi had a piece of this as well. So the combined number is a little different because they had a piece. Yes. I was referring to the management of the Valley total over those 16, 17 years. When we acquired Leumi, they were also a participant in the bank group. The charge-offs and the reserve represents both bank shares. Thank you. And I'm showing no further questions. And I would like to turn the conference back over to CEO, Ira Robbins, for any further remarks. Well, I want to thank everyone for taking the time and the interest in Valley today, and we look forward to showing you our performance for 2023.
|
EarningCall_1110
|
Good morning, and thank you all for joining us as we discuss the fourth quarter and full year financial results for Roper Technologies. Joining me on the call this morning are Neil Hunn, President and Chief Executive Officer; Jason Conley, Incoming Executive Vice President and Chief Financial Officer; Rob Crisci, Executive Vice President and Chief Financial Officer; Brandon Cross, Incoming Vice President and Principal Accounting Officer; and Shannon O'Callaghan, Vice President of Finance. Earlier this morning, we issued a press release announcing our financial results. The press release also includes replay information for today's call. We have prepared slides to accompany today's call, which are available through the webcast and are also available on our website. Now if you please turn to Page 2. We begin with our safe harbor statement. During the course of today's call, we will make forward-looking statements, which are subject to risks and uncertainties as described on this page, in our press release and in our SEC filings. You should listen to today's call in the context of that information. And now please turn to Page 3. Unless otherwise noted, we will discuss our results and guidance on an adjusted non-GAAP and continuing operations basis. For the fourth quarter, the difference between our GAAP results and adjusted results consists of the following items: amortization of acquisition-related intangible assets; purchase accounting adjustments to commission expense; a legal charge related to the settlement of the Boral versus Verathon patent litigation matter. The case related to the sale of certain Verathon products from 2004 through 2016, there are no future financial obligations for Verathon related to this matter. Next, transaction-related expenses for completed acquisitions, and lastly, we have adjusted our cash flow statement to exclude the cash taxes paid related to our divestiture activity. GAAP requires these payments to be classified as operating cash flow items even though they are related to divestitures. Reconciliations can be found in our press release and in the appendix of this presentation on our website. And now if you please turn to Page 4, I'll hand the call over to Neil. After our prepared remarks, we will take questions from our telephone participants. Neil? Thanks, Zack, and good morning, everyone. As we turn to Page 4, we'll walk through our usual year-end agenda, highlights for the most recent quarter and full year, followed by color commentary for each of our segments and then the initiation of our 2023 guidance. Let's go and get started. Next slide, please. As we heard on Page 5, the main takeaways for today's call are First, we delivered another great year of strategic, operational and financial progress. To this end, we concluded our multiyear divestiture program, which was centered on improving the quality of remaining portfolio, namely emphasizing less cyclical, more asset-light and higher-growth businesses. In addition, we successfully deployed $4.3 billion towards market-leading and application-specific software businesses. More on this later, but we also continue to have substantial M&A firepower well north of $4 billion. Organically, we grew just shy of 10% for the year while simultaneously improving the underlying quality of the enterprise. During the course of the year, our businesses did a terrific job of innovating and capturing share, which leads us to our second main takeaway for today's call that we're well positioned for another solid year of performance in 2023. Our higher quality, less cyclical and more highly recurring nature of our portfolio will serve us well during 2023. Now as I hand the call over to our Incoming CFO, Jason Conley, let me take a moment and thank Rob Crisci for all he's done for Roper and for me. Rob has been a significant contributor to our success and an important member of our executive team with meaningful insights and contributions across a variety of topics, including our most recent portfolio repositioning. We're excited to welcome Jason to his new role. Many of you know, Jason, for those of you who do not, Jason has been with Roper for 16 years. He started in corporate IR and FP&A, then the operating CFO at MHA or one of our businesses and most recently serving as Roper's Chief Accounting Officer. Since he has returned to corporate, he has been a member of our capital allocation team and has attended every Board meeting. The team and I are excited to partner with Jason for the next leg of our evolution. So, with that, looking forward to the partnership, Jason, and thank you, Rob, for all of you done to make Roper better than when you joined. Jason, let me turn the call over to you, can walk through the fourth quarter and the full year financial summary. Jason? Thanks, Neil. I am very excited and incredibly grateful for the opportunity to work with you and the team in this new role. And of course, thanks, Rob, for your awesome partnership and mentorship over the years. It's been just a great experience working together. So first, I'd like to introduce Brandon Cross as our new Principal Accounting Officer. Brandon joined Roper about five years ago, progressing to our Assistant Controller and more recently, has led and transformed our audit services function. He has significant M&A and integration experience. So this is a natural and well-earned promotion for him. Brandon, I look forward to working together in your new role. If you indulge me, I'll rip on Roper for a few seconds. I've been blessed to help guide and execute our evolution from Roper Industries to Roper Technologies, which has been underpinned by our North Star belief that cash is the best measure of performance. And as we enter 2023, our best years are ahead of us. We have a family of market-leading businesses with durable growth drivers and terrific free cash flow margins. Further, the leadership teams and talent processes at our businesses are the best in the company's history. And finally, we have significant capacity to execute our proven and disciplined M&A strategy that I've been a part of for many years. I anticipate being quite active on the road this year. So for those on the call, I look forward to either meeting you or reconnecting in the coming months. All right. Let's get into the financials. Turning to Slide 6. We'll do a quick review of our Q4 performance. We capped off a solid year of growth with revenue of over $1.4 billion, which was 14% higher over prior year. Organic growth was 7% with strength across the portfolio, which was enhanced by 10% software recurring revenue growth. Acquisitions added eight points of growth, led by our Frontline business that closed in early October, and currency was a two-point headwind. EBITDA of $592 million, was up 17% over the prior year. We experienced strong operating leverage across the enterprise and improving gross margins in our TEP segment to finish out the year. DEPS came in at $3.92, which was 17% against prior year and $0.18 above the midpoint of our guidance range. Next, we'll look at free cash flow. free cash flow. Free cash flow of $457 million was down 8% over the prior year. Excluding the Section 174 impact, we were down 3%. And factoring out a $30 million Vertafore tax benefit in 2021 that doesn't repeat, we're up about 3% to 4% in the quarter. Taking a broader view, you can see we compounded cash 11% over a four-year period, despite the Section 174 headwind, and we're well positioned for double-digit cash flow compounding going forward. Turning to Slide 7. We'll now do a quick overview of our Q4 segment results, as Neil will unpack more detail on the full year a bit later. We had a nice finish to a great year across the three segments. For Application Software, revenue was up 22% to $740 million, with organic growth of 7%. EBITDA margin increased to 45.6% in the quarter. We had strong SaaS bookings growth and overall solid net retention throughout the year, which is just naturally rolling through recurring revenue in the quarter. Growth was broad-based across the segment, aside from some delayed decision-making in the large government contract in space within Deltek. On margin, we had lower incentive-based SG&A and employee medical costs, so some favorability in the quarter. If you look at the full year margin of 44%, that's about where we would expect to be over a longer horizon. Our Network Software segment grew nicely in the quarter, with revenue up 9% to $350 million and EBITDA also up 9% to $189 million or 54% of revenue. Growth was led by our freight matching businesses, which continued driving higher ARPU from premium offerings to offset moderating carry activity as we expected. Tech-enabled products revenue was $340 million and grew 5% organically in the quarter. Demand remained strong, and we had some orders that didn't get delivered toward the end of the quarter, which will benefit Q1. EBITDA grew 7% to $119 million, resulting in EBITDA margin of 34.9% or 100 basis points over prior year, with strong operating leverage as the price cost dynamic was neutralized in the quarter. Turning to the full year 2022 performance on Slide 8. Revenue was 11% higher than prior year to $5.4 billion, with 9% organic growth. EBITDA was 12% better to nearly $2.2 billion, with EBITDA margin coming in at 40.4%. The of $14.28, was 15% over prior year and reflected strong P&L leverage against the 11% revenue growth. Notably, compared to our 2018 pre-divestiture financial profile, our revenue is about $175 million higher, while EBITDA is nearly $365 million higher. So, through a combination of organic growth and capital deployment, we've grown despite divesting about 40% of our 2018 revenue. And most importantly, the composition of our portfolio today positions us for higher and more durable growth going forward. Free cash flow came in at about $1.5 billion, so down 7% versus prior year. It's a bit of the same situation as our fourth quarter with both the 2022 headwinds of Section 174 of nearly $100 million and the nonrepeating of the 2021 Vertafore tax benefit of $117 million. If we normalize for those items, free cash flow grew about 8%. We've had a bit of an inventory build within our tech segment as supply has become more available. This is not a new normal, and we certainly expect that to improve in 2023. If we kind of take this up to a multiyear view, you can see we've compounded cash at 15% over a four-year period. And as we look forward, the impact from Section 174 will be fairly neutral, and we expect to convert plus or minus 80% of flow. So, we're clearly well positioned for double-digit growth. Turning to Slide 9. Let's take a look at our financial position. We certainly had a lot going on in Q4. On November 22, we completed the majority sale of our industrial businesses, which are now operating under the name Indicor and received $2.6 billion in upfront proceeds. Also, in the quarter, we paid $270 million, representing all taxes due related to the majority sale. So, this yielded us net proceeds of over $2.3 billion, a very good outcome here indeed. Related to our stake in Indicor, this is now appearing as an equity investment on our balance sheet. We will be updating the fair value of the equity investment each quarter going forward. To provide a clearer picture of our continuing operations, we will provide a non-GAAP adjustment for this fair value accounting and any tax expense related to this investment. So just looking at our balance sheet, even after our $3.7 billion Frontline acquisition, which was completed in October, our net debt-to-EBITDA ratio stands at 2.7 times. So, our solid leverage profile, coupled with strong free cash flow generation and an undrawn revolver of $3.5 billion, gives us $4 billion plus of M&A capacity. Clearly, we are very well positioned for disciplined capital deployment in 2023. Thanks, Jason, and well done. Let's turn to Page 11 and walk through our 2022 highlights for our Application Software segment. Revenues here were $2.64 billion, up 7% on an organic basis, and EBITDA margins were 44.1%. Performance across this segment was just solid in 2022. Vertafore, our software business that tech enables property and casualty insurance agencies accelerated their growth, led by continued strength in their enterprise class segment. In addition, the two Vertafore bolt-on acquisitions are strategically on point, integrated and performing well. As we've been discussing, SaaS migrations have been a key theme for us over the past few years, and 2022 was no different. Both Aderant and Deltek continued their SaaS migration momentum and both grew nicely based on solid customer adds and strong retention. Deltek was particularly strong in their private sector end markets. But as Jason mentioned, Deltek did see some slower decision-making specific to new bookings in the enterprise segment for their GovCon solutions. At our upcoming March 21 Investor Day, you'll get an opportunity to hear directly from the leaders at Vertafore, Deltek and Aderant about how they're competing and consistently winning in the market. As it relates to Power Plant, we liked what we saw last year. PowerPlan was strong given their refocused and narrowed strategy combined with a highly aligned team. As a result, PowerPlan crossed a meaningful milestone, launching a SaaS solution for their flagship product, tax fixed assets. Congrats to the team for a great 2022 and looking forward to more great things in 2023. 2022 is a very good year for application health care IT businesses as well. Strata's combination with EPSI has just been great. The integration is complete and the number of EPSI, the Strata has conversions and upsell, cross-sell are both meaningfully ahead of our deal expectations. Clinisys and Data Innovations continue to win in the marketplace. The internal combination of Clinisys and Sunquest has rejuvenated and energized their high-performance culture, which is enabling the business to more effectively compete and win in the marketplace. Data Innovations continues to gain share and evolve to become the de facto standard as it relates to Lab Middleware. Finally, Frontline, our cornerstone 2022 acquisition is off to a solid start. We look forward to sharing the strategic and financial success of this business in the quarters and years to come. I'd like to reiterate with what we started with. Performance here strategically, operationally and financially was just great in 2022. Very proud of the team and the performance. Congrats and thanks. Looking to the outlook for 2023, we expect to see organic growth in the mid-single-digit area based on our market positions and growth in recurring revenues. Turning to Page 12. Revenues in 2022 for our Network Software segment were $1.38 billion, up 13% on an organic basis, and EBITDA margins were strong at 53.3%. As we dig into business-specific performance, our U.S. and Canadian freight matching businesses were great in 2022. Their exceptional growth is based on many factors, certainly favorable market conditions, but also continued product and network innovations as well as terrific product and package designs that drove increased value for the network participants. iPipeline and iTrade network were stellar performers throughout 2022 and benefited from having strong renewal and expansion activity. iPipeline like that a PowerPlan is benefiting from having a narrowed and more focused strategy, namely tech-enabling the life insurance and annuity distribution network. Moving to Foundry, which had another great year as part of Roper. Foundry continues to be the market-leading software in postproduction media entertainment. During 2022, Foundry's product innovations were impressive with several new features focused on ML-based automation. Starting in 2023, Foundry's flagship product Nuke will begin its subscription transition, so looking forward for solid progress on that front. Growth in our businesses that focus on alternate site health care was led by SHP and SoftWriters and importantly, retention rates across SHP, SoftWriters and MHA remained extremely high. Broadly, the performance across this segment was great. Congrats to the teams for this terrific year of financial performance. Turning to the outlook for 2023. We expect to see mid-single-digit organic growth for this segment based on broad and sustained growth across the group and a normalization of market conditions for freight and logistics applications. As we turn to Page 13, revenues in 2022 for our Tech-enabled Products segment were $1.35 billion, up 10% on an organic basis. EBITDA margins for this segment were 35.4% for the year. As expected, EBITDA margins expanded in the second half of the year as pricing and supply chain improvements flow through. Let's start with Neptune, our water meter and technology product business. This past year was just terrific with very strong growth based on strong margin conditions, strong share gains and strong adoption of their static ultrasonic meter technology. In addition, Neptune launched their cellular connectivity solution and did a fantastic job migrating a large chunk of their customer base to their newest data management solution. Spectacular job Neptune, congrats you and your team. Northern Digital, which is our precision measurement tech company, continued to see terrific demand for their optical and EM solutions. NDI benefits from having a strategy that is laser-focused on health care applications and an R&D capability that is unmatched in the industry. NDI's core tech is using countless life-saving procedures on a daily basis across the globe. Verathon turned in another solid year performance in 2022 as well. The growth is based on momentum across their video innovation and single-use bronchoscope product lines. As you saw in the press release, we did take the opportunity to clean up a legacy patent dispute. Make no mistake, the innovation capability at Verathon is nothing short of exceptional, and we cannot be more confident about their most recent product launches and the new concepts in the development pipeline. As it relates to the single-use rock space, we hope to see Verathon capture the number one market position in North America in 2023. Our outlook for the year in this segment is in the high single-digit area and is based on continued strength in backlog at Neptune as well as continued growth across our medical product businesses. Now please turn to Page 15, and let's review our 2023 and Q1 guidance. For 2023, we're initiating our DEPS guidance to be in the range of $15.90 and $16.20. Underpinning this guidance is expected organic growth of 5% to 6% and a tax rate in the 21% to 22% area. Specific to the first quarter, we're establishing our DEPS guidance to be in the $3.80 to $3.84 range. Now please turn with us to our final page, Page 16. As we turn to this page, we want to leave you with the same key points with which we started. First, 2022 was a year of great accomplishment for our teams and our enterprise. We grew revenue 11%, 9% on an organic basis. And we did this while continuing to increase the underlying quality of our revenue base. In fact, we delivered double-digit increases in our Software organic recurring revenue during 2022. EBITDA grew 12%. Our EBITDA margins expanded 20 basis points to 40.4%. Also, we successfully concluded our multiyear divestiture program and deployed $4.3 billion against our long-standing capital deployment strategy, headlined by Frontline Education. The second key takeaway is that we're well positioned for double-digit cash flow compounding in 2023 based on our organic revenue growth outlook, contributions from our 2022 acquisition cohort and having well north of $4 billion of M&A capacity. To this end, we continue to be very active in the M&A markets. But as you saw during 2022 and as always, we will remain super patient and highly disciplined to ensure optimal deployment of our available capital. Finally, and perhaps the most important, the new higher quality Roper portfolio is becoming increasingly more evident, and we've never been more excited about the future of enterprise. As we open up to your questions, we'd like to take this opportunity to remind everyone that we're hosting an Investor Day on Tuesday, March 21, in New York. We look forward to seeing many of you there. Thank you. Good morning, everyone. Just start with the best wishes to Rob. I remember when he was a starting as a rookie Investor Relations professional and just wish him all the best. Thank you. It's fabulous. And then, Jason, I think you've been on every one of our callbacks for the 16 years. So you're absolutely -- we know exactly who you are and your experience. And so congrats on the new role. All right. So for a question, maybe we can start with a bit of a macroeconomic sensitivity because you typically, you don't see much of this within Roper, but just called out the Deltek delayed decision-making, Neil, is there any change in the pace of like new customer adds or the migration, new logos? Anything that you would point to that perhaps there is some economic sensitivity reading through in that kind of the pace of business? Yes. I think the -- if I take it at the highest level, we've been 8% to 10% organic. The last couple of years, obviously, are guiding a little bit below that for 2023. So I think you see it in our guidance model reading through as a general matter. If you take the Software businesses, our retention rates will stay very high. We expect that as to the intimacy and the criticality of our applications. So retention rates to be very high. But as our customers, I mean, across all these end markets, I mean, if there's macroeconomic sort of headwinds or slowdown, then they're going to be affected to some degree, so we expect customer expansion activity maybe a little bit of net new to be slowed a little bit. The Software businesses will be great. They'll grow for sure, but a little bit slower. From an end market perspective, we're in a number of end markets that are generally macro insensitive. There's a little bit, obviously, in our transportation business is that we called out on the call. That will be a little bit slower. But there's some hedges inside the portfolio. ConstructConnect should be good in the slower economic environment and also our medical product businesses as staffing levels and hospitals gets a little bit easier. Patient volume should come back and that should help those businesses. And then from a product, Neptune has got a gigantic amount of backlog, which will carry them through much of this year. So we feel pretty well set up. It doesn't mean that we're completely insensitive to macro, but relatively insensitive. That's real helpful. And then let's just switch over to free cash flow and maybe I'll be accused of quibbling. The $161 million free cash flow conversion is still elite, but it did lag your five-year average. And I know there's some dynamics here, and you touched on them in the remarks, the Section 174 and the comparison from the tax benefit last year. Anything that on the working capital side or maybe the Frontline contribution because they're on a different school year, so maybe more of a third quarter collection. But is there any change in the seasonal tilt on free cash flow conversion? Yes, Deane, good question. I think you're spot on. So we typically convert on -- from an EBITDA to free cash flow will be in the 90s typically and Section 174. If we adjust for that, we are in the 80s. And so you're right. Frontline has a very seasonal sort of cash collection cadence. So the third quarters when all the renewals and upsells happen, so most of their cash comes in the third quarter. So in the fourth, you won't see that converting to cash from EBITDA. So that's exactly what you saw. So we're looking forward to next year and especially in the third quarter will be a little bit more weighted than normal. Good morning, guys. Congrats, Rob, and good luck, Jason, et cetera. I wish you guys well, but [indiscernible]. Jason you get to work a few more years with Neil. Good luck. I can say that, I guess. But anyways, I don't want to climb in a minutia here, but I know there's no one particular asset that moves the needle in a huge way. But can we walk back and talk a little bit about PowerPlan? I mean you mentioned the narrower product focus. I think, I heard you say, which didn't really understand what that meant. And the cloud rollout, again, like is that -- how relevant is that to the business? And -- but maybe if we just go back and you can explain to us again what kind of drives PowerPlan? And I'll just leave it there and leave it behind. I appreciate the opportunity to talk about, anyway our businesses, it's been a while since we've been able to do a double-click on PowerPlan. So just remind you what they do, right? So PowerPlan software and services live at the intersection of the financial system and the asset tracking system for these large utilities, investor-owned and public utilities. And when the PowerPlan software has a perfectly curated view of what the assets look like inside our customer base. When you have that perfectly curated view and these assets are constantly being updated and changed, they're not static, right? And so that's why you have to live between these two systems. And we have this perfectly curated view of what the assets are, then you get the most appropriate tax treatment you can, the most appropriate lease accounting and a series of other financial benefits associated with that. We bought the business. The business was doing that, but it was also reaching outside its core customer base and the core products I just described, looking for growth sort of in all the wrong places, if you will. And then we -- what we did when we did our strategy work with them going back probably a year, 1.5 years ago is the amount of opportunity inside the core of what they do was large enough to support the growth thesis for many years to come. So it's just refocusing back on the core. That's a common theme. We talked about that. I think you'll see that increasingly more inside of Ropers as we do our strategy work, right? So not getting too far away from the core and getting distracted. So that's what they've done. The first impact of that is they now have this 100% SaaS solution for their principal product fixed assets just released in Q4. And we're excited by that because as you lift and shift your customer base from an on-premise to a cloud solution, there's a tremendous value capture opportunity, and it will unlock some growth for the business. No, that's the value unlock, right? So we're doing more for our customers with the SaaS solution, right? So we're not just hosting it. There's more features. You're on the latest release, where certainly, we know how to operate our software ourselves better than third parties. And so it's the efficiency and the uptime is higher. And as a result of all that, you do get price. We'll see we talked about there's roughly $900 million in legacy on-premise maintenance in our revenue base. And as that is lifting and shifting to the cloud over a long arc of time, that should lift and shift north of 2 times, right? So there's $1 billion of growth that's latent inside the portfolio as we lift and shift that on-premise maintenance to the cloud. Okay. I look forward to the Analyst Day. I'm going to pass it on. Thanks, guys. Congrats on another good year. See you on Analyst Day. Hi, good morning. Thank you, Rob. And I look forward to working with you, Jason. So maybe my first question, just to try and home in a little bit more on the sort of macro framework in the guide. Maybe specifically, I think about 25% of your Software revenue is reoccurring and non-recurring, so maybe more cyclical kind of talk. Maybe just remind us sort of what the organic growth of those two in aggregate was last year and what you're dialing in for 2023 or any flavor of that? And then within Network Software specifically, transport and freight, it's almost 1.25 of the revenue. And you mentioned you're dialing in, I think, normalization was your phrase. Maybe just any finer point on what that means exactly of growth this year versus last? Yes. So let me take -- let's take those, Jason, I take those in sequence. So I'll set up what the difference between recurring and reoccurring revenue is in our base. I'll let Jason talk about the relative growth rate, then we'll tackle the DAT freight question you're raising. So just to level set what everybody is, if we have a recurring revenue is subscription, contractual recurring revenue, reoccurring revenue is principally located at our MHA business. We take a percentage of the drug and food spend that goes to the network and so it's not technically recurring, it's highly reoccurring. So it's not -- and that's probably the most -- one of the most stable parts of our portfolio, long-term care, health care, residents and buildings, consuming food and pharmaceuticals, right? So it's highly secure for lack of a better word. It's not transactional relative to a macroeconomic sort of situation. So I'll stop just in terms of framing recurring versus reoccurring. I'll let Jason take the relative growth rate question. Yes, sure, glad to. So MHA, as Neil mentioned, it's really about drug purchases from the pharmacies, and they have very strong retention in those businesses from a customer standpoint. We always sort of think about the business being at the -- maybe at the bottom end of the mid-single digits, maybe a little bit low singles. And that's sort of what we experienced this year, and that's kind of what we're baking in for next year. Great. Okay. Now let's take to your freight and logistics around DAT specifically. So to remind you, there's this tension between the cyclical freight dynamic and a secular push or a secular benefit that DAT and DAT's customers are experiencing relative to the spot market becoming a more efficient place to place freight. So there's tension between those two. From a cyclical point of view, we expected and have seen the carrier side of the network reduce a little bit. And it's -- and we expect it to reduce over the course or shrink or get a little bit smaller over the course of this year. DAT grew through the 2019 freight recession. I think DAT has grown every year since 2010. So the business is talking about the rate of growth at DAT, not does it expand and contract. It tends to be much more stickier than that. As an early read, January is actually a little bit better. I mean the number of carriers in the network is sort of flattish through January and not declining. And the people in the industry that sort of call like the freight timing and if there's going to be a freight recession, I actually think there's a queuing for a large spring shipping season, mostly around -- this triggered by produce. And we might start to be seeing a little bit of that bleed in, but we'll have to see how the next couple of quarters play out. That's very helpful. Thank you for the color. And then just within TEP, I understand the recurring piece is minimal there in its 99% product-related. Any flavor you'd give us on the sort of what you're seeing in medical versus Neptune for 2023, any major difference in kind of visibility between the 2two or the growth rate expected? Yes. So we have the most visibility we've ever had at Neptune. That's right. The order volume continues to flow. The order duration, meaning the longer date orders continues to flow. And so we feel quite comfortable and good how 2023 is shaping for Neptune. For medical products, there's actually -- I think we've talked about a few quarters ago, the reoccurring elements of Verathon became the largest part of the revenue stream. There's a lot of consumable pull-through in the capital equipment there. Northern Digital has a decently high amount of consumables that are pulled through that zip code [ph]. And so it is more procedure and patient driven. And we like I said a few minutes ago, we feel that were decently well set up there, but it's not in our base case. So we saw 6% to 8% declines in patient volumes in the areas in which we service in 2022, all tied to hospital staffing levels. And we're cautiously optimistic that as the labor market solution, hospitals be able to staff and be able to see patient volumes pick back up the prior levels. Good morning. Congrats to all. Rob and Jason, I'm looking forward to working with you. Just on the free cash, you mentioned plus or minus 80% conversion to EBITDA. Obviously, the last couple of years have been a bit volatile around all these tax items. But in '21, I think you had a decent number of deferred revenue benefit on the cash flow statement. Maybe just give us a little bit of color looking into next year with concerns around the macro that can be a pretty big variable. I mean are you going to be around that 80% in '23? Or will you be kind of more in between what you did in '21 and '22, I think, adjusted around 70%? Maybe just a bit of color on the free cash, and then I have a follow-up on Frontline. Yes, happy to. No, I think we're feeling very good about the 80% Our deferred revenue, our renewals were really strong this quarter, and we felt good how it moved up sequentially, how was up year-over-year. And just what we're hearing from our businesses, we feel good about the renewals. And then we're going to have -- we expect -- I think I said on the call that we'll get some improvement on our inventory ratios next year. We had a little bit of build at the end of this year. Frontline will certainly help with our negative working capital profile. They're at negative 40%. Like I said, most of that will hit in the third quarter when all the renewals take place. Of course, if Section 174 gets repealed, this will be a home run year, but we're not banking on that for now. No. They were somewhere in the '80s. We had a few days knocked off at the beginning of the quarter because we closed on the 4th. Okay. By the way, I really appreciate all the discussion on the businesses and looking forward to the Investor Day, learning more on this portfolio. So very helpful detail on the moving parts of all the different businesses. Good morning. Just want to circle back on DAT. I know you talked about it growing historically through cycles, but it's certainly been an unusual one. A lot of new entrants here. Is there any risk to the retention rate should that spot rate not hold in terms of stabilization in some of those new entrants, I guess, can't survive? And then I guess along with that, that premium offering, in this type of uncertainty, does that drive maybe more increase or interest in that premium offering versus just to gain some visibility here in an uncertain market? Just any thoughts there? Yes. So in terms of the number of -- when you say new entrants, I assume you're referring to the number of new carriers that are in the network as opposed to a competitive entry or the sort because there really are no new competitive entrants. Relative to the carriers, yes, I mean, it was -- it's been just a tremendous last couple of years, driven by the things we've talked about for a couple of years, which is the fluidity and the liquidity in the spot market, which is a secular tailwind and then obviously, a huge boom on the cyclical piece. We -- historically, when you look at like peak carriers to trough carriers through cycle, it sort of goes carriers declines by plus or minus 10%. We've assumed that it will decline by more than that in our guidance model because the buildup was unprecedented. But -- so that's sort of -- we think we have this conservatively planned in our outlook, but it's unprecedented ramp up leading up to this. We do take some early confidence in the carrier count in the first couple of weeks of January. So the fact that we're flattish versus continuing to see some declines is certainly encouraging, but it's only a handful of data points we want to see take together. In terms of the premium offering, I mean, DAT has just done a tremendous job creating product and package designs that have more value for all the network participants. It's helped drive some ARPU increases because there's more value that the participants are getting. Great. No, that's helpful. And then just in terms of the M&A pipeline, are you still under the new portfolio, PE primarily your source of opportunities here? Have you expanded it? And if I guess if you have, are you looking -- I know CRI is your metric that is your foundation. But are you providing any other controls with maybe some new opportunities out there? Just any thoughts there? Yes. You're right. We've obviously historically sourced all. But in my time here, I think one meaningful deal from private equity. One was from a small founder or founder, and that has been sort of the pod in which we fish. But we're -- that's not exclusively where we have business development activities going on. We've always looked in public markets. We just haven't found anything that's been compelling from a value point of view yet. We'll continue to look there. You could see us get a little bit earlier in the cycle and try to compete a little bit more with private equity sort of half a click earlier in the company's life cycle. So when we did the Vertafore transaction and the Frontline transaction, many of our investors said, why didn't you buy it when the first you bought it from a private equity firm, you bought it from bought it. And so that's something that you could see us explore in the right situations. But still, all that being said, the predominance of what we're going to do is what we've done for the last 20 years, which is sort of lower risk of highly recurring software -- application software businesses from private equity. Hi, thank you. And good morning. You noted that your adjusted EPS calculation will include the fair value accounting and tax impact of Indicor. But why would you not include the minority interest contribution as well? Just wondering what is the logical downside not including that, shouldn't it be a positive and growing contribution? Well, it's a calculation that's going to be based on many variables, right? It's mainly an accounting exercise. We don't think that it's going to -- we'd rather see the outcome when we do the exit. We think that's the better reflection of what the economics are going to be. We feel really good about what that's going to look like. We've worked with CD&R on a strategy there. They typically look at several multiples of return on investment, and that's what we're playing for upon exit. Okay. Great. That's helpful. And then in terms of price contribution in Q4, what did that look like? And then also how much pricing is embedded in your 2023 guidance? So price for us, I mean, it's an important lever to our growth algorithm, not just for '22 and '23, but all prior years and all forward years. Teasing out specifically how much is price is a very, very difficult thing across our 27 companies and rolling it up to a number that is meaningful. And so we're not going to share a specific number in that regard. I'll tell you the pricing, the value capture that we have, given what we do, the criticality of what we do, we've always had pricing power and pricing value capture and there's nothing different with that. Do you want to add anything to that, Jason? Good morning. Just wanted to take a quick look at macro, question here. I was wondering if you could offer any color on your exposure to construction end markets? And how that's playing into your growth expectations for FY '23. And I guess, specifically, I'd be curious around Deltek, ConstructConnect and Neptune as well. Yes. So I appreciate the opportunity there. So let's just take it by those three. So ConstructConnect, to remind you what it is, right, so we have a near perfect database of all the construction -- commercial construction projects that are in the planning phase across North America. As a result, when -- it has a bit of countercyclical demand attached to it. So when there is a tremendous amount of new projects and you're a subcontractor general contract and building product manufacturing and business is flowing from everywhere, then you don't have to look too hard for what you're going to do next. When there's fewer projects, then you subscribe to the subscription service of ConstructConnect so you can identify what projects are coming down the pipe that you want to try to bid for and win. And so the ConstructConnect has been a modestly good performer for us over the years. We expect it to actually have a good run here in '23 as a result. Deltek does have -- it's been a strategic focus of Deltek. Deltek is 60% government contracting, 40% private sector and private sector. The smallest sliver is construction and we sell software to large contractors. That's what we do. That business, we -- in our prepared comments, we talked about how the private sector was very strong in Q4 for Deltek. We would expect and do anticipate some softening on the construction side for Deltek in 2023, and we think we have that fully covered in our guidance. And then Neptune, we believe strongly Neptune is not a cyclical business. As you sell water meters and water meter technology to the municipalities when they're -- they tend to have a budget for meters. When there is a large new residential new construction, then a higher percentage of the budget goes to install new meters. When there's fewer new starts, the budget stays the same, but they take the meters and they do the retrofits and trade outs of the aging fleet and infrastructure. So that is a general cross-cycle sort of view of Neptune, But then we're further -- our confidence is further buoyed by the fact that we have this just unprecedented amount of backlog at Neptune for 2023. So we think that Neptune will perform well for us this year. Yes, good morning. And congrats as well to Jason and Rob. Maybe just stick on the technology-enabled products area. I think the -- there was a mention of some products didn't ship in the quarter maybe got pushed. Just to step back, maybe update us where you think you are around supply chain just on the product side in your businesses? And then I'm curious what kind of impact that those deferral shipments might have had in the fourth quarter? Let me just set it up, and I'll hand it over to Jason. So in TEP, we talk obviously -- about Neptune, we talk about medical process. There's also a small cohort of RF product businesses [indiscernible] and RF Ideas. The fourth quarter was particularly brutal supply chain wise on those RF product businesses. And so with that, I'll give it to Jason to sort of talk through anything you'd like to. Yes. It wasn't significant. It was probably in the $5 million to $10 million range, and it was across a number of businesses. So I think we expect the first quarter for TEP to be up a little bit more than the rest of the year because of that and because of some of the easier comps. So maybe low double digits in the first quarter, but that's sort of the range. So yes, a lot of this is in the rearview. Of course, things do pop up here and there, but we're not hearing as much sort of meaningful impact in the quarters. And as a general matter, we're not the only ones that. But supply chain is generally, as Jason just said, improving and there's essentially the chip shortage and chip issues. There's more of a globally is just -- but we're not -- you're not just hearing that from us. We do think this -- the supply chain issues abate over '23. Sure, sure. Neil, you've made several references to Neptune through the call and share gains and the strength in your backlog. And that tends to be a business where share doesn't move around that dramatically. I'm just -- could you expound a little bit just on how what's going on there? What you've done, whether it relates to ultrasonic adoption or the introduction of cellular? Or is this a broader effort at Neptune that's driving that? Neptune has been just a steady and consistent share gainer made the whole time I've been here, right? I mean, for a decade. And the reasons for that are manifold, but they have a product orientation that starts with, they never want to strand their existing customers with technology. So for instance, this goes back to the prior iteration of communication software, but the proprietary protocols between mobile and fixed point, Neptune has a solution where if you're a municipality and you can have one fixed point, roaming points and still have some manual reads and the master data management software package in Neptune can ingest all that data and you don't strand a customer having to pick piece of technology for the totality of what they have to do. So it comes from a product orientation that starts with flexibility. The second thing is the products are just well thought out for the long arc of what the customer wants to do. For instance, on the large commercial meters for ultrasonic, you have to be able to read high flow and low flow equally accurate our products do that. So think about a big hotel application, a trickle that happened 3 in the morning versus the high flow takes their showers in the morning, our ultrasonic meter will perfectly read the low flow and the high flow and the competitive products have to tend to be focused on one or the other for the precision. More so for that application when the ultrasonic -- the battery that drives the ultrasonic technology needs to be replaced. In our case, it's essentially a drop in battery, the competitors you have to cut the meter out and replace the meter. So it's small things -- it's seemingly small things like that, that help drive market share gains over a long arc of time. Final thing I would say, in 2022, it was particularly beneficial for us because we had product availability throughout the totality of the year. And so some of our competitors were quoting year plus lead times. I think our lead times went from like 8 to 12 weeks. And so just some accounts that we typically have not had any presence in, they need meters, we can deliver meters, all of a sudden, you have presence and the opportunity to compete in that account. So that's helped gain some market share in the relative short term. Thank you. Good morning. First, I just want to say that I think your format for the slide presentation this time is probably the best ever. And I think you should stick with it. It's really a great presentation. Now most of my questions have been answered, but something came up from one of the other participants regarding the business that accumulates commercial construction plans. And Barry Sternick, who's the CEO of Starwood was on CNBC yesterday, saying that in his business and across the board really in commercial construction, as interest rates have gone up, people will complete the projects they have, but hold off on starting new ones. And so that's why he's looking for a big drop in commercial construction in the second half of this year because new projects are sliding. Do you see that in your statistics? So it's interesting. So I can add Zach -- ConstructConnect publishes, look at that quarterly, quarterly the macro of what they're seeing from a construction planning point of view, and I can have Zack for that to you. I have not read the -- personally, I've not read the most recent report yet, so I don't want to comment on its content, but we can send that to you. Okay. Because it would seem that if new construction projects are not being put into implementation, it would show up in those numbers, wouldn't it? So here's the countercyclical nature of that. And so if you have several hundred thousand construction workers, construction, small subcontracting firms ConstructConnect has tens of thousands of customers. So as those hundreds of thousands are looking for work, it only takes a small percentage of that cohort to become a customer of ours to exhibit countercyclical growth behavior, which is what's happened in every prior slowdown in the history that we've been able to observe with ConstructConnect. And ladies and gentlemen, this concludes our question-and-answer session. We will now return back to Zack Moxcey for any closing remarks. Thank you, everyone, for joining us today, and we hope to see you all at our Investor Day on March 21 in New York. Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines, and have a wonderful day.
|
EarningCall_1111
|
Welcome to Flushing Financial Corporation's Fourth Quarter and Full Year 2022 Earnings Conference Call. Hosting the call today are John Buran, President and Chief Executive Officer; and Susan Cullen, Senior Executive Vice President, Chief Financial Officer and Treasurer. Today's call is being recorded. [Operator Instructions] A copy of the earnings press release and slide presentation that the company will be referencing today are available on its Investor Relations website at flushingbank.com. Before we begin, the company would like to remind you that discussions during this call contain forward-looking statements made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Such statements are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contained in any such statements, including as set forth in the company's filings with the U.S. Securities and Exchange Commission to which we prefer you. During this call, references will be made to non-GAAP financial measures as supplemental measures to review and assess operating performance. These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for the financial information prepared and presented in accordance with U.S. GAAP. For information about these non-GAAP measures and for a reconciliation to GAAP, please refer to the earnings release and/or the presentation. I'd now like to introduce John Buran, President and Chief Executive Officer, who will provide an overview of the strategy and results. You may begin. Thank you, operator. Good morning, everyone and thank you for joining us for our fourth quarter and full year 2022 earnings call. Following my prepared remarks, Susan will review the financial trends and we will then answer any questions. The company recorded its second best historical earnings for 2022 behind the record-breaking 2021 earnings in spite of aggressive Fed movements and resulting net interest margin compression. For the year, GAAP return on assets was 93 basis points, with a return on equity at 11.4%, while core return on assets totaled 92 basis points with return on equity at 11.4% and Returns were within our goals of 1% and 10%, respectively. We executed well on our strategic objectives for the year. Average noninterest-bearing deposits increased 10% year-over-year. Period-end loans expanded by 4% and net charge-offs were only 2 basis points for the year. We capitalized on the merger disruption in our market by adding 51 people from merged or merging institutions. Trends in the fourth quarter were more challenging given the rate environment. We reported GAAP earnings per share of $0.34 and core EPS of $0.57. And -- this translated to a return on assets of 48 basis points and a return on equity of 6% on a GAAP basis and 82 basis points and 11.4%, respectively, on a core basis. The primary difference between GAAP and core earnings is the approximate $11 million loss on the sale of securities that yielded approximately 1%. Core loan yields increased 28 basis points quarter-over-quarter, while core deposit yields expanded 87 basis points, resulting in net interest margin compression of 37 basis points on a reported basis and 40 basis points on a core basis. We expect the net interest margin to remain under pressure until the Fed ceases raising rates. Then after a lag, we expect the net interest margin to expand from contractual loan repricing. The yield on the originated loans increased 150 basis points quarter-over-quarter and 259 basis points year-over-year. Loan closings and the loan pipeline have declined from record levels earlier in 2022 due to higher rates, suppressing demand and our greater emphasis on full banking relationships. For the quarter, average noninterest-bearing deposits increased slightly year-over-year and the overall deposit mix has shifted more to CDs. The loan-to-deposit ratio improved to 107% as of December 31 compared to 114% at the end of the third quarter as deposits grew more quickly than loans. Asset quality remains solid with low charge-offs, nonperforming assets of only 63 basis points, strong debt service coverage ratios and low average loan-to-value ratios. We continue to hire people from institutions within our markets that are or were involved in a merger. Overall, we're managing the balance sheet to deal with a rising rate environment while maintaining our focus on credit quality. On Slide 4, you can see the annual trends for the past 6 years. We feel looking at annual trends provide a better perspective compared to the quarter-to-quarter volatility. I -- as you can see, we reported record levels of GAAP and core earnings in 2021. Coming off this record level in 2022, we reported the second highest gap in core earnings. As we've said many times, credit quality is important to our company and the trends remain solid as net charge-offs were below 10 basis points for the past 5 years. We continue to prudently manage and have the appropriate levels of capital. Book value and tangible book value per share grew every year, except when we acquired Empire in 2020. However, we recaptured the effects on tangible book value for the Empire purchase in approximately 9 months. We believe this is a good view of our track record and our ability to adapt to different environments. Slide 5 shows what we believe are the 3 important macro issues facing the banking industry today, credit quality, liquidity and interest rates. Flushing Bank has a long history of sound credit quality over several cycles. Our conservative underwriting standards have served us well in the past and will continue to serve us well in the future. The combination of low average loan-to-values and high debt service coverage ratios means our borrowers have substantial investment in their properties and have the ability to make payments even with the significant increase in rates. We are also conservative in liquidity management. We have over $3 billion of unused lines of credit available and our liquidity to assets ratio at the bank is 43%. Unlike others, we were able to grow period-end deposits both quarter-over-quarter and year-over-year. Interest rates are pressuring our net interest margin in the short term. After the Fed stops raising rates and the lag, the funding pressure should ease and the benefits from contractual loan repricing should become more evident. In the meantime, we're becoming more disciplined on originations to ensure risk-adjusted returns are achieved. Over time, we expect our interest rate positioning to move towards neutral. Bottom line, while the macro environment is becoming more challenging for the industry, our balance sheet today is well positioned to handle the credit quality and liquidity challenges with the outlook for interest rates expected to move in our favor shortly after the Fed stops raising rates. Slide 6 depicts the growth in our digital banking platforms. We continue to see high growth rates in monthly mobile deposit active users, users with active online banking status and digital banking enrollment. The numerator platform which digitally originates small dollar loans as quickly as 48 hours continues to grow. We originated approximately $23 million of commitments in 2022. Most of these commitments have an average rate that is greater than the overall portfolio yield. We continue to explore other fintech product offerings and partnerships. Fourth quarter had several important events to highlight, as you can see on Slide 7. We signed a lease for a Benson Hurst branch which expands our Asian banking footprint. This branch is expected to open in 2023. We maintained our investment-grade rating from Kroll Bond Rating Agency. Community support is one of the key pillars of the bank and we're proud to contribute to transforming Queens into a leading hub of innovation and technology. Lastly, we were very happy to participate in the ribbon cutting [ph] ceremony for the Charles B. Wang Community Health Center as we were a significant participant in the financing. Thank you, John. I'll begin on Slide 8. As John mentioned, deposit growth is a challenge for the industry as the Fed raises rates and liquidity leads the banking system. Our results were contrary to this trend by growing average deposits 3% year-over-year and 6% quarter-over-quarter. While growing noninterest-bearing deposits is a priority for us. It has become more challenging given the higher rate environment. Average noninterest-bearing deposits increased slightly year-over-year and comprised nearly 15% of average deposits. Our teams continue to open new checking accounts which were up 41% year-over-year. Our incentive plans place greater emphasis on increasing noninterest-bearing deposits. CDs continue to expand as customers are seeking higher yields. The increase in the deposit base assisted in lowering the loan-to-deposit ratio to 107% from 114% at the end of the third quarter. Slide 9 shows how our deposit rates change compared to Fed funds. For 2022, our cumulative interest-bearing deposit beta was just over 45% which has exceeded the previous rising rate cycle. The key difference in this cycle versus the prior one is the magnitude and frequency of rate increases. In this cycle, so far, average Fed floods have increased 357 basis points compared to only 226 basis points in the previous cycle. We expect the cumulative deposit betas to rise as rate increases continues. We expect the majority of deposit pricing will be included in the cost from the Fed stops increasing rates. Slide 10 outlines our loan portfolio and yields. Net loans increased 4% year-over-year. As expected, loan closings in the loan pipeline have declined from the record levels seen in previous quarters. Core loan yields increased 28 basis points during the quarter and the yield on loan closings exceeded the yields on satisfaction by 47 basis points. Loan repayment speeds also declined year-over-year and quarter-over-quarter as higher rates are impacting refinancing activity. Prepayment penny income declined slightly to $1.2 million in the fourth quarter from $1.5 million in the quarter a year ago. Slide 11 provides more detail on the contractual pricing of the loan portfolio. A little over $1 billion or 15% reprices with each Fed move, the majority of the loan portfolio reprices over time. Another approximate $1 billion or 14% of loans will be priced in 2023, followed by $758 million or 11% in 2024. As of December 31, 2022, these loans are expected to reprice over 200 basis points higher. This does not consider any future Fed rate moves which could push the contractual repricing rates up even further. This repricing is what should drive net interest margin expansion once funding costs stabilize. Slide 12 outlines the net interest income and margin trends. The GAAP net interest margin declined 37 basis points to 2.7% during the fourth quarter. Net interest income decreased 11% quarter-over-quarter to $54 million. Core net interest income which removes the impact of net gains from fair value adjustments and purchase accounting accretion decreased 12% quarter-over-quarter as the core net interest margin declined 40 basis points to 2.63%. Core deposit yields increased 87 basis points this quarter compared to a 28 basis point increase in core loan yields. We often get asked when the net interest margin will bottom out and when it will start to expand. On Slide 13, we provide a look at what happened during the last rising rate cycle. The net interest margin bottomed out approximately 2 quarters after the Fed stops raising rates. We are expecting a similar path to the cycle but there are important differences. First, Fed raised rates over a longer time in the prior cycle. Second, the amount of Fed increases are greater in this cycle. Thirdly, the magnitude of the rate increases has been greater this cycle versus last. And all of these items will have an impact on when and where the net interest margin will bottom out. Additionally, loan growth in the competitive environment for incremental funding will be important considerations in the margin recovery. On Slide 14, we outline our funding swap portfolio which is in place to help mitigate the impact on net interest margin from rising rates. As we have talked about in prior quarters, we have funding swaps that mature and will be replaced with other swaps at lower funding rates. By the end of 2023, $600 million of swaps were priced 65 basis points lower. During the fourth quarter, we terminated certain swaps and locked in a $6.5 million gain that will be amortized into net interest income over the original swap life. This transaction has the effect of locking and gains while pulling some of the benefit forward. We also have $384 million of swaps converting fixed rate loans into floating. Moving on to asset quality on Slide 15. We have a long history of solid credit quality as a result of our low-risk credit profile and conservative underwriting. Net charge-offs were only 5 basis points for the quarter and 2 basis points for the year. Our low-risk credit profile and conservative underwriting has served us well through many cycles. As you can see, our losses have been well below the industry. We expect limited loss content in the loan portfolio if there's an economic downturn due to greater than 88% of the loan portfolio is secured by real estate with an average loan-to-value of less than 37% and the weighted average debt service coverage ratio is 1.7x and over 1.15x in a stress scenario for our multifamily and investor commercial real estate portfolios. These factors contribute to our expectation of low loss content within the portfolio. Slide 16, our allowance for credit losses as presented by loan segment. Overall, the allowance for credit losses to loans ratio decreased 1 basis point to 58 basis points during the quarter. Nonperforming assets increased slightly during the quarter and the loan to value on these assets is 52%. I Criticized and classified loans decreased to 98 basis points at the end of the quarter compared to 89 basis points for the prior quarter. As you can see, our levels of criticized and classified loans are at lower levels than our peers. The coverage ratio is 125%, meaning we have approximately $1.25 reserved for each dollar of nonperforming assets. Because all of these factors are allowance differs from peers, largely due to loan mix as we have a higher percentage of real estate collateral at a low average loan to value. We remain very comfortable with our credit risk profile and continue to expect minimal loss content. Our capital position is shown on Slide 17. Book value and tangible book value per share increased during the quarter. We took advantage of the attractive stock price and repurchased nearly 375,000 shares during the quarter and returned 71% of annual earnings through dividends and share repurchases. The tangible common equity ratio increased 20 basis points quarter-over-quarter to 7.82%. In the short and medium term, the company will maintain its target of 8% tangible capital ratio while balancing the attractiveness of share repurchases. Slide 18 outlines the notable pretax effective items for the fourth quarter. First, we sold $84 million of low-yielding mortgage-backed securities for a loss of approximately $11 million. We are currently reinvesting these proceeds and expect to have an earn back period of 3 years or less. Second, we received an employee retention tax credit refund under the CARES Act of approximately $1.4 million which was partially offset by an increase in professional fees paid to obtain the refund. Third, a lower discount rate was required for certain benefit plans, creating a $2.8 million expense reduction. These 2 expense reduction items are included in core expenses. Absent these 2 items, noninterest expenses would have totaled $37.9 million. Turning to Slide 19. I'll provide some color on the outlook. As a reminder, we do not provide guidance, so this is meant to provide our thinking in this challenging environment. With higher interest rates and greater emphasis on full banking relationships, loan closings are expected to decline versus 2022. However, we expect prepayment speeds to continue to decrease as well. Overall, loan growth is expected to be tempered in 2023. There will be less need to grow funding with limited loan growth. As we have outlined in the past, we have a liability-sensitive balance sheet and expect the interest rate margin will remain under pressure as well as the Fed continues to raise rates. While we have a significant benefit from contractual loan repricing over the next several years, there will be a lag from the Fed stops raising and the net interest income bottoms out. Noninterest expense was positively impacted by several benefits in the fourth quarter but there will be headwinds in 2023 from increased FDIC deposit and medical insurance premiums. Overall, noninterest expense is expected to increase by low double-digit percentage points in 2023 of the reported base of $144 million. As a reminder, we have $3 million to $3.5 million of seasonal expenses in our first quarter compared to the fourth quarter. We expect the tax rate for 2023 to approximate 24% to 25%. Thank you, Susan. Slide 20 shows our strategic objectives for 2023. As Susan just outlined, the environment is challenging but we will navigate through and focus on what we can control. We're looking to expand our funding sources with a particular emphasis on noninterest-bearing accounts. We will place greater emphasis on full relationships across business units while generating appropriate risk-adjusted returns. We will not change our underwriting model as credit quality is an important metric for us. Lastly, we'll continue to expand our technology platform to drive engagement and upgrade where appropriate. On Slide 21, I'll wrap up our key messages. While 2022 was an unprecedented year given the pace of Fed rate increases, we had our second highest annual earnings. Strong credit quality is a pillar of the bank and our conservative underwriting should help to protect us from significant losses even during times of stress. We are managing through the higher rate environment and should start to benefit after a lag once the Fed stops raising rates. There's a greater emphasis on full banking relationship lending and achieving proper returns. Our stock has a strong dividend that approximate 4.5% and we will continue to balance repurchasing shares with a desire to move toward an 8% tangible common equity ratio. Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question will be from Mark Fitzgibbon from Piper Sandler. It's actually [indiscernible] stepping in for Mark at the moment but I -- do you think there are any more security portfolio sales likely in the coming quarters ahead? We continually evaluate the portfolio in light of the market. And if we see an opportunity that presents itself, I wouldn't say no. But at this point, there's no plans on the table. Okay. And how do you think -- how low do you think the NIM goes if the Fed follows a fever curve, or a rough ballpark, do you think? So as we talked about, the NIM has many moving components. It's our loans repricing, the swaps, the local market competition and what the Fed does. So where we bottom out will all depend on where the Fed moves rates and how quickly they stop raising rates and then we have that slight lag before we start coming back to expanding NIM. If loan growth tapers, we will expect the allowance always depends on the economic forecast as we do the CECL modeling and the mix of our loans. So if the economy continues on this uncertain path, we may see more provisioning. So on the -- just to nail down the operating expense guidance and the seasonality for the first quarter. If you -- well, I guess, first off, how much of the additional FDIC impact for next year? So the FDIC raised the premium across all banks as the depository insurance fund is underfunded. So all of us will be going -- increasing the insurance premium from 1 basis point to 2 basis points on deposits. Okay, great. And then just kind of putting it all together with some of the kind of onetime stuff from this quarter is like -- like 41.5%, a good expense number for the first quarter with the seasonality? Okay. Got it. And then I appreciate the color on the overall NIM trajectory. Just trying to figure out how big the moves are in the near term. Do you guys have a spot rate or the end of quarter NIM at the end of the fourth quarter? We have not provided that as we may have in the past because we don't think it's representative necessarily of what our GAAP NIM will be or what are reported even core NIM will be. So we will not be providing that information. Okay. I mean any color that you can give on kind of the sense of the magnitude of the compression just in the immediate near term? I mean you have a move that I looked for a while, like it was going to be 25 basis points in February. Now there's even talk of it might be 50%. So you have that uncertainty to begin with. We do have within our market, a couple of crypto-related banks that have upped the ante in terms of looking over -- looking for deposits. I think quite frankly, there's too many factors going on in too many moving parts to give any reasonable guidance. And I think your assessments on these things and these activities are no better, no worse than ours at this point. So I think the important thing to remember about us and you can kind of watch it as time goes on is that it's unclear how much and how long the Fed will raise rates. We've got some projections but those projections run from the Fed to the market. Futures contracts look like the bulk of the rate increases have already happened. So after fully absorbing the December rate increase, the incremental pressure might, in fact, ease as the Fed raises rates by smaller amounts than the 75 basis points that we've seen for the bulk of 2022. So we're kind of looking at the possibility of a declining -- maybe some declining pressure, although continued pressure, maybe declining magnitude, let's say, or declining incrementals -- so the market believes that the rate and the magnitude of the Fed rate increase should slow. That should help slow the pressure on our funding costs. And we think after the first quarter, a lot of this will be behind us. We may see another quarter or so clearly, there's a lot of speculation about that. But one thing is certain and that's the structure of our balance sheet. And the Fed increases don't last forever. And this one looks like it's coming more to a close than to the beginning. So I think we're in a very, very good position toward the latter half of the year to see some better movement in the margin, whether it's stabilization or increase as a matter of what's happening in the market. Okay, great. And then for the securities move this quarter, what's the timing of the reinvestments of what was paid off? And I guess like what's the assumed spread or what's the assumed rate that those are coming on at and where they're being funded at? So we have already purchased about $10 million of floaters with a yield of about 5.5%. The SBA floating bonds. So the expectation is that they will continue to come on in that range or even higher. But again, we are ensuring that we are keeping within the 3-year payback period. Well, we took off securities that had a yield of $17 million. So we're bumping up the NIM by that differential 430 basis points rough and tough. Okay, got it. I mean are you guys locking in, in particular, any type of funding directly tied to those? Or just in general, like the overall new funding costs? When we sold these securities, we did pay off any funding, most of the funding or the proceeds are sitting in the Federal Reserve Bank yielded $4.4 million versus the 117 that we were getting on the securities. So... Got it. Got it. That's helpful. And then any update as the progress towards resolution of the larger NPA that came on a couple of quarters ago? So we're still working through those. I'm glad you asked this question, Chris. We did -- even though some cost pie criticized picked up 9 basis points. Approximately $7 million of that has resolved itself subsequent to quarter end. So our NPAs, as we're sitting here today, are really down 1% quarter-over-quarter. Got it. Is that $7 million related to that particular credit? Or just any update, I guess, on that or relationship? The $7 million is not related to the big held-to-maturity security that is driving the increase in our NPAs that is still working its way through the process. We're still very careful with that security loan -- and we don't have any further details on any resolution at this point. Good morning. I really like to slide for Slide 13 but I just wondered if the scenario is a little different. What happens if the Fed pauses and then holds, basically, do you need the Fed to actually start declining for your NIM to have that kind of inflection? Just kind of talk about that scenario where the Fed holds for a bit? So the loans will continue to be coming on. So right now, loans are either being rolled -- they're either rolling off or; for example, at a 3 handle because they were been put on for quite a while and the loans that we're putting on right now this past quarter, we had a 6 handle. So we're talking about a very, very nice increase in the NIM just by stability taking place. And I didn't mean to say an increase in the NIM but obviously, the positive pressure in the net, let's just say that -- that as part of it. Okay. Because it seems like it kind of really took off once the Fed decline. But there's a number of different factors at play. Do you have an update on with the current market offers you have out there, are you seeing success? You talked a little bit about -- you had success this past quarter but you're seeing continued success and you're talking about kind of competition shifting a little bit. You're seeing more players competing for deposits. Can you just kind of talk about those 2 items? Sure. So look, it's always a competitive environment in New York. This is -- this one has been heightened due to the Fed activity and the removal of liquidity from the market. So we're looking at other vehicles to compete in maybe areas that might be a little bit less competitive outside of the New York metropolitan area as a means of, let's say, compensating for the intense level of competitiveness in New York. So I think -- it's always a competitive market here. There's a couple of things that I think are probably going to write themselves in a few -- in a couple of quarters in terms of the extreme competitiveness. But at the end of the day, most of the market in New York is controlled by a few very, very large banks. They have a lot to protect in terms of their cost of funds. So that always has a little bit of a dampening effect, although we haven't quite seen it yet. I expect that we will see it going forward. Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to John Buran for any closing remarks. Well, once again, thank you all for your attention and for calling in and for the questions. And just again, I think that our net message is that we've got a very strong balance sheet, very strong credit quality. And this environment doesn't last forever and we're looking forward to a better opportunity as the Fed starts to reduce some of its aggressive moves. So, thank you again for your attention and look forward to talking to you all soon.
|
EarningCall_1112
|
Good morning, and welcome to this presentation of SCA's Year-End Results for 2022.With me here today, I have President and CEO, Ulf Larsson; and CFO, Andreas Ewertz, to go through the results and take your questions. Over to you, Ulf. Thank you, Anders, and good morning also from my side. Warm welcome to the presentation of the results for the full year, but also for the fourth quarter 2022.When I summarized last year, I can state that we have delivered the best year ever. We reached SEK10.2 billion on EBITDA level, and by that, 49% profit margin. We have had a strong demand and high prices for all our products in combination with good cost control. We have also benefited from a high degree of self-sufficiency in wood, energy and logistics. And together, this has created a strong cash flow from which we have been able to finance all investments, including strategic. True major investment projects in Obbola and Ortviken have both started up during last year, approximately one quarter ahead of plan and we are now in an exciting start-up phase. The new OCC line, which is needed to reach full capacity in Obbola is scheduled according to the original plan, and will be up and running during the first half of this year to meet the planned start-up curve. In addition, I can also mention that our reinvestment in a new grading mill at Bollsta sawmill is finalized and the trimming has started according to plan. From first of January this year, we will start to disclose our new segment, Renewable Energy. And the reason behind this is that we already today have a leading -- we are a leading producer of renewable energy, and we annually produce 12 terawatt hours of bioenergy. We have 20% of installed capacity wind power on SCA land, and we have a big ongoing investment in biofuels that will start up Q4 this year. And as we've said earlier, we have the ambition to grow this segment further and we also recently announced that we have acquired our first wind farm in the northern part of Sweden. The big capacity today in Skogberget, which is the name of the wind farm is approximately 200 gigawatt hours, but after repowering, we expect the capacity to double or triple. The price level of forest land has continued to rise. And when we follow our described model based on transaction prices in our region for setting the market price, we can state that the total value has increased from SEK84.5 billion, the 31st of December '21 to almost SEK98 billion same date 2022. Finally, EBITDA increased 12% in comparison with last year due to higher selling prices and the stable cost base. And sales increased during the same period by 10% due to higher prices. Turning over to some financial KPIs related to the full-year '22. As just mentioned, our EBITDA increased by 12% in comparison with last year and reached SEK10.2 billion for '22, and that corresponds to a 49% EBITDA margin. Our industrial return on capital employed came out on 40% for the full-year '22, which is seven percentage points higher than '21. The leverage is stable at one, despite our almost finalized large ongoing investment projects in Obbola, Ortviken and Bollsta sawmill. And we continue to finance all our investments, including strategic projects with our operating cash flow. The proposed dividend for the AGM to decide on is SEK2.50 per share, and this is in line with our aspiration to give a stable and increasing dividend. Last year, we gave SEK2.25 as an ordinary dividend and then an extra dividend of SEK1. Last but not least, earnings per share went up by 14% in comparison with '21 to SEK9.61 per share. This slide will give you an overview of KPIs for the fourth quarter '22. And when we compare quarter-on-quarter, we can note that our EBITDA reached close to SEK2 billion during the fourth quarter '22, which is 29% lower in comparison with a very strong Q4 2021. This gave us an EBITDA margin of 41%, and an industrial return on capital employed of 24%, calculated as the average for the last 12 months. And the leverage is, as already mentioned, stable at one. So, then I will make some comments for each segment, starting with the forest. During the fourth quarter, we have had a stable supply of wood raw materials to our industries. In general, and also in our region, we can note a high demand of wood raw materials. And by that, also increasing wood prices, as you can see in the graph in the bottom left. When we compare the fourth quarter '22 with the same quarter '21, pulpwood prices have increased by almost 20% and corresponding figure for sawlogs is around 15%. On the other hand, we can see that pulpwood prices in the Baltics have now started to come down from an all-time high level. When we compare quarter-on-quarter, EBITDA has decreased 15%, and that is mainly driven by lower revaluation effect of biological assets. We have also seen cost inflation in transportation and harvesting, and that is driven by fuel price -- higher fuel prices. On the positive side, we can note a higher harvesting level in our own forest. Finally, we can note a continued high interest of purchased forest land in Sweden and in the Baltics. And Andreas will come back to some data around that. Turning over to business area, wood. And in general, we have seen a lower global demand during the fourth quarter last year. Anyway, in most markets, customers have finalized destocking and started to buy again. Building activities remained on a more or less normal level, but housing starts decreased during the end of last year. For SCA, we have maintained normal deliveries during the fourth quarter. Price levels for solid wood products, as expected, hit the bottom in several markets during the fourth quarter last year. And I did communicate a price drop of 25% between Q3 and Q4, and that was also realized. As you can see in the graph, bottom left, prices on solid wood products have come down substantially, while on the other hand, sawlog prices have gone the other way. My best guess for the coming quarter is that we will see more or less unchanged prices. Sales and EBITDA was substantially down due to price and cost of wood raw materials when we compare quarter-on-quarter. Today's stock level of solid wood products in Sweden and Finland is in relation to the average for the last five years, described at the top left on this slide. And we note that inventory volumes are on a somewhat high level. Anyway SCA, as mentioned, has maintained normal deliveries during the fourth quarter. And by that, we have a balanced stock at the end of the year. As can be seen in the diagram to the bottom left, the Swedish and Finnish sawmills production has been on the low side. Most producers in Scandinavia also announced production curtailments during the fourth quarter. When looking at the diagram to the top right, we can see that the price peaked in the third quarter '21, and that was on a historically high level. Prices have come down substantially since then. And as I mentioned, at the same time, prices for sawlogs has increased with the major negative effect on the profitability. Then some words about pulp. And comparing quarter-on-quarter, all fundamentals like price and currency were better in the fourth quarter '22 in comparison with the fourth quarter '21. The result for the fourth quarter '22 was up 36%, but it was negatively impacted by a planned but also an unplanned production stop, which reduced both the volume and the energy production during the period. The estimated impact on EBITDA level is approximately SEK260 million when we compare quarter-on-quarter. SEK138 million out of that is related to the unplanned stop, and we will have a negative impact from this unplanned stop also in the first quarter this year, ascending to approximately another SEK140 million. And the reason for the unplanned stop is significant disturbances in the fiber line and the recovery boiler at Ostrand. And there have been difficulties with the process conditions in the boiling process, which in turn has caused instabilization and leakage in the recovery boiler, which led to this unplanned stop. Now, we are up and running again. The CTMP alignment at Ortviken is now on the ramp-up, one quarter ahead of plan. Still we have, of course, a lot of fine-tuning left, but our goal is that the production should reach at least 150,000 tonnes during this year. Full capacity achieved in 2025 will be close to 300,000 tonnes. We see a weakening demand in the pulp market, mainly in Europe and also in China. The European fixed price peaked in September, October last year and that was close to USD1,500 per tonne. Since then, we have seen declining prices on all markets and the price for deliveries to Europe in January is USD1,410 per tonne. But then one need to keep in mind that discounts in Europe have increased by approximately 2% to 3%, while on the other hand, discounts in US is on an unchanged level in comparison with last year. Today, we have a better net price in the US in comparison with Europe and China. And one reason might be that we note weakening supply from competitors in Canada. We have seen announcements of curtailments, and that is mainly due to lack of fiber, but also the cash cost situation that -- yes, the cash cost situation for Canadian mills. Inventories for both hardwood and softwood pulp is, as you can see in the graphs on a rather normal level. Finally, containerboard and the new kraftliner paper machine in Obbola has started ahead of the time schedule in the last quarter last year. The successful startup was affecting the production volume and costs negatively in the fourth quarter in comparison with the fourth quarter '21. But of course, long-term, this will create good foundation for a highly successful project. And as mentioned before, overall, this is a unique project, also based on the fact that we have delivered a strong cash flow throughout the whole project since we started. The new recovered fiber line, which is a necessity to reach full capacity in Obbola is progressing according to plan, and that one is planned to be ready in first half of 2023. As earlier communicated, we expect to reach full capacity in Obbola in 2026. Sales was up quarter-on-quarter due to high prices, while EBITDA was down by 13%, mainly due to the effects of an early start-up causing lower production and delivery volumes for Q4 '22. Also, of course, higher energy costs had a negative impact on the result for containerboard. After a long period of increasing prices for kraftliner, with the peak in Q3 last year, we have now started to see decreasing prices. One can note some reasons for that. And if we start with the demand, it has declined in the fourth quarter, mainly related to lower retail sales, which has led to lower demand of boxes. Europe is facing a double-digit inflation and that will, of course, lead to reduced purchasing power. Deliveries of kraftliner have decreased significantly, 8% in the fourth quarter '22 compared with the fourth quarter '21, and that is by otherwise similar to the box demand. Secondly, natural gas prices have come down sharply from the peak in August '22, and that will ease the cost pressure for testliner producers and at the same time, availability of OCC is good and demand lower due to reduced production of testliner. Anyway, availability of OCC will gradually decline when lower box consumption is translated into less availability of OCC. Today's price for OCC is around EUR65 per tonne, and that is more or less EUR120 per tonne, lower than the peak price in July '22. The price for unbleached kraftliner has decreased by EUR90 per tonne in the fourth quarter '22. Testliner prices have decreased somewhat more, and the price gap between kraftliner and testliner today is around EUR155 per tonne, which I think is a rather normal gap. During the same period, the price for kraftliner white top has decreased with EUR30 per tonne. Despite the lower demand, inventories have been kept on a stable level during the fourth quarter by producers, reducing supply. And we would estimate production to be around 10% lower in the fourth quarter '22 in comparison with the fourth quarter 2021. So, by other words, inventories of containerboard are still on a high level, no doubt about that. But they have not increased more than according to a normal seasonal effect due to the mentioned production curtailments. Thank you, Ulf, and good morning, everybody. I will start off with the forest valuation. Forest prices in Northern Sweden continued to increase. In the graph, we have the development of forest prices in SCA's region, according to Svefa and Ludvig & Company. And the prices have increased over SEK400 per cubic meter. In SCA's forest valuation, we used a three-year average price, which has increased by 13% to SEK366 per cubic meter. The valuation of SCA's forest increased by over SEK13 billion to SEK98 billion in 2022. The increase was driven both by the price increase of 13%, and the increase of standing volume by 2% to 267 million cubic meters, approximately SEK1.8 billion and through the P&L. If we move on to the income statement and focus on the full year to the right, net sales grew by 10% to SEK20.8 billion, mainly driven by higher prices. EBITDA increased a record high of SEK10.2 billion, corresponding to a margin of 49%. The EBIT margin increased to 42%, and financial items totaled minus SEK39 million. We had an effective tax rate around 20%, bringing net profit to SEK6.8 billion, or SEK9.6 per share, which is the highest ever. If you look at the fourth quarter to the left, EBITDA declined to just below SEK2 billion, corresponding to margin of just below 41%. The decrease was mainly driven by lower prices in wood and the production stop at Ostrand, which impacted results with SEK138 million. Net profit for the quarter totaled SEK1.2 billion, SEK1.76 per share. Looking at the dividend, we have proposed dividend of SEK2.5 per share, a SEK0.25 increase compared to the ordinary dividend last year, which is in line with our target to have a stable and increasing dividend over time. On the next slide, we have the sales bridge for the full year. Prices increased 12%. Record high prices in pulp and containerboard, partly offset by lower prices in wood. Volumes declined 3%, mainly driven by a weaker wood market and the start-up of new paper machine in Obbola. Currency had a positive impact of 4%, and exit publication paper had a negative impact of 3%. Moving on to the EBITDA bridge. Price/mix had a biggest impact of SEK2.3 billion, driven by higher prices in pulp and containerboard. Volumes had a negative impact of SEK340 million, driven by weaker wood market and a start-up of new paper machine in Obbola. High cost of wood raw material and chemicals had a negative impact of SEK980 million, while high energy costs had a neutral impact, which will show us our high self-sufficiency post exit publication paper. We had a positive impact from currency and a negative impact from higher fuel prices. In total, EBITDA increased 12% to approximately SEK10.2 billion, corresponding to a margin of 49%. On the next slide, we have the financial development by segment. Starting with the forest segment to the left, net sales increased to SEK6.7 billion and EBITDA increased to SEK2.7 billion, mainly driven by higher pulpwood and sawlog prices, which was partly offset by increased fuel costs. In wood, we had another strong year with an EBITDA of SEK2.1 billion, corresponding to a margin of 31%. EBITDA was driven by a very strong first six months, while the market deteriorated during the second half of the year and prices go down 20% in Q3 and another 25% in Q4, as Ulf mentioned. In pulp, we had a record high year, where net sales increased to SEK7.2 billion and EBITDA increased almost SEK3 billion, corresponding to a margin of 41%. In the fourth quarter, we had the unplanned production stop at Ostrand, which impact result with SEK138 million in lower volume and reduced energy production. And the stop will impact Q1 with a similar amount, as Ulf mentioned. In containerboard, we had a record high EBITDA of almost SEK2.9 billion, corresponding to a margin of 42%. And this is despite having lower volumes and start-up costs relating to the ongoing ramp-up of the new paper machine. On the next slide, we have the sales bridge between Q4 last year and Q4 this year. Prices decreased 5%, where lower prices in wood was offset by higher prices in pulp and containerboard. Volumes increased 1%, where higher volumes in wood and pulp was offset by lower volumes in containerboard due to the start-up of the new paper machine. And lastly, currency had a positive impact of 7%. Looking at the EBITDA bridge for the fourth quarter and starting to the left, price mix had a negative impact of SEK330 million, mainly driven by lower prices in wood. Higher volumes in wood and pulp was offset by lower volumes in containerboard, again, due to the start-up of the new paper machine. Higher costs for wood raw material and chemicals had a negative impact of SEK400 million and higher energy costs had a negative impact of SEK70 million, mainly relating to lower electricity production at Ostrand due to the production stop. We had a positive impact from currency, and a negative impact from higher fuel prices and start-up costs in CTMP, where we now have the full organization in place. In total, EBITDA decreased just below SEK2 billion, corresponding to a margin of 41%. We had another year with strong operating cash flow, almost SEK5.7 billion in 2022 compared to SEK5.2 billion in 2021. This means we're continuing to fund our strategic investments with operating cash flow. In the quarter, we had several large strategic CapEx payments. Obbola investment of around SEK800 million, acquisition of the wind farm in Markbygden of SEK800 million, forest land in the Baltics of SEK400 million and the CTMP investment of SEK300 million. Looking at the balance sheet. The value of the forest assets increased to SEK98 billion. Working capital increased to SEK4 billion due to higher prices. Total capital employed decreased to SEK106 billion, and net debt stood at SEK10 billion or 1time EBITDA. Equity increased to SEK96 billion, and net debt to equity was 10%. Renewable energy will be reported as a new segment in 2023. On this slide, we have the EBITDA impact on each segment for 2022. Starting with forest segment to the left, unprocessed biofuels and wind power leases will be reported in renewable energy. The pro forma effect for 2002 was approximately SEK90 million. In wood, pellets will be reported in renewable energy, which had an impact of approximately SEK130 million. Pulp and containerboard sell tall oil for our fossil-based price to renewable energy, which is responsible to maximize the value of the green premium. The impact was around SEK80 million in pulp and SEK60 million in containerboard. In total, renewable energy had a pro forma EBITDA of SEK355 million. And from January, our new wind farm will also be included, and from late next year, also our investment in liquid biofuels. Thank you. And if I try to give you the short version, I mean, 2022 has been the best year ever. SEK10.2 billion, 49% EBITDA margin. We have been able to finance our ongoing investment projects by our operating cash flow. Our two major investment projects, they are now up and running. Of course, we still need to do some fine-tuning and so on but nevertheless, producing premium products for the market. From this year, we will start to disclose renewable energy as a separate segment, which is interesting. And we also announced end of last year that we have taken the first investment decision in our own wind power capacity in Markbygden. And last, but not least, we see a substantial increase of the value for forest land. So, by that, I think I open up for questions, please? Thank you very much and hello to everybody. My first question is related to the wood segment and to pricing outlook there. I guess, you call for unchanged prices of sawn timber now in Q1 Q-on-Q after the declines we had last year in H2. Is this now in your view the bottom of this cycle? And when should we expect the prices to increase, and what is the best leading indicator for us to look at for the pricing for those wood segments? Yes. It is hard to say, really. But I mean, yes, I think we have reached the bottom. I thought that already in the third quarter, and the estimation at that time was that we should -- the price should decrease by 25% from the third quarter to the fourth quarter and that came through. The best guess we have now is that we will see unchanged prices for the first quarter next year -- this year. And I think that we might see an upward trend in the second quarter, but that is too early to say. What we see is now in the market, at least in Sweden is that prices -- I mean, they are still on a -- if you look to the prices in a historical view, they are on a reasonable okay level, but log prices has come up substantially, I thought about 15% to 20% in one year. And I mean, 70% of the cost for sawmill is related to raw materials. I mean, that put pressure on the profitability in the sawmill. And that you can also see now when -- I mean, when more companies released their results that they will be very close to zero cash flow. And I mean, that cannot continue for a longer while, of course. So, I think we will find. We have found some kind of balance in the market now and we will remain on this level. But, of course, again, you don't know what will happen with cost inflation, interest rates and all that kind of things. But personally, I think that we have reached the bottom. I understand. Thank you very much. And we could see yesterday a smaller sawmill reported numbers in the red already in Sweden. You guys are more efficient, obviously, and black figures still. But related to that, then the higher log costs. Should we expect log cost to start to decline already now in Q1 or perhaps, is it then Q2? And what is the outlook for pulpwood for this year? I think that is tricky to say, really. I mean, ourselves, we increased prices in the beginning of this week. And again, for us, it's not a very big issue because I mean, 50% what we need, we take from our own forest. So, I mean, we are in a rather good position in this perspective. But again, if you don't have a good profitability industry, then, of course, prices on raw materials will start to come down sooner or later, but it's hard to say when it will happen. Normally, you have some kind of lagging effect of six months, but it will be just now how to say. I mean, in Sweden, we have also seen that Sveaskog, they reduced the harvesting level by 1.5 million cubic meters. We have 10 million cubic meters, which are -- they are not coming from Russia, Belarus and also. So that have also an impact. So, you have a slightly different balance this year in comparison with the past. That was -- yes, that was both for sawlogs and pulpwood in the northern region. And I mean, we've seen other companies that have done more or less the same thing. Yes. True. Thanks. And the final question I have, it seems like Obbola has come off very well to production. Should we expect that 500,000 tonnes produced in Obbola this year still, is that the good sort of a outlook still? If we can reach 500,000 tonnes in the first year, that will be a big success, of course. And as said, I mean, the bottleneck just now is the recovery line, but that one is now under construction. We have 200 entrepreneurs on site and also that part of the project is running well. So that was positive. And as mentioned, I mean, we took some extra -- as you always have to do when you ramp up, you have to take some extra costs related to -- yes, when you start up, I mean you struggle somewhat, but it has been a fantastic journey so far. We have between 60,000 tonnes and 80,000 tonnes now out in the market of premium products and with a very good reaction from our customers. So far it has been a fantastic project, really. Thank you, very much. And good morning to everyone. Couple of questions on wind. And maybe starting off with Markbygden. If you could share with us what the EBIT, and/or EBITDA was from that recently acquired operation in full-year 2022, please? So, if you look at the wind acquisition, the capacity is just below 200 gigawatt hours and then, I mean, it all depends on what electricity price you assume. So, if you take the price that you assume for 2023, multiplied volume and then the margins for wind power is very high at 60%, 70% range. And the reason for us to acquiring just that project was that we have a good potential for repowering. I think that's most important. I mean, of course, again depending on the prices and price development, but you have good conditions for repowering in this area. You have good capacity in the net and so on. So, in 5, 10, 15 years, you can double or triple the capacity with, I mean, no big investment means. So, I mean, that is the big potential in this project. And also, will help to maintain our self-sufficiency. Now we're ramping up CTMP and Obbola production, our electricity usage will increase. But because of the wind farm, Markbygden, will help to balance that again. Right. But you're not sharing -- is it hedged? Are you giving any kind of indication of what to expect in the first quarter? What the contribution is from this? It's not hedged. You look at Nord Pool and look at the wind prices in SE, one area to get that feeling of the numbers. As I said earlier, I mean, we plan to build up the capacity of, let's say, three terawatt hours in 10 years and it might be acquisitions. But I mean, we are much more focused on organic growth. We think that we have a better margin in organic projects and we're working hard on that one. And what's the timeline do you think on that when -- and I understand it's to do with permitting processes, et cetera. When will you start investing in repowering in, for instance, Markbygden? I mean, that depends on the price development and what kind of conditions you have. But I mean, that's always, we take it step by step. So, I think if you -- you can take three terawatt hours and divide by 10, and that is more or less the target we have. Then you can just multiply with approximately the CapEx cost per terawatt or gigawatt or -- and so then you get the feeling of it. If we start with current CapEx, we had -- this year, we had just about SEK1.4 billion, but we have some CapEx that went down to other -- to 2023. We were expecting SEK1.5 billion. So, we guess around SEK1.6 billion in current CapEx for 2023. And if we look at our strategic CapEx, we have around SEK1 billion to SEK1.5 billion left in our ongoing decided projects in CTMP, Obbola, the biorefinery in Gothenburg and some forest acquisition. And then it depends on, if we do any other investments, but SEK1 billion to SEK1.5 billion on already decided CapEx? Yes. Good morning gentleman. Couple of questions. First on the forest land market in Sweden. What was the developed -- what did you see in the market in the second half of the year and what's your outlook or your expectation for 2023? And then the second question is on cost inflation outlook for 2023 and especially concerning chemicals, which I believe is often quite closely tied to energy, how do you see that momentum developing? And then just a third question on the Markbygden wind farm. I mean -- so you have no immediate plans for any investments there, is that correct? If I start to comment on the forest prices, if you look at the compared prices for the first six months compared to the second six months, the price has increased slightly during the second half of the year. So, so far, we have -- prices have continued to increase on a high level. I don't know if you want to comment, Ulf. And then for the second question on cost inflation, as Ulf mentioned, pulpwood and sawlog prices are continuing to increase during the beginning of this year. And that's, of course, our biggest cost, but we get half of that back from our own forest. And then if we look at chemicals, the chemical prices are still very high and continue to increase, especially sodium hydroxide. But as you said, it will also depend on development of energy. If we look at transportation costs and oil, they're starting to come down and also OCC prices have started to come down now at the index around EUR65 per tonne. So, it's a mix. Some costs are still going up and some have peaked and starting to come down. And about the third question, we have no immediate plan for investments in Markbygden. I mean, it is rather more than wind park and now we will learn how to operate in the best way. But no investments during the coming short term, at least. If I may, just a final question on the sawn timber market in Europe. Are you seeing sort of some sawmills starting to take downtime or reduce production significantly? I know there were some announcements in the second -- during the second half of last year, but I'm not sure to what extent they actually came about. I mean, it's hard to say, but I believe maybe around 10% during the fourth quarter. And as someone mentioned, I mean, we -- now we see red figures and negative cash flow. And I mean that will not continue. So then, I think we will see more closures and you have a rather -- I don't know if I have seen this before when sawlog price has continued to rise and at the same time, we have -- more or less, we are in the bottom in the price for solid wood products. So, the combination here is not sustainable, I would say. So, that's the reason why I think that we have reached the bottom when it comes to prices for solid wood products. And then, I think also we have some kind of lagging effect when it comes to prices for sawlogs. But again, it is impacted now by -- not at least by the reduced harvesting level at Sveaskog, and again, we have different situation also when it comes to the Russian flow and so on. Good morning and thank you. Could you give us some views on what segments or areas you're seeing on demand for the containerboard markets? I know you mentioned deliveries down minus 8% and production down minus 10% across the industry to kind of balanced inventory levels. But any color you can talk about on the end markets for demand on containerboard? And then linked to that, what are you seeing from imports from the US players. The import data hasn't really picked up as much. And I'm just wondering if there is any particular reason or your thoughts on the imports from the U.S. as well? Thank you. I mean, it's hard to say, really. I mean, the figure that we have got is that e-commerce went down 6% during last year, and that is also at least the estimation for the first half of this year. You saw the graph on box consumption, and that one also came down. On the other hand, not to the trend line. But I think maybe we see more. Yes, it's hard to say what will happen there, but it is a rather balanced situation when we compare what we see in box demand with the reduction in kraftliner and as I said, some companies, they have already started to reduce capacity here. The inventory level is on a high level, but it was positive that we had a rather stable situation over Christmas. Normally, you have a negative seasonal effect when it comes to the stock level over Christmas, but this year it was rather stable. When it comes to the import, I believe that we have more or less the same flow from US down to the southern part of Europe as we've had before and that is not -- no major volumes. It's rather tiny flow, I would say. And then maybe just an open question. But the cost curve for containerboard has effectively steepened and players that are lower down the cost curve are much better positioned at the moment. How do you see this industry reacting? Will it be kind of a two-tier market where the lower players can run to demand, keep good operating rates and the high-cost players set the price and we'll have a lot more variable production with energy volatility and just remain under a lot of pressure, even though low-cost producer can still earn good margins? How do you see the dynamics playing out? Thank you. I mean, I don't like to comment too much, but you can look into the figures that will be presented now coming weeks. And I mean, you can see that we still are on a rather good level when it comes to our containerboard business. And we disclosed it very transparent and you can see other players where -- and they have become close to, yes, single-digit figures. And then, of course, when you are cash negative, then you start to take curtailments, no doubt about that. What we see us now and that is a different situation in comparison what we had six months ago, and that is the situation for testliner. I mean, I think we peaked in -- cost for energy peaked in August, September last year and now we know that natural gas prices, they are ona, let's say, a decent level, at least. And as Andreas mentioned, I mean, the price for OCC has come down from 180, down to 60, or something like that. And I think it will not decrease much further. I think we are more or less at the bottom. But still they -- I think the testliner producers today, they have a rather -- they have a rather strong profitability in comparison with kraftliner produces. And then, of course, depending on what kind of sites you have and cash cost position and so on, but in general. Just to quickly comment on cost position. I mean, Obbola was even, before the investment, the largest kraftliner machine in Europe. And after the ramp-up, it will be even bigger than the competition. So, we have a good cash cost position. You can also see that, as Ulf mentioned, if you compare our EBITDA margin to some other players. But then you have to keep in mind that during this ramp-up period, normally, you have a negative cash flow during a ramp-up period. We have delivered a substantial cash flow throughout the whole project. But, of course, we will have some kind of impact during this ramp-up phase. I mean it is so if we see something that is wrong or not perfect, then we stop and we take care of that and then we start up again. And that is what we have to do now during the ramp-up phase. And so.... Yes. Thank you. I just had one follow-up question on the opportunity you talked about, the recovering potential and you have talked about it before as well. But have you received any initial response from municipalities and so on? I mean, still you will increase -- the turbine size is quite material, I guess, and the wind mills will become quite much bigger. So, have you received any response to those projects that you are planning to repower? In general, okay. I mean -- I think that, again, you know that it is not so easy to get the permission to build up a new wind farm. But from my point of view, I think all, including politicians, they realize that it is much easier to get the permission to replace old unefficient turbines with new and bigger in already existing places. I think that might not be a big problem, I would say. Of course, you need some kind of permission process. And what we are fighting for just now is to reduce the number of years in order to get the new permission. I think that should be done in six months or so. And yes, now, we don't know what kind of time it will take. But I think in that perspective, we have a good response from politicians and we also have ongoing discussions here in this field and so on. And just finally then -- because I guess -- when you built or when the operators built the wind farms initially, they had one, I mean, they had to build the transmission according to the turbine types, I guess. So, this may also mean that you have to invest quite significantly into new transmission from the parks to powering them? That's a good question. That depends. I mean, that was the reason why we went for Markbygden. And I mean, you have a higher value in a wind farm where you have a storing net and storing capacity in the net, because then you don't need to take this kind of extra investments. But if you have a limitation in the net, then of course, then you need to do extra investments. And then you can also be dependent on other actors. So that's the reason why we choose Markbygden and that's also how we tried to choose other projects. So, we tried to find projects with good net capacity in order to have the flexibility. Good morning. My questions have been answered now. But say, the start-up of Obbola, CTMP and the biofuel, could you indicate which quarter that will have an impact on EBIT, please? So, if we start with Obbola and we are currently running at around the same volume as the old machine, slightly lower in Q4. So, I think as we mentioned -- Ulf mentioned that our target is around 500,000 tones on Obbola for this year compared to 450,000 -- 460,000 tonnes last year. So, we're gradually ramping up Obbola. And when the volume comes -- when the volume increases, we'd also get the EBIT contribution. If we look at biorefinery in Gothenburg, that will be finalized during the end of the year, that would be starting in Q4 where we get some volumes from the biorefinery. And then CTMP, I mean, we are just starting to ramp up now also. We would not expect any significant contribution from CTMP during Q1 now. It will be fairly similar to what we had in Q4. And then, again, you have to keep in mind when you ramp up, you might see some surprises and things like that and we have to fix that. So, I think don't be too positive to what we -- what kind of impact we will have this first year. Give us this year and then I think next year we'll see substantial impact on the result. No. This is rather a negative effect and since we have start-up costs. And as Ulf mentioned, we run and then we find something that is relatively fine-tuned. And then we stop, fix that and then start the machine again. So, you lose some volumes, but you also -- you're not running on optimal cost when you have to start and stop and that's a normal part of the ramp up. So, the investments have affected EBITDA negatively during Q4. And again, that is very positive long term because that has created a good foundation for a very successful project and that goes for both Obbola and also for the CTMP project and Bollsta and so on. So, I mean, basically, this is very positive good news. We have some extra costs earlier than we thought, but that is due to the fact that we are ahead of plan. And that concludes the presentation for the full-year results for 2022. Thank you very much for listening in. And welcome back in April when we present our first quarter results for 2023. Thank you.
|
EarningCall_1113
|
Welcome, and thank you for standing by. At this time, all participants are in a listen-only mode. Today's conference is being recorded. If you have any objections, you may disconnect at this time. Thank you. This is Patricia Murphy and I'd like to welcome you to IBM's Fourth Quarter 2022 Earnings Presentation. I'm here today with Arvind Krishna, IBM's Chairman and Chief Executive Officer and Jim Kavanaugh, IBM's Senior Vice President and Chief Financial Officer. We'll post today's prepared remarks on the IBM investor website within a couple of hours, and a replay will be available by this time tomorrow. Provided additional information to our investors, our presentation includes certain non-GAAP measures. For example, all of our references to revenue growth are at constant currency. We have provided reconciliation charts for and other non-GAAP measures at the end of the presentation, which is posted to our investor website. Finally, some comments made in this presentation may be considered forward-looking under the Private Securities Litigation Reform Act of 1995. These statements involve factors that could cause our actual results to differ materially. Additional information about these factors is included in the company's SEC filings. Thank you for joining us. Our fourth quarter and full year results demonstrate the execution of our hybrid cloud and AI strategy. We delivered strong revenue growth in our business. The growth was broad-based across our software, consulting, and infrastructure segments as well as across geographies. Our clients recognize that technology continues to be a fundamental source of competitive advantage. Over the last several quarters, it has become clear that technology is playing a significant role in boosting productivity in the face of inflation, demographic shifts, supply chain challenges and sustainability requirements. We entered 2022, a more focused company and took steps to reinforce our position. We strengthened our consulting expertise and expanded strategic partnerships. To bolster our software portfolio, we invested in hybrid cloud and AI capabilities. We also delivered significant innovations in infrastructure with our z16 and Power platforms. All of this was brought to market with a more technical and experiential sales approach. Looking back on the year, we are pleased with the progress we made. We delivered revenue growth above our mid-single-digit model and we delivered solid free cash flow. But I'll acknowledge there is more to do. This year, we'll unlock more productivity, expand our strategic partnerships, and put more investment in specific growth markets. For 2023, we see revenue growth in line with our mid-single-digit model range and about $10.5 billion of free cash flow. This keeps us on a path of sustainable growth. I will now provide some color on the progress we are making in the execution of our strategy. Our perspective is clear. Hybrid cloud and AI are the two most transformative technologies for business today. These technologies work together to drive business outcomes. Hybrid cloud is where the world is going. Containers are the preferred destination for applications. Hybrid cloud offers more value than relying on a singular public cloud. It enables organizations to drive business value across multiple clouds, on-premise or at the edge. This includes scale, security, ease of use, flexibility of deployment, seamless experiences and faster innovation cycles. Our platform, built on Red Hat, is the leading container platform, allowing clients to harness the power of open source software innovations. IBM software and infrastructure technologies have been optimized for this platform. Our consultants and others leverage their extensive technical and business expertise to accelerate clients' digital transformation journeys. Clients realizing real value from working with IBM's hybrid cloud platform approach. For example, we worked with the Canadian Imperial Bank of Commerce, CIBC, to adopt a hybrid cloud approach. Using Red Hat technology, CIBC manages and skills its infrastructure with greater speed and flexibility. They can now develop applications in a private cloud and quickly deploy them to a public cloud. They deliver hundreds of new applications and reduced -- provisioning time by 95% and deployment time by 50%. We are helping Delta Airlines leverage hybrid cloud to modernize options, automate operations and integrate security. IBM Consulting deployed Red Hat on Amazon Web Services and IBM Cloud Packs to provide a consistent platform. Delta now has more levers that can use to boost developer productivity, reduce time to market and improve employee satisfaction. CIBC and Delta are both great examples of the value hybrid cloud can provide. Let's now talk about artificial intelligence, or AI. AI is projected to contribute $16 trillion to the global economy by 2030, including a massive boost in productivity by infusing AI into every enterprise process. We have been co-creating with many clients to deploy AI at scale. We automated the drive-through experience for quick-serve restaurants. We accelerated the rollout of COVID-19 vaccines by automating the processes that assist millions of customers with inquiries and appointments. By applying AI and automation we have helped security analysts to use the time to respond to threats from hours or days, to minutes. Recently, the U.S. Patent and Trademark Office partnered with IBM to leverage a host of AI capabilities that make it easier for people to glean insights from their vast database of patents. The BBC is now using our AIOps software to automate the management of its IT infrastructure. For businesses, deploying AI can be challenging because it takes time to train each model. But by using large language models, companies can now create multiple models using the same data set. This means businesses can deploy AI with a fraction of the time and resources. That is why we are investing in large language, our foundation models for our clients and have infused these capabilities across our AI portfolio. Our partner ecosystem plays a critical role in the execution of our strategy. In the fourth quarter, we made a series of new IBM software offerings available as-a-Service in the AWS marketplace. Likewise, Red Hat continued the expansion of its offerings in hyperscaler marketplaces, making Ansible Automation Platform available on both Azure and AWS. Adobe and Salesforce are also leveraging open source innovation based on Red Hat technologies in their offerings. Business with our strategic partners continues to grow with SAP, Microsoft and AWS, all over $1 billion in revenue for the year. We've had great success with our strategic partners and as we enter the New Year, we are expanding and better enabling our broader ecosystem. Recently launched Partner Plus, a new simplified program that increases our reach and scale through new and existing IBM partners. We remain focused on delivering new innovations that matter to our clients. In the fourth quarter, we introduced Red Hat Device Edge, a lightweight solution to flexibly deploy traditional or containerized workloads on small devices such as robots, IoT gateways, point-of-sale and public transport. We also formed a collaboration with the Japanese consortium, Rapidus to leverage the depth of our intellectual property on advanced semiconductors. We unveiled Osprey, a 433-qubit quantum processor, that brings us closer to delivering our goal of building a 1,000 qubit system later this year. At the same time, we continue to acquire companies to complement our organic innovation. In the fourth quarter, we acquired Octo, which improves our footprint in the US federal market. This caps the year with eight acquisitions across software and consulting. As sustainability becomes more of a priority, companies need digital technologies to analyze data, creating a baseline and improve the way they operate. Our software has helped IBM reduce its own carbon footprint. Across IBM's global real estate presence, we were able to reduce carbon emissions by over 61% when compared to 2010. Using IBM sustainability software, we have simplified and automated our sustainability reporting processes and reduced reporting costs by 30%. Let me wrap by saying I'm pleased with the progress we have made with our portfolio, our go-to-market and our ecosystem. I'm confident in our ability to leverage hybrid cloud and AI to help clients turn business challenges into opportunities. Our strategy continues to strongly resonate with clients and partners, and this gives us a solid foundation to build upon in this year. While there is more to be done, we enter the New Year as a more capable and nimble company, well-equipped to meet our clients' needs. Thanks, Arvind. I'll start with the financial highlights of the fourth quarter. We delivered $16.7 billion in revenue, $3.8 billion of operating pre-tax income and operating earnings per share of $3.60. In our seasonally strongest quarter, we generated $5.2 billion of free cash flow. Our revenue for the quarter was up over 6% at constant currency. While the dollar weakened a bit from 90 days ago, it still impacted our reported revenue by over $1 billion and 6.3 points of growth. As always, I'll focus my comments on constant currency. And I'll remind you that we wrapped on the separation of Kyndryl at the beginning of November. The one-month contribution to our fourth quarter revenue growth was offset by the impact of our divested health business. Revenue growth this quarter was again broad-based. Software revenue was up 8% and consulting up 9%. These are our growth vectors and represent over 70% of our revenue. Infrastructure was up 7%. Within each of these segments, our growth was pervasive. We also had good growth across our geographies, with mid single-digit growth are better in Americas, EMEA and Asia Pacific. And for the year, we gained share overall. We had strong transactional growth in software and hardware to close the year. At the same time, our recurring revenue, which provides a solid base of revenue and profit also grew, led by software. I'll remind you that on an annual basis, about half of our revenue is recurring. Over the last year, we've seen the results of a more focused hybrid cloud and AI strategy. Our approach to hybrid cloud is platform-centric. As we land a platform, we get a multiplier effect across software, consulting and infrastructure. For the year, our hybrid cloud revenue was over $22 billion, up 17% from 2021. Looking at our profit metrics for the quarter, we expanded operating pre-tax margin by 170 basis points. This reflects a strong portfolio mix and improving software and consulting margins. These same dynamics drove a 60 basis point increase in operating gross margin. Our expense was down year-to-year driven by currency dynamics. Within our base expense, the work we're doing to digitally transform our operations provides flexibility to continue to invest in innovation and in talent. Our operating tax rate was 14% which is flat versus last year. And our operating earnings per share of $3.60 was up over 7%. Turning to free cash flow. We generated $5.2 billion in the quarter and $9.3 billion for the year. Our full year free cash flow is up $2.8 billion from 2021. As we talked about all year, we have a few drivers of our free cash flow growth. First, I'll remind you, 2021's cash flow results included Kyndryl related activity including the impact of spin charges and CapEx; second, we had working capital improvements driven by efficiencies in our collections and mainframe cycle dynamics. Despite strong collections, the combination of revenue performance above our model and the timing of the transactions in the quarter led to higher-than-expected working capital at the end of the year. This impacted our free cash flow performance versus expectations. Our year-to-year free cash flow growth also includes a modest tailwind from cash tax payments and lower payments for structural actions, partially offset by increased CapEx investment for today's IBM. In terms of cash uses for the year, we invested $2.3 billion to acquire eight companies across software and consulting, mitigated by over $1 billion in proceeds from divested businesses, and we returned nearly $6 billion to shareholders in the form of dividends. From a balance sheet perspective, we ended the year in a strong liquidity position with cash of $8.8 billion, this is up over $1 billion year-to-year and our debt balance is down nearly $1 billion. Our balance sheet remains strong, and I say the same for our retirement-related plans. At year-end, our worldwide tax qualified plans are funded at 114%, with the US at 125%. Both are up year-to-year. You'll recall, back in September, we took another step to reduce the risk profile of our plans. We transferred a portion of our U.S. qualified defined benefit plan obligations to insurers, without changing the benefits payable to plan participants. This resulted in a significant non-cash charge in our GAAP results in the third quarter, and we'll see a benefit in our non-operating charges going forward. You can see the benefit of this and other pension assumptions to the 2023 retirement-related costs in our supplemental charts. Turning to the segments. Software revenue grew 8%, fueled by growth in both hybrid platform and solutions and transaction processing. We concluded the year with seasonally strong transactional performance as well as a solid and growing recurring revenue base in software. In hybrid platform and solutions, revenue was up 10%, with pervasive growth across our business areas: Red Hat, automation, data and AI and security. Our platform-based approach to hybrid cloud and AI is resonating with clients. As a proof point, OpenShift, our industry-leading hybrid cloud platform now has $1 billion in annual recurring revenue, and we modernize and optimize our software capabilities, including through cloud packs across automation, data and AI and security for that platform. Red Hat revenue grew 15% in the quarter, led by strength in OpenShift and Ansible, both growing double digits and gaining market share. Automation revenue was up 9%. Growth was led by business automation, application servers and integration as clients look to automate business workflows and improve applications. Data and AI revenue grew 8% with enterprise needs to organize, store and manage their data. This performance reflects demand in areas including data management, data fabric and asset and supply chain management. Security delivered 10% revenue growth. We're helping clients detect, prevent and respond to security incidents, which led to strength across threat management, data security and identity. Across these businesses, the annual recurring revenue or ARR for hybrid platform and solutions is $13.3 billion. And for all of software, hybrid cloud revenue is now more than $9.3 billion over the last year, up 16%. In transaction processing, revenue was up 3%. Demand for this mission-critical software has followed increases in Z Systems installed base capacity over the last couple of product cycles and strong renewal rates continued this quarter. Both are evidence of the importance of this platform in a hybrid cloud environment. Moving to software profit. Our pre-tax margin was up 2 points this quarter, contributing to a full year margin of nearly 25%. Consulting revenue grew 9%. Clients are leveraging IBM's hybrid cloud leadership and deep industry expertise to navigate the complexity of their digital transformation journeys. Revenue growth was broad-based across all business lines and geographies. And I'll remind you that this is on top of the 16% growth consulting delivered in the fourth quarter of 2021. Strong demand for our offerings led to signings growth of 17%. With this, fourth quarter had the best quarterly book-to-bill of the year, and we sequentially improved our trailing 12-month book-to-bill ratio to 1.1. Clients are partnering with IBM Consulting as they decide what applications to modernize and how to migrate those applications across hybrid, multi-cloud environments. Over the last 12 months, consulting delivered $9 billion in hybrid cloud revenue, which is up 23%. This quarter, our Red Hat practice was again a meaningful contributor to this growth. Revenue from strategic partnerships also grew at a strong double-digit rate. We continue to see momentum in this space. In aggregate, our strategic partnership bookings were up over 50% with Azure and AWS more than doubling. Turning to our lines of business. Business transformation revenue grew 7%. Growth in business transformation was once again driven by data and client experience transformation along with supply chain and finance optimization. Our partnerships with key ISV partners like SAP, Salesforce and Adobe enable IBM Consulting to transform critical workloads at scale. In technology consulting, where we architect and implement clients cloud platforms and strategies, revenue was up 10%. Growth was led by cloud application development practices. Red Hat engagements along with our strategic hyperscaler partnerships contributed to the growth. Application operations revenue grew 12%. We help clients to optimize their operations and reduce costs by taking over the management of applications in hybrid and multi-cloud environment. Our incumbency and understanding of clients' applications are key differentiators. Moving to consulting profit. Our pre-tax margin was 11% for the quarter and nearly 9% for the year. The fourth quarter margin is up nearly 2 points year-to-year and over 1 point sequentially. We are starting to see the benefit from pricing actions and productivity and our acquisitions have become more accretive. Turning to Infrastructure segment. Revenue grew 7% driven by hybrid infrastructure, which was up 11%. Within hybrid infrastructure, Z systems revenue grew 21% this quarter. Among the new z16 capabilities, clients are leveraging cyber resiliency to comply with business regulations and proactively avoid outages in their operation and the new on-chip AI accelerator, for example, has been helping mitigate risk and detect fraud in credit card application processes. Our distributed infrastructure revenue was up 5%. This performance was fueled by strength in power following the extension of Power 10 innovation throughout the product line. Infrastructure support performance was flat including the impact from client adoption of new hardware with the latest z16 product cycle. Moving to infrastructure profit. Pre-tax margin was down less than 1 point in the quarter. And for the full year, our pretax margin was nearly 15%. Now let me bring it back up to the IBM level to wrap up. At our investor briefing 15 months ago, we laid out our hybrid cloud and AI strategy and our priorities of revenue growth and free cash flow generation. Since then, we've been focused on our portfolio, our go-to-market model, our ecosystem and our capital allocation to execute that strategy and create value through focus. We now just completed the first year as today's IBM. Our 2022 revenue was up nearly 12%, including nearly 4 points of incremental Kyndryl contribution that's above our model of mid-single-digit growth. Over 70% of our revenue was in our growth vectors of software and consulting and about half of our revenue is recurring. With this high-value mix and contribution from the incremental Kyndryl revenue, we expanded our full year operating pre-tax margin by 2.5 points. And our free cash flow was $9.3 billion, up $2.8 billion from the prior year. We invested organically and inorganically and return significant value to shareholders through dividends. Now there were some external factors that we faced this past year that impacted our profit and cash. We exited a profitable business in Russia. We are dealing with a much stronger dollar, and we are operating in a highly inflationary environment, which put pressure on our margins, especially in consulting. Putting it all together, we are pleased with the fundamentals of our business and the progress we have made in executing our strategy. Our 2022 performance demonstrates that we now have a higher growth, higher value company with higher return on invested capital and a strong and growing free cash flow. For 2023, we again expect solid growth in our two most important measures of success; revenue and free cash flow. Arvind talked about the important role technology plays in this environment and how our solutions are closely aligned to the needs of our clients. With this, we expect constant currency revenue growth for the year to be in line with our mid-single-digit model. As we enter this year, I think it's prudent to expect the low-end of the mid single-digit model. And for free cash flow, we'd expect to generate about $10.5 billion in 2023, which is up over $1 billion year-to-year. Let me spend a minute on our expectations for constant currency revenue and pre-tax profit performance by segment. In software, with continued momentum in our recurring revenue stream in both hybrid platform and solutions and transaction processing, we expect revenue growth in line with software's mid single-digit model. This revenue growth generates operating leverage, and we'd expect software pre-tax margin to expand by about 2 points year-to-year. Consulting's model is to deliver high single-digit revenue. We're coming off a strong year with revenue growth of 15% as we help clients with their digital transformations. This momentum and strong book-to-bill ratio support consulting revenue growth at the high-end of its model despite the tough compare. We expect to expand consulting pre-tax margin by at least 1 point as we continue to realize more of the price increases and improved utilization. Infrastructure revenue is roughly flat over the midterm model horizon, with performance in any year reflecting product cycle dynamics. We're entering the year three quarters into the z16 cycle, and will also ramp on Power 10. As a result, we expect 2023 infrastructure revenue below its model and pre-tax margin in the low-teens. For perspective, infrastructure should impact IBM's overall revenue growth by over 1 point. With these segment dynamics, we would expect IBM's operating pretax margin to expand by about 0.5 point. That's in line with our model and our tax rate should be in the mid- to high-teens range. Let me comment on a few items within our expectations. First, as I said, currency was a significant headwind in 2022, impacting revenue by $3.5 billion. With the movement of spot rates over the last 90 days, currency translation would be fairly neutral to revenue in 2023 with a headwind in the first half, flipping to a tailwind in the second. But I'll remind you that we had over $650 million of hedging gains in 2022, which will not repeat in 2023, resulting in an impact to our profit and cash on a year-to-year basis. Second, as you know, we've taken a number of significant portfolio actions over the last couple of years, which has resulted in some stranded cost in our business. We expect to address these remaining stranded costs early in the year and anticipate a charge of about $300 million in the first quarter. We would start to see benefits in the second half and pay back by the end of the year. And then third, we regularly review the useful lives of our assets. Due to advances in technology, we are making an accounting change to extend the useful life of our server and networking equipment effective the 1st of January. Based on our year-end asset base, we expect this change to benefit 2023 pre-tax profit by over $200 million, primarily in our Infrastructure segment. Given this is a change to the depreciation, there's no benefit to cash. Looking at the first quarter, our constant currency revenue growth should be fairly consistent with the full year. Reported growth will also include about a three-point currency headwind at current spot rates. With operating leverage, we'd expect operating pre-tax margin to expand 50 to 100 basis points in the first quarter. And that's before the charge I just mentioned for the remaining stranded costs. Given the timing of currency and stranded cost dynamics, we'd expect about one-third of our net income in the first half and about two-thirds in the second half. To sum it all up, we have made a lot of progress this past year. While there's always more work to do, we're confident in the fundamentals of our business, and how we're positioned as we enter the New Year. Thank you, Jim. Before we begin the Q&A, I'd like to mention a couple of items. First, supplemental information for the quarter and the year is provided at the end of the presentation. And then second, as always, I'd ask you to refrain from multi-part questions. Operator, let's please open it up for questions. Thank you. At this time, weâll begin the question-and-answer session of the conference. [Operator Instructions] Our first question will come from Amit Daryanani with Evercore. Your line is open. Thanks a lot for taking my question. I guess my question is around the free cash flow numbers. And perhaps you could spend a little bit of time on, you touched on kind of the 22 levers a fair bit and how you got there. But as you think about calendar 2023 free cash flow of $10.5 billion, upwards of $1.2 billion. What are the puts and takes? What are the bridge that gets you there? And then maybe related to that, as I think about what you did in 2022 and 2023, it does imply to get to the $35 billion number over the three years, 2024 would have to be $14 billion plus. So perhaps you can level set that because I do think from, when you provided the $35 million number, a fair bit has changed. So maybe a bridge for 2023 and just an update on how you think about the $35 billion number over three years as well? Thank you. Thanks, Amit. This is Jim. I appreciate the question. So let's start there. We saw a solid free cash flow generation in 2022, up $2.8 billion year-over-year. Now as you remember, we entered 2022. We talked about a very strong free cash flow generation engine. And we put in place a guidance for 2022 well in excess of our model of $750 million year-to-year. First, as we were very transparent, we were going to get at least about half of that out of the Kyndryl related spin dynamics. That's the charges and CapEx. And we were going to get a little bit more than half of that out of our base operations overall. And I think when you look at 2022, what happened we got impacted by two external factors. Number one, the unfortunate humanitarian crisis with the war in Russia and Ukraine, and we exited that business, the right decision. Second is unprecedented US dollar appreciation. I think last time I looked, the rate, the breadth, the magnitude of the change is the most we've seen in multiple decades. We got hit with that. But we're able to overcome some of that with the fundamental underpinnings of our business overall and still delivered almost $3 billion of free cash flow year-over-year. By the way, Russian currency by themselves is over $600 million of profit and cash we had to absorb. So now to your question about 2023, we guided, as you heard in the prepared remarks, a $10.5 billion, that's up $1.2 billion year-over-year, and again, above our $750 million year-to-year. The underpinnings of that, though, are going to be very different in 2023. Given the improving business fundamentals of our now sustainable revenue growth with a high value mix contribution, we see then continued operating leverage. So our cash PTI is going to deliver a substantial amount of that free cash flow generation year-over-year. We're still going to get working capital efficiency. So our realization will definitely be up over 100%. But that's really given the volume dynamics of what happened in the fourth quarter with a very strong and accelerated growth profile as we went through fourth quarter, we finished extremely strong on our transactional business in the month of December. So that now creates an opportunity for free cash flow generation in 2023 and that's in our guidance. And then there are some other puts and takes. Yes, we'll get modest structural actions tailwind, but they're going to be offset by a cash tax headwind for the year. So that kind of plays out 2022 and 2023 now. How does that relate to a mid-term model? First of all, we're one year into that mid-term model. And as I talked about, the dynamics in dealing with the decision to exit our Russia business and the significant US dollar appreciation, I quantified it for you over a $600 million impact on profit and cash. But as you all know quite well, that's not a one-time impact, that will continue over a multi-period and it definitely puts pressure on our mid-term model to the tune cumulatively about over $2.5 billion. So, we are entirely focused on how we execute this company on a sustainable revenue growth profile and generating that $10.5 billion of free cash flow. So it enables us, with the right ample financial flexibility, to continue to invest in our business and return value to our shareholders overall. Hi, yes. Thank you. Arvind, nice to see the revenue guide here. I was wondering if you could share some thoughts around what's happening in software, in particular, you've had a really strong performance in transaction processing over the past year. How are you thinking about the trajectory of that? I know historically, we've kind of thought about this as mid-single-digit or higher decliner, and clearly, we're tracking very differently here. If you could share some thoughts around the trajectory of that in 2023 and beyond, that would be very helpful. Thank you. Yeah. Thanks Wamsi, for the question. So, I'll address your transaction processing question first and then all of software right after that. So some of you have heard me talk about that transaction processing would be a mid-single-digit decliner in the past. And that's effectively, Wamsi, is what you asked, what's going to be different. As we look at our business there and we look both at the underlying MIPS growth, as well as the criticality of that software, as well as our ability to have some very modest pricing uplift, we would now look at that business as being a slight increaser as opposed to a modest decliner. So, I think, if you are looking at that one, Wamsi, low single-digit increases for transaction processing is what we think is appropriate for the short to medium-term model looking forward. Now, that does help in overall software. So first, let's look at software and decompose it. Software, as Jim mentioned in his prepared remarks, is almost 80% recurring revenue. We see that recurring revenue increasing consistent with our model of the mid-single digits, based on both the consumption, the usage, as well as what we have seen through '22 in people renewing that base of software business. Then, I will acknowledge to you that '22 was a great ELA year, '23 will be not as good as '22. But with the transactional piece of the business being less than 20%, that has a much smaller impact on the overall growth rate. As you put all that together, we see the mid-single digits as being appropriate for the software business. Yes, thank you. I was wondering if you could just comment on operating profit more broadly. I think your target at the beginning of the year was for operating profit to improve 400 basis points, and it came in at 270. I think your target for the fourth quarter was 250 basis point improvement in operating margin and came in at 170. And so -- and that's manifesting itself into a free cash flow number that was lower than you had expected and this year and potentially for next year relative to your $35 billion target. So, you have a dual mandate, Arvind. One is to try and grow mid-single digits and the other is to deliver very strong cash flow, which is impacted by margins. The margin was not as strong this year, and I'm wondering, if you can highlight what was different from your expectations? And what were the challenges in forecasting that and how investors should think about that and free cash flow realization going forward? Yes. Toni, thanks. So, you're completely accurate that these numbers are slightly below our expectations from the beginning of the year. I will ask Jim to comment and give you a lot more color on it. But let me first comment on your statement of, we have a double mandate of revenue growth and free cash flow growth, but I want to also be clear, revenue growth has -- which manifests itself in client satisfaction, higher NPS from our clients, better consumption of both software and consulting from our clients, which allows them to consume more and more over time is what we are focused on. And it's an and we have to deliver the free cash flow growth. Jim mentioned in a response to the first question that we were not expecting the business and Russia to get shut down, that impacted it a little bit. We were not expecting the currency headwinds to be as severe as it turned out to be. That's certainly impacted. And I'll acknowledge, an inflation as in wage inflation showed up and impacted our margins in consulting a lot more than we were expecting. Now an answer could have been to not hire people and to not give that but that would have resulted then in lower capacity at the end of this year, which would not have allowed us the confidence into the growth, both in consulting and in software that we are now committing for 2023. So as we balance those, it becomes a business decision to say, we are going to keep going on increasing capacity, which results in healthier revenue and it will result in improving margins, but that flows through into 2023 as opposed to giving it all to us in 2022. So Toni, that's kind of how we think about balancing the investments in the business versus a quarterly result. And I'll ask Jim to comment a bit more on some of the specifics of what you were asking. Yes. Just to put some numbers around this, Toni, you're exactly right. We entered the year. We talked about a business profile, higher revenue growth company, higher operating margins, strong free cash flow yield. And we had guided at mid single-digit revenue growth, and we guided that four points of operating margin improvement. The two points of external that both Arvind and I have both talked about Russia and currency. By the way, that was about 0.5 point because currency member, as we've talked about many times throughout these calls, not only the rate breadth and velocity and change in magnitude that we haven't seen in about two to three decades, but it impacts human capital-based consulting business very differently than a product technology-based business. As we talk about human capital is all pretty much a natural hedge because your cost is basically matched with your revenue outside of global delivery. But in a product-based business, our costs like the industry is predominantly US dollar source, and that's why you've seen pressure on the gross profit margin line and the pre-tax profit margin line around our technology base of business. Now underlying that though, I think you're seeing a fundamental improvement in our margins as we go forward. So about 50 basis points of currency. The remaining 100 basis points was consulting. And we talked about that. That's been a rate and pace discussion. You dial back 15, 18 months ago, we called a very accelerated demand environment of our clients shifting to digital transformation and journey to cloud. And starting in the second half of 2021, we made the bet to make investments around skill capability ecosystems, and we opened up the aperture to build extended capabilities inorganically. And we knew as we went through 2022 that we then we're operating in a highly inflationary environment. And then it became a rate and pace discussion on how quick can you get price margin and optimization and realize through your backlog. And I think we've acknowledged that we were pretty slow throughout the year. Now with that said, we finished the year about nine points of margin in consulting. We had nice improvement. We exited fourth quarter at 11-point PTI model that was up almost 200 basis points year-over-year, our first half to second half, we saw an acceleration of three points of margin from about a seven-point operating PTI model to well over 10 points of an operating PTI model. And most importantly, the green shoots are starting to play out in the fourth quarter. Our utilization of effective capacity, one of the three levers we talked about all year, up three points in the fourth quarter. Our price margins, third consecutive quarter are up year-to-year, and you're seeing that play out in that operating profit performance. And finally, acquisitions. Now, we're on a steady state and our acquisitions are back to accretion. So, we see nice green shoots that lead to our guidance in 2023 at the high end of our high single-digit model in consulting on revenue coming off of a very strong 15% growth in 2022 and guiding another one point plus in operating margins going forward. Our next question will come from Shannon Cross with Credit Suisse. Your line is open. Shannon, weâre not able to hear you in conference, please shift the mute feature on your phone. Okay. Interesting. Yes. Arvind, can you talk a bit about AI and how it runs through your business? There's obviously so much discussion right now about OpenAI and Microsoft making investments? And I guess I'm trying to think about how we should think about IBM monetizing it, capitalizing on it, how you think about your competitive position relative to others. I don't know if there are examples you can give where you're utilizing it. But I'm just -- I'm wondering, as AI gets more and more of a -- becomes more and more of a discussion point apparently for 2023 and you have such a long history with it, how we should think about where you are now and where you're going to take it? Thank you. Thanks Shannon. So, first, let me acknowledge AI has become a big topic of conversation this year. I was in Davos last week, and it probably came up at almost every single discussion around technology, what's happening with AI as well as what's happening with OpenAI. If I think about it over the last decade, I think there were three moments you can talk about, and then I'll begin to translate those into a business impact. One, when IBM won Jeopardy! with Watson, I think it was a big moment, and AI came on to everyone's roadmap. Second, when deep mind from Google or Alphabet started winning competitions around, for example, GO, and that became another big moment along with the protein folding that they did and now with OpenAI and ChatGPT. But if I step back just a moment, all of this latest version is based on what is called large language models as the underlying science. Universities do it, Google does it, IBM does it as does OpenAI. To just get to why it's so exciting. For example, for us, it allows us to do 13 language models when we are looking at understanding different natural languages in the same cost as originally one. That is what is so exciting about these technologies because if you can get an order of magnitude improvement in cost and speed and the resource consumed, both in terms of hardware and people, that is incredibly exciting. Now, let me translate this into how do we monetize this. So, our monetization of AI is very much focused on that $16 trillion of productivity that I've talked about that we're going to get over the decade. The vast majority of that comes from enterprise automation, and when I say enterprise, I include governments into it. Some examples, if you can automate the drive-through and order taking for quick-serve restaurants, that's an example of what can happen. If we can get deflection rates of 40%, 50%, 60% at everyone's call centers, that's a massive operational efficiency for all of our clients. If we can help retirees get their pensions through interacting with a Watson-powered AI chatbot that is an enterprise use case where all of these technologies come into play. By the way, all my three examples are real clients where we are resulting in anywhere from hundreds to thousands of people, efficiency for each of these clients. So that's how we get it. If I look inside IBM, how we do promotions, how we do people movement, how we begin to improve our code to cash, how we improve our customer service and people ask complicated questions around triage of IT systems going down are all very real examples where we are improving client service and saving money all at the same time. Hey, guys. Good afternoon. Thanks for taking the question. I wanted to just touch on the consulting business. Signings were very strong in the December quarter, up 17%. Your quarterly book-to-bill was an improvement from the September quarter. Can you maybe just, again, just step back and elaborate on the environment, what we're in, what you saw in 4Q that potentially stood out to you where strength in signings is coming from changes to contract duration? Maybe just double-clicking on the consulting business. Just to help us understand what gives you confidence to be kind of at the high end of your midterm model for 2023? Thanks. Thanks, Eric, for the question. I'll take this. When we entered the fourth quarter, we had a pretty solid pipeline. And we talked about reaffirmed mid-teens growth for consulting for the year, which as you know, is well above our model. But again, as I talked about on the previous question, we had made the investments in bringing in skill capability, expanding ecosystem, strategic partnerships and acquisitions. But we saw that pipeline entering the quarter we saw a very solid and pretty disciplined sales closure rate as we move through the year. Now, how did the year end that positions us for 2023 and let me just put some stats to really bring it home. Number one, ecosystem velocity, we saw continue to increase throughout the year of our strategic partnerships. I think we said in the prepared remarks, strategic partnerships, one grew revenue 25% in 2022 and was about 40% of our consulting base of business. That is up about 50% year-over-year. We have saw â seen extensive acceleration. And by the way, in the fourth quarter, our signings growth which delivered a 1.3 book-to-bill, our hyperscaler partnerships with Azure and with AWS, our signings were 2x. And our ISV portfolio with the likes of SAP, Salesforce, Adobe, we were up over 50% in signings. So our book of business and the partnerships we have tremendous strength that's fueling our backlog, point number one. Point number two, Red Hat. We continue to see acceleration of consulting being the tip of the spear that's really driving the scale and adoption of our hybrid cloud platform. And oh, by the way, is also dragging IBM technology and software. Since inception, a little over three years, we signed $7.4 billion of business in Red Hat, tremendous strength and that, again, fuels our backlog for 2023. And then you look at full year, we grew both large transformational deals, and we grew small deals double digit, both sides. So it's pervasive across the board. So when we look at our backlog, we look at all of our indicators of our business on the realization of that model. We look on the acquisition portfolio and how it's scaling. We feel pretty confident about the high end of our high single-digit model in 2023. Oh, by the way, to Toni's question, at operating margins being accretive. Hi, good afternoon. Thanks for taking my question. Maybe following on that, I had a broader question, Arvind, on the overall demand environment you're seeing. I think with earnings coming in from various enterprise tech players so far, we're seeing a pretty wide range of signals about how the demand environment is shaping up for 2023. Can you just comment a bit on what you're seeing from your large clients, say, relative to this past year? Thank you. Yeah. Thanks, Lisa, for the question. Look, if I think about our overall client base, we were first really pleased that there wasn't much of a difference by geography. As I go through it, Japan, India, Australia, the Middle East, Western Europe, the UK, North America were really pretty strong in demand across. So I think Lisa, if I break it down into the two portions around technology and consulting, what we are seeing is that most of our clients do believe, but even if there are some I call the minor or different headwinds in 2023, they are going to emerge stronger. As they want to emerge stronger, that means they're all deploying technology to help offset wage inflation, cyber issues, supply chain challenges and all the demographic shifts, meaning there's just fewer skilled people to hire. Consequently, we're seeing them double down, and that is why we have focused on certain areas and certain partners, both for consulting and in technology. So they all want to deploy automated ways to get from the front to the back maybe Salesforce and Adobe play a very strong role in that. They all want to leverage cloud technologies that they can scale technology up to better handle client demand. Our partnerships with the hyperscalers play into that. They all want to leverage far more technology than they have before to counteract the wage inflation and other inflationary aspects and what we do with Red Hat plays into that. So I kind of see, Lisa, that all of our clients play into that. Now you've mentioned a wide spectrum from the people you're seeing recently, I think the reason that we are remaining in this optimistic frame of mind, we have no consumer business. I agree that our clients may have a consumer business, but we don't have that directly. And so I think consequently, we might be seeing a little bit different subset of the economy than those who might have a large direct exposure to a consumer business. Thank you. So you had a very good transactional momentum in the software business in the fourth quarter, and you provided some good high-level commentary in your prepared remarks about the business and the broad-based growth may reflect many of those changes that you've been talking about in the go-to-market strategy and sales changes. That said, Arvind, can you talk specifically or identify any product-specific changes in software that you think may be driving that momentum and that may suggest your competitive positioning is shifting in any of those three non Red Hat segments. And then just one other thing -- just sorry about the two-part question, but just for Jim, I just wanted to clarify with that working capital headwind in the fourth quarter that you talked about reverses in 2023. Thank you. Yes. Thanks, David. Let me talk a little bit about the product capabilities. And as you said outside Red Hat called focus on automation, data AI and cyber. If I look at those, let's take automation. I'm really pleased with the progress we have made around an area Iâll call AIOps. But if you think about, we made a couple of small acquisitions Instana and Turbonomics, we built our own AIOps portfolio. And we're seeing tremendous pickup from that as our clients want to take out labor complexity but also want to optimize their overall IT infrastructure, hardware and software. They also want to have uptime that is now the talk about not just 2 9s and 3 9s, but up to 5 9s. And they also want to worry about how to make sure some go to always on. And so I think our AIOps portfolio there really advantages us, and I believe we're in a unique position because we help our clients in an environment across multiple public clouds and on-premise, and with their private clouds in that space. If I think about data and AI, our focus on data fabric and allowing our clients to leverage the data wherever it is, not always moving it, but allowing them to catalog it, leveraging AI, deep inside our products is another example of where we have a unique capability. And third, if I look at cyber, we focus a lot on threat management. And if we think about how we can leverage the inputs from all kinds of sources in these days, and people are really worried about all of the threats coming, whether from nation states, all from just bad actors, then it allows them to leverage that portfolio better. Consequently, we're going to remain pretty focused on these areas. You should expect both organic and inorganic investment. And David, I can't help us say, we are giving our clients the ability to deploy these capabilities on multiple public clouds as well as on-premise and I believe that does advantage them because it gives them a lot more flexibility and freedom than they might have from some other vendors. Yes. I would just build on that, Arvind. I mean, Software book of business today, it's an integral part of our hybrid cloud platform thesis. It is the foundation. We eclipsed $25 billion for the first time ever here in 2022. So over 40% of IBM's revenue and two-thirds of our EBITDA. So when you look at it, we are a hybrid cloud AI platform-centric company overall and software is right at that course. So why that recurring revenue stream and the improvements we've been seeing throughout 2022. And as Arvind answered earlier, getting that back to a growing contribution, not only helps the competitiveness and market share of our top line, but I think all of you understand the marginal dollar of that book of business is in the 90-plus percent range, as we move forward. So David, I think you also asked a question about clarification. Free cash flow growth, $10.5 billion about, up $1.2 billion year-to-year, above our model of $7.50 billion. That will be driven based on the fundamental improvements of our underlying revenue growth and operating leverage and cash PTI, but there will also be, yes, a working capital efficiency contribution to our cash generation next year, really just the volume dynamics of what played out in the fourth quarter. We'll get that back. Thanks very much for squeezing it in. This one is macro related as well, but just pretty quick. It seems like some of the long macros implied in your 2023 guidance, but I don't think you talked specifically about whether you're seeing anything specifically slowing. It sounded generally positive for you guys, even though there's a bit of a slowdown implied in the guidance. Microsoft and F5 talked about a divergence between new business and new applications, seeing some growth versus renewal business, capacity expansions, cross-selling and things like that. Are you seeing a similar thing in terms of new applications slowing a bit and some of the kind of recurring and cross-selling capacity expansion is holding up? How much of either of those is driving your lower end of mid-single-digit growth guidance for 2023 and kind of break it down, if you can. Thanks. Okay. Look, I think that first and I'll address your point of new application versus existing pretty directly. The point about the lower end of the mid-single digit is largely from the fact that Infrastructure segment will be a headwind going into 2023, whereas it was a tailwind in 2022. I wouldn't read anything more than that into our low end as opposed to the middle of the range. Now, for us, I don't really see that. I see that our clients do want to do new development. Now, from our perspective, if somebody is doing an expanded sales force deployment, I call that a new application. If somebody is doing a new application on Azure or if they are moving, well, they never really directly move. They always talk about refactoring, putting in new function, integrating with other applications they might have in their shop, or that they buy a SaaS properties, we consider all that new development. And so, for us, our consulting teams are largely doing that new development for our clients. And in that process, they tend to use OpenShift from Red Hat, it tends to use Red Hat Linux, they tend to use our AI automation. Our AI automation then surrounds all those things to make them much more resilient, much more robust, much more secure, and those are the capabilities we bring. So we are not really seeing that divergence, I will tell you straightforwardly, but there is likely a focus that in that new application, is it helping automate things more? Is it helping make things I call it straight through as opposed to with a lot of manual intervention. That is probably a bigger focus. Maybe we don't see it because we kind of call that play in late 2021, because we kind of saw those things coming and becoming more important. And we decided to invest in them, both in technology and in consulting. Patricia, with that being the last question, let me now make a couple of very quick comments to wrap up the call. 2022 was an important year for us. As Jim said, it was the first full year of the new IBM. The results we delivered reinforce our confidence in our strategy and our model. While there is always more to do, we are pleased with our position as we enter 2023, and I look forward to continuing this dialogue as you roll through the year.
|
EarningCall_1114
|
Ladies and gentlemen, welcome to the STMicroelectronics' Fourth Quarter and Full Year 2022 Earnings Conference Call and Live Webcast. I'm Moira, the Chorus Call operator. [Operator Instructions]. At this time, it's my pleasure to hand over to Celine Berthier, Group Vice President, Investor Relations. Please go ahead, ma'am. Good morning. Thank you, everyone, for joining our fourth quarter and full year 2022 financial results conference call. Hosting the call today is Jean-Marc Chery, ST's President and Chief Executive Officer. Joining Jean-Marc on the call today are Lorenzo Grandi, President of Finance, Purchasing, Enterprise Risk Management and Resilience and Chief Financial Officer; and Marco Cassis, President of anal Velvement and Sensor Group and Head of STMicroelectronics Strategy, System Research and Applications and also the Innovation Officer. The live webcast and presentation materials can be accessed on ST's Investor Relations website. The replay will be available shortly after the conclusion of this call. This call will include forward-looking statements that involve risk factors that could cause ST's results to differ materially from management's expectations and plans. We encourage you to review the safe harbor statement contained in the press release that was issued with the results this morning and also in ST's most recent regulatory filings or a full description of these risk factors. Also to ensure all participants have an opportunity to ask questions during the Q&A session. [Operator Instructions]. So thank you, Celine. Good morning, everyone, and thank you for joining ST for our Q4 and full year 2022 earnings conference call. Let me begin with some opening comments, starting with Q4. ST delivered net revenues and gross margin above the midpoint of our guidance. Net revenues of $4.42 billion increased 24.4% year-over-year and 2.4% sequentially. Gross margin was 47.5%. Operating margin was 29.1% and net income was $1.25 billion. Looking at the full year 2022. Net revenues increased 26.4% to $16.3 billion, driven by strong demand in automotive and industrial and our engaged customer programs. All 3 product groups contributed to the growth. Profitability improved on a year-over-year basis. Gross margin was 47.3%, up from 41.7%. Operating margin was 27.5%, up from 19%. And net income was $3.96 billion, almost doubling from $2 billion. We generated stronger net cash from operating activities. We invested $3.52 billion in CapEx and delivered free cash flow of $1.59 billion. Our net financial position increased to $1.8 billion at December 31, 2022, from $977 million 1 year ago. On Q1 2023, at the midpoint, our first quarter business outlook is for net revenues of $4.20 billion, increasing by 18.5% year-over-year and decreasing 5.1% sequentially. Gross margin is expected to be about 48%. For the full year 2023, we will continue to execute our strategy, with a strong focus on automotive and industrial as a broadband supplier and a selective approach in personal electronics and communication equipment and computer peripheral. We entered this year with a backlog higher than what we had entering 2022. We plan to invest about $4 billion in CapEx, mainly to increase our 300-millimeter wafer fabs and silicon carbide manufacturing capacity, including our substrate initiatives. Based on our strong customer demand and increased manufacturing capacity, we will drive the company based on a plan for full year 2023 net revenues in the range of $16.8 billion to $17.8 billion, representing a growth range of 4% to 10% compared to full year 2022. Now let's move to a detailed review of the fourth quarter. Both revenue and gross margin came the midpoint of our guidance by 60 and 20 basis points, respectively on a sequential basis, Q4 net revenues increased 2.4%, driven mainly by ADG, which increased 8.5%. MDG revenues increased 0.7%, while AMS revenues decreased 3%. On a year-over-year basis, Net revenues increased 24.4%, with ADG and MDG growing 38.4% and 29.1%, respectively, while AMS increased 7% year-over-year. Sales to OEMs increased 26.8% and 19.5% to distribution. Gross profit was $2.1 billion, increased on a year-over-year basis. Gross margin was 47.5%, increasing 230 basis points year-over-year, mainly driven by favorable pricing, improved product mix and currency effect net of hedging, partially offset by the inflation of manufacturing input costs. Fourth quarter operating income increased 45.4% to $1.29 billion. Q4 operating margin was 29.1%, up from 24.9% in the year-ago period, with ADG at 27.7%, AMS at 25.8% and MBG at 35.8%. Q4 net income was $1.25 billion, including a onetime noncash income tax benefit of $141 million, compared to $750 million in the year ago quarter. Earnings per diluted share were $1.32 compared to $0.82. Let's now discuss our full year results, starting with the business. 2022 was a year marked again by strong demand in Automotive and Industrial, still impacted by supply chain challenges due to continuing shortages and capacity constraints. In the second half, we started to see market softening in personal electronics and computer peripherals. In Automotive, we again saw unprecedented demand across all geographies, driven by increasing semiconductor [indiscernible], structural transformation,and inventory replenishment. We continue to execute our strategy for car electrification, in particular in our silicon carbide business. We added a wide range of wins in next-generation electrical vehicle design with our home on discrete solutions. The latest one is with Hyundai Motor, we have chosen our AsPac drive silicon carbide MOSFET generation 3 based power module for traction investors in its current generation electrical vecatform. In silicon carbide for Automotive and Industrial, we achieved $700 million of revenues with silicon carbide in 2022, with a plan to be above $1 billion in 2023. We finished the year with 115 order projects, spread over 80 customers, adding 25 projects and 8 customers during 2022, about 60% of these projects are for Automotive customers. We continue to lead in silicon carbide as we have moved to high volume production of our third-generation transistors for multiple Automotive customers, and we will ramp our fourth generation transistor in volume in the second half of this year. In car digitalization, we are the range of wins with our MCUs and power solutions for new zones car architectures. We won designs with our next-generation [indiscernible] Automotive and announced a cooperation model with Volkswagen Cayan, including the joint development of a system on chips NPU. We also received awards with our partners mobilize for ADAS and Autotalks for VIP. In our automotive sensors, we continue to increase the scale of our business in inertial sensor, growing by over 40% year-over-year. In global shutter imaging sensors, we receive our for 5 key programs during the year. In Industrial, demand was also very strong through the year, especially in power & energy, factory automation and robotics and in industrial infrastructure. So what we define the B2B part of the industrial market. We continue to strengthen our processing solution leadership with our STM32 microcontroller and microprocessor families and ecosystem. We continue to win many designs in a wide range of industrial applications and to achieve record volumes and sales of STM32 products. In power and energy management applications, such as electric vehicle charging stations, photovoltaic systems,and industrial power supplies, we have many important design wins with our discrete portfolio of both silicon and wideband gas-based devices, and we further extended our product offer during the year. We progressed with sensors for industrial applications with revenue growth of around 50% year-over-year. We introduced new industrial sensors, such as the first sensor processing unit, launched together with Generation 3 MEMS sensor, as well as time time-of-flight sensors for substrate sensing application. These enabled design wins with customers in many areas, such as equipment condition monitoring, asset tracking and health care. During 2022, we introduced 80 new industrial Analog products, with our application for factory automation, motion control, metering, power tools and on appliances. In personal electronics and computer peripherals, we started to see a market softening in the second half of the year, while communication equipment demand remains solid through the year in the areas we are focused on. In Personal Electronics, in 2022, we won many projects in flagship smartphones, with motion and environmental sensors, time-of-flight charging sensors, wire products, display controllers and secure solutions. We also leveraged our broad portfolio to address high-volume personal electronics applications, such as smart watches, acts and other wearables, as well as gaming accessories from leading player in each area. In communication equipment, we progressed well with Engage Customer Program for selected applications in cellular and satellite communication infrastructure, and received new awards based on our property technologies. These were for satellite, optical and wireless infrastructure IC base on our mix signal processes and 28-nanometer FD-SOI. Let me now share a summary of our main 2022 manufacturing initiatives. We are transforming our manufacturing base to enable our future growth and drive enhanced profitability with a significant expansion of our 300-millimeter capacity and a strong focus on the wideband gap semiconductors. In silicone carbide, we are following our plans to increase tenfold the front-end capacity versus 2017 and to have 40% of our substrate need internally sourced by 2024. We continue to ramp our silicon carbide content device production in our Singapore facility on top of the Catania one, and we increased back-end manufacturing capacity in our sites in Morocco and China. We are building an integrated silicon carbide substrate manufacturing facility in Catania as an important step in our silicon carbide vertical integration strategy. Volume production is expected to start in the second half of this year. And just recently, we have produced, in Catania, the first 150-millimeter ingot of this facility. In terms of R&D activities, we have completed full MOSFET device processing using our internally produced 200-millimeter substrate. We have announced that we will cooperate with Soitec on silicon carbide substrate manufacturing technology, with an agreement to qualify Soitec's SmartFix technology,for future 200-millimeter fixed substrate production. In our 300-millimeter strategy, in 2022, we have further expanded capacity in our core front side. We also signed a MoU witrh GLOBALFOUNDRIES to create a new 300-millimeter semiconductor manufacturing facility adjacent to ST's existing facility in Crolles. In Agrate, Italy, having completed in 2022 the first industrialization line and the qualification of the engineering sample, we are on the ramping our new 300-millimeter wafer fab. We plan to have a capacity of about 1,000 wafer per week by the end of this year. These initiatives will be aligned with our sustainability strategy and our sustainable manufacturing commitment in terms of energy consumption and greenhouse gas emissions, air and water quality. We are on track to achieve our carbon neutrality in 100% renewable energy goals by 2027 as announced in December . One important contributor to our plan was the adoption in 2022 of a district cooling system in Singapore sT's single largest wafer fabrication site. We expect to eliminate 30% of the site carbon emission on completion. We also continue to work closely with external bodies and were well aware by the carbon disclosure project and included in the Dow Jones Sustainability World and Europe indices. Looking now at full year 2022 financial performance in greater detail. Net revenues increased 26.4% to $16.1 million. On a year-over-year basis, Automotive volume grew 51%, industrial was up 34%, communication equipment and computer peripherals increased 19% and personal electronics grew 2%. This performance was consistent with both end market dynamics and our strategy. We have a strong focus on automotive and industrial as a broader supplier of application specific and general purpose products targeting leadership position. Automotive represents about 33% and Industrial about 29% of our total revenues in 2022. We selectively address the personal electronics and communication equipment and computer peripherals market, targeting some leadership positions with a few differentiated products or custom solutions, complemented by our general purpose product portfolio. In 2022, Personal Electronics represented about of our total revenues, and Communication Equipment, Computer Peripherals, 11%. By customer channel, sales to OEMs and distribution represented 67% and 33%, respectively, of total revenues in 2022, similar to the split in 2021. By region of origin, 41% were from Americas, 30% from Asia Pacific and 29% from EMEA. Looking at the sales performance by product group. ADG revenues grew 37.2% on strong growth in Automotive and in Power Discrete. AMS revenues were higher by 7.1% with an increase in imaging and MEMS, partially offset by a decrease in Analog. MDG revenues increased 37.5%, with strong growth in both microcontrollers and radio frequency communication. Gross margin increased to 47.3% for 2022 compared to 41.7% for 2021, specifically driven by favorable pricing, improved product mix, QLC effect net of hedging, partially offset by deflation of manufacturing input costs. We delivered a strong increase in operating margin to 27.5% for 2022 compared to 19% in 2021. All product groups demonstrated year-over-year growth, with ADG operating margin up to 24.6% from 11.8%, AMS operating margin up to 25.2% from 22.3% and MDG operating margin up to 35% from 23.9%. Net cash from operating activities increased 70% in 2022, totaling $5.2 billion. After investing $3.52 billion in CapEx in 2022 compared to $1.83 billion in 2021, our free cash flow increased 4.1% to $1.59 billion. Cash dividends paid to stockholders in 2022 totaled $212 million. In addition, during 2022, ST executed share buybacks totaling $346 million under our current share repurchase program. ST debt financial position of $1.8 billion at December 31, 2022, reflected total liquidity of $4.52 billion and total financial debt of $2.72 billion. Now let's move to our first quarter 2023 financial outlook and our plan for the full year 2023. For the first quarter, we expect net revenues to be about $4.2 billion at the midpoint, representing year-over-year growth of about 18.5% and a sequential decrease of about 5.1%. Gross margin is expected to be about 48% at the midpoint. For 2023, based on our strong customer demand and increased manufacturing capacity, we will drive the company based on this plan for full year 2023 revenues in the range of $16.8 billion to $17.8 billion, representing growth over 2022 of about 4% to 10%. Automotive and Industrial will be the key growth drivers of our revenues in 2023. We plan to invest about $4 billion in CapEx, about 80% of this amount is mainly related to the increase of our 300-millimeter wafer fabs and silicon carbide manufacturing capacity, including our silicon carbide substrate initiative. The remaining 20% is for R&D, laboratories, manufacturing maintenance and efficiency, and our corporate sustainability initiatives. To conclude, last May at our Capital Markets Day, we shared our value proposition. This is based on sustainable and profitable growth with our $20 billion-plus revenue ambition and the related financial model. Our end market focus on Automotive and Industrial as a broadband supplier of application-specific engineered purpose products, targeting leadership positions. On electronics and communication equipment and computer peripherals, with a selective approach, targeting some leadership position with a few differentiated products or custom solutions, contributed by our general [indiscernible] portfolio, providing customers with differentiating enablers and a rollable and secure supply chain. And last but not the least, a strong commitment to sustainability. In 2022, we made important progress in all these areas and we will continue along the same pace in 2023. Congratulations for strong results and a very solid guidance. Now I'd just like to understand, given your first quarter gross margin outlook at 48%, are there any specific positive mix effects here at play that will shape out differently in the remainder of the year? I remember, Lorenzo, you said previously that we should probably look at the gross margin flat to maybe slightly up for the current year, is that still valid? And how should we think about the shape of gross margin over the year? Okay. Good morning, everybody. Thank you for the question. For the gross margin of Q1, when I look at sequentially this improvement, this is mainly driven by 2 factors, I would say. The first one is related to a positive product mix that is continuing impacting positively our revenues and our gross margin. And actually, I would say that in this first quarter, we have still some positive effect on price increase. This was mainly on some specific customer and some specific area, I would say, mainly in Automotive and partially also for some customers in the Industrial. Of course, it's not the same magnitude that we experienced last year, but still there some positive negotiations that are improving our gross margin. On the other side, of course, our gross margin is impacted by some increase also in our input cost in the manufacturing. All in all, anyway, we see this improvement in respect to the previous quarter and expect to Q4 of around 50 basis points. Moving forward, the gross margin at the midpoint of our revenue indication for the year is expected similar to the one that we had in 2022. So we are substantially confirming what I was saying also in -- during Q4. On one side, we have a positive product mix. The manufacturing productivity, we expect some improvement. In terms of pricing, we expect a substantial stability in terms of prices. So we pay price, we do not expect in the course of the year play significantly high positive or negative, as said, but to stay substantially stable. This -- all these will be offset for sure by increased input cost in our manufacturing. And then we have not to forget that we start our 300-millimeter in Agrate, that is suboptimal in terms of, let's say, volume and production this year, and this will impact for some extent, our gross margin, especially in the second part of the year. So at the end, starting from the 48%, we see as average in the year, something more similar to 47% for the total year. Excellent. And just a quick follow-up, if I may. Can you tell us how far out your current plant capacity is currently fully booked? And is the top end of your guidance range aligned with the hypothesis that you remain sold out into year-end? How does this work out? So about capacity, there is different dynamics. It is clear that we have to look now by technology and packaging clusters. It is clear that all technology which are related to Automotive and, let's say, B2B industrial. And here, I have spoken about power technology. So SiC, MOSFET, IGBT, vertical integrated power, high-voltage, low-voltage MOSFET, but as well, okay, so advanced polar driver like BCD and high-performance microcontroller on 40-nanometer, our capacity are fully booked for the year, definitively. Well, for the other one, which are more addressing personal electronics, consumer market, we are going back, okay, something we classify normal, okay? So entering the year, the capacity is well utilized but not fully booked for the year. And that's the reason why for such, let's say, market, now our lead times are improving, okay, moving forward. Congratulations on the spectacular guidance for Q1 and '23. Jean-Marc, I'd like to understand one thing on your silicon carbide business. So number one, is it clear or is it -- or did I understand correctly that you slightly raised that guidance to $1 billion to $1 billion plus? And then secondly, in that number, can you tell us a little bit about the mix between discretes versus modules? Because it seems like some of your competitors are shipping mostly modules, whereas you're shipping mostly discrete. And obviously, the value-added modules is substantially greater than the value added of discs. In other words, not comparing apples to apples, if that makes any sense. And I've got a follow-up. Thank you. Yes, I confirm that our plan for 2023 is above $1 billion. And clearly, the mix, okay, we have is mainly modules, okay? First of all, okay, with one of our main customers. And the main part of the program, okay, we have been awarded are significantly based on the [indiscernible], okay, module we have for our main business is module-related. However, as this is not a KPI, okay, we communicate in detail. But qualitatively, I can confirm to you that it is mainly on modules. Okay. Excellent. And on the second half gross margin comment that you made, Lorenzo, can you quantify the sort of start-up costs in Agrate, Catania in the gross margins? That would be helpful. Yes, in terms of start-up cost, we have 2 components, I would say. One is what is qualified startup. So it means that this cost will not hit our gross margin but will be reflected in other incoming expenses. This from an accounting standpoint, let's say, are the pure startup cost. When your fab is not yet, let's say, at a minimal capacity. This will be visible in the line other income and expenses, that actually this year will be somehow lower in respect to what we have seen in 2022 for this reason, but not impacting the gross margin. What I'm referring is in -- once the fab will be out of the startup and will start to produce, we'll be still in suboptimal situation in terms of efficiency because the volume is not yet enough to really to have wafer cost that is comparable with a full buildout of fab 300-millimeter. This will impact the second part of the year of our gross margin. But what I'm saying is that starting with 48%, the average of the year will be in the range of 47%. So it means that will not give us an opportunity to improve in respect to the first quarter, but will not be even a big detractor because at the end, the average stay in this range. All right. And maybe just one quick one for Jean-Marc. Is there anything you want to call out for the second half for personal electronics, is there a win or a loss or anything that we should be aware of when we model the business, please? Okay. So yes, maybe I will comment, okay, the full year plan, okay, we have indicated at the midpoint. Well, clearly, at the midpoint of the plan, we indicated, so $17.3 billion. It is clear that we will grow every quarter sequentially and we will grow every quarter year-on-year basis. But moving forward, okay at, let's say, suffer the base. And why, because we have to look dynamics, by product group and dynamics, by verticals. So by product group, as we said, okay, clearly, ADG and MDG will grow double digit, okay; while IMS, okay, will have let's say, slightly decrease. By end market, it is clear that on Automotive and Industrial, the company will grow and will perform better than the market we address with double-digit, driven by the high-growing application we are focusing on and by the increasing capacity, okay, we built in H2 2022 and we are building in H1 2023. On communication equipment and computer peripheral, we will grow slightly in line with the market. And clearly, here it is driven mainly by the engage customer program we have, offset by, let's say, the computer personal. Well, now in Personal Electronics, it's another dynamic year. We will have a decrease. We will, let's say, decrease our revenue, so lower definitively than the market. Why? Because we will have a change in detail in important engaged customer programs, which will be accretive on our gross margin, but with less [indiscernible]. So this is okay the dynamic, okay, we will have on the -- moving forward in 2022. This is Josh Buchalter on behalf of Matt. And congrats on the awesome results. I guess I wanted to follow up on a previous question and double-click on Industrial and Auto in particular. I mean there's widespread, I guess, concerns of macro softening. And one of your large peers earlier this week called out some weakness in digestion in industrial. I guess can you walk us through and provide a little more granularity on what gives you confidence in Industrial? And I guess also Auto, is that still benefiting from replenishment inventory like it was last quarter? Yes, okay. I think it's important to spread the industrial market into. I repeat, this is what we classify the B2B. B2B, first of all, there is power and energy. And when I have spoken about power and energy, I have spoken about the generation of energy, conversion of synergy and storage. And with the whole initiative, you have worldwide and renewable energy, okay? And in all geographies, okay, the demand for power electronics and, let's say, board controllers, encompassing microcontroller, gate driver and sensor, is huge, okay? There is absolutely no investment softening in the field of power energy. Then the second point, okay, about power energy is the main consumption of electricity in the world is related to motion, okay, but engine, water or electrical. Everywhere in the world, okay, there is an initiative, okay, to make more efficient all the engines which are connected to industry and factories. And here, the demand for power electronics, again, in terms of investors, in terms of board controllers, MCU, power electronics, is huge. This is exactly the same for factory automation and robotics, okay? So because of the shortage of talent in the world, because of the lesson learned, okay, for the post pandemic, okay, there is many, many industries which are making them more automated and asking for more robotics. Here is the same. It's also the same in the logistics, okay? The robots you need in the massive, let's say, storage infrastructure are completely with the robot, okay, asking for many microcontroller and so on and so forth. And last but not the least, you see the heavy infrastructure that you have in countries and in cities. This market is growing at the same pace in automotive, asking for power, MCUs and BCD technology for driver. Then the second part of the industrial market is more what we call the consumer one, which are battery-operated tool, okay? Because since 2, 3 years, there is an acceleration of all, let's say, professional and consumer small tools, okay, to move from thermal combustion engine base or plug-in on the grid to battery operators. Yes, here, okay, there is a softening of the market, but the expectation of customer is a restart in Q2. Except there is health care, where the volumes are less, but is in the, let's say, similar part. So here, I would like to insist that on Industrial market, you have 2 different dynamics. You have really a dynamic which is strong, the B2B, and here is driven by a transformation, so decarbonization and automation of the industry. So [indiscernible]. And there is a second dynamic which is going back to [indiscernible] suffering, which is battery operated tool, all appliances is basically the same and health care. So I don't know what the bad competitor, you refer say. But I can confirm to you, this is what we see. This is a backlog we have and this is what the customer demand is. I guess for my follow-up, I wanted to ask about silicon carbide substrates. You've seen a player -- the leading player in substrates sort of have yield issues of the last quarter or 2, it was great to hear you reiterate the confidence in 40% internal substrates over the next year. Could you just walk me through what gives you -- how can you be so confident, I guess, in your ability to, both medium term and longer term, get access to substrates, and particularly given some of your peers are going full vertical, others are going to the other end and placing bets all over the place with multiple suppliers? Would just be great to hear an update on the silicon -- your view of silicon carbide substrate supply. No, I would like to comment, okay, let's say, the planning horizon of 3 to 5 years, okay, and to confirm what is our strategy. Again, on substrate initiative, our intention, okay, was to, let's say, build an internal source in order, okay, to warranty to any customer with whom we have a strategic agreement, okay, let's say, some security of the supply chain, okay? We have seen during the past few years, okay, that some issues could occur. And one of the lessons learned we have taken, this silicon carbide is so key enabling technology for the electrification of the MOSFET and the decarbonization of the industry that we consider that, for a while, to offer strategic independence to our key customer was, let's say a key initiative of us. But then the second objective to acquire internal capability on this substrate initiative is R&D and efficiency. We want to be, let's say, not dependent in anybody to move our production to 200-millimeter. And we do not want, okay, to be dependent to anybody to insert strong innovation in our substrate initiatives. As an example, just mark technology from Soitec. So now ST will be equipped, is equipped, very soon with all this internal capability to offer strategic independence to our customers, and to drive in the safe management mode, our efficiency and innovation. So this is what we want during now and the next 5 years. So beyond this reason, okay, we will see which complementary partnership or open partnership we can do. No, ST is not a company close to partnership. I would like to recall a global foundry partnership, [indiscernible] partnership. So ST, okay, is perfectly open to any manufacturing cooperation and agreement. But it's too early to speak about that. I have 2 quick ones. The first one is on maybe microcontroller has been a big driver in 2022 and seems to be still in Q1. Can you give some color around the dynamic in microcontroller, specifically that has been constrained for the last few quarters? I mean it looks like inventories are going up significantly. So what do you see in terms of supply demand and pricing dynamic inventories for microcontrollers specifically? Even though you assume pricing to be flat on average, but it would be very interesting to have your macro controller view specifically. And the second question I had is on silicon carbide. Actually, to confirm the 40%, 4-0, subset in-house for, I think it was 2024, Jean-Marc, I was not understood your answer. I mean do you still to have 40% next year? Or it's maybe more like a 3, 5 years aspiration? And I just wanted to clarify that point. On MCU, the market remain strong overall. We have spoken about STM32, I guess, general purpose. So remain -- the market remains very strong. But overall, I have spoken then -- okay, I will give maybe some specific color. Yes, the demand, the capacity and the inventories have started to be more balanced, clearly. And the lead time are starting to reduce step-for-step in certain product family and the pricing is stable. But where we are still, let's say, capacity constraint, It's on some ultra-performing, okay, microcontroller for industrial applications, for B2B application, because of as this ultra-performing microcontroller sometimes including let's say, connectivity, security and AI are in competition with microcontroller for automotive. And basically, they are sharing the same 14-nanometer technology capacity. And here, clearly, we are still on the, let's say, important capacity saturation. Lead time, which are, let's say, quite above a normal situation. And in a certain extent, it is some allocation. For the mainstream microcontroller STM32, for the ultra-low power microcontroller STM32, we are moving step by step to a more normal situation. But I repeat, okay, with still a strong demand and in the pricing environment, which is stable. Whatever is, let's say, go-to-market channel we use. Next question, please. I think we have time for 1 or 2 questions depending on the length of the question and answer. So next question and then we will adjourn. Two or 3 questions, if I may, quickly. Jean-Marc, you've had a great guidance for the full year. And you are highlighting that in the second half that there is some mix shift with your main consumer electronics customer. So essentially, it looks like all your growth for the year is coming from the automotive industrial space. Is that correct? And I would like to understand what is exactly happening in terms -- because you mentioned in an earlier question that there is some shift happening in terms of the consumer electronics customer, in terms of the part, I'd like to understand that. And I have 1 quick follow-up. Yes, okay. What I would like to confirm, okay, that in 2023, completing, okay, the plan we disclosed to you at the midpoint. Our company will have about 70% of our revenue generated by automotive and industrial markets, and about slightly above 30% from personal electronics and communication equipment and computer peripheral. But it is perfectly aligned with in ambition that we share with you at the Capital Market Day. This is exactly what we want to do. So this, yes, I confirm, okay, in 2023, we will finish the year in the mix in terms of vertical exposure, which is a strategic target we set up, okay, at the management team during the Capital Market Day. Now the year, okay, let okay, on the personal electronics overall, moving forward along the year, we have a mix change, okay, in the important engaged customer program. Again, this mix change will translate in less revenue year-over-year, but better gross margin generation. This is what I can confirm to you, and this will happen, okay, smoothly moving forward across the year. Understood. And just a quick follow-up on manufacturing. I have -- I mean, how much of your production in '22 was 300 millimeters? And going forward, with your ramping up of Agrate, how should we look at that 300-millimeter as a percentage of your production in '23 and '24? And Jean-Marc, is it -- because there was some conversation earlier on the margin mix because of the ramp-up of the Agrate fab that there will be some negative impact on gross margin in the second half of this year, but will it be accretive in '24? Yes. Yes, definitely. Of course, in the course of this year in 2023, we will not be in scale for our 300-millimeter in Agrate, such as that it will be accretive at the level of our gross margin. Because at the end, as we said that we will end the year with the 1,000 wafer per week. Still it's too low, and you know that our priority is to grow as fast as we can in this. In 2024, our expectation is that we will start to start to be neutral to our gross margin, and then in the second part of next year to be accretive as we target to increase this capacity along the 2024. This year, no, it will not be, let's say, accretive to our gross margin. This is one of the reasons that you see that, in respect to the starting point of our gross margin in the first quarter, we have no opportunity to improve over the year. And we -- and our average for the full 2023 will be close to 47%, similar to the one that we had in 2022. Lorenzo, perhaps one for you. You normally give us an update in terms of your operating expense outlook, if you could help both in terms of first quarter as well as how you see things trending through the year. And then a quick follow-up after that, if you don't mind. In terms of expenses, net operating expenses actually in the first quarter are expected to increase in respect to our Q4 operating expenses. And this is mainly due to negative impact of the calendar because during Q4, we had, let's say, vacation at the end of the year, as you know very well, with the Christmas period. We have an increase of activity. We have also some unfavorable currency effect during -- in this quarter in respect to the previous quarter. We have also to consider that we will have a negative impact in the line other income and expenses. So there are 2 reasons for that. One, I was explaining before, is due to the start-up cost that we account in this line. And the second reason is that we do expect in the -- in Q1, a lower level of R&D income grants, let's say, due to the fact that for administrative reasons, we are not in the position to recognize, let's say, all the amount of R&D grants in Q1, most likely there will be a catch-up of these R&D grants due to the renewal of the various convention with the various authorities. So at the end, when we look at Q1, our net operating expenses, including other income expenses, should fall in the range of $900 million, $950 million. Both for the year 2023, let's say, I would say that this year will be a year quite significant, let's say, investment in terms of R&D, in terms of activity, in terms of, let's say, digitalization of our company. So we have many programs running. I would say that a midpoint, while in 2022 we enjoy a significant, let's say, leverage on our expenses, my expectation is that, let's say, in 2023, we will not enjoy a significant leverage on our expenses at the midpoint of our revenues indication. Okay. And if I could just squeeze a quick follow-up in back to the personal electronics question. If I go back to how you guys framed the outlook for '23 back at third quarter, you've given us an initial indication of growth, and you said at that time that you thought you could grow across all 3 divisions in 2023. As we start the year here in January, you're now saying no -- AMS is going to be down, driven by this reframing of the personal electronics relationship. Has something materially changed in the last few months with that, that's driving the this mix towards lower revenue but higher gross margin? It feels like it's more socket changed than any pricing dynamic because if it was pricing on a similar part, gross margin largely wouldn't move up. So is there anything more you can add to that? Here, okay, there is 2 points. Point number one is the usual, okay, seasonality of Q1 of the personal electronic overall. But this is not a surprise. And again, what I commented on the mix change, okay, with an important engaged customer program, is absolutely not a [indiscernible]. And just to clarify because we had a question from the [indiscernible], the amount of net OpEx for Q1 is $900 million to... So with this, thank you very much to all of you. I think you can end our call for this time. Ladies and gentlemen, the conference is now over. Thank you for choosing Chorus Call, and thank you for participating in the conference. You may now disconnect your lines. Goodbye.
|
EarningCall_1115
|
Good day, and welcome to the Seagate Technology Fiscal Second Quarter 2023 Conference Call. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Shanye Hudson, Senior Vice President, Investor Relations and Treasury. Please go ahead. Thank you. Good afternoon, everyone, and welcome to today's call. Joining me are Dave Mosley, Seagate's Chief Executive Officer; and Gianluca Romano, our Chief Financial Officer. We posted our earnings press release and detailed supplemental information for our second quarter fiscal 2023 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 that was filed with the SEC. 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 easily be predicted. Therefore, a reconciliation to the corresponding GAAP measures is not available without unreasonable efforts. Before we begin, I'd like to remind you that today's call contains forward-looking statements that reflect management's current views us 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 by these forward-looking statements as they are subject to risks and uncertainties associated with our business. Regarding the matter raised by the proposed charging letter from the U.S. Commerce Department's Bureau of Industry and Security, or BIS, Seagate maintains that it has complied with all relevant export control laws and regulations. We've been cooperating with BIS and engaging in discussions with BIS to seek a resolution. Please note that we won't be addressing questions regarding this matter on today's call, but we'll provide additional updates as appropriate moving forward. 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. As always, following our prepared remarks, we'll open the call up for questions. Thanks, Shayne. Good afternoon, everyone, and thanks for joining us today. Seagate delivered on what we set out to do in the December quarter, and I'm proud of our team's accomplishments amid this tough business environment. Revenue and non-GAAP EPS came in slightly above the midpoint of our guidance range and free cash flow generation increased by more than 50% quarter-over-quarter. We are managing well what is in our control and executed on the actions we outlined on our October call. We retired more than $200 million in debt, strengthening our balance sheet. We lowered operational costs by realizing a meaningful portion of the expected savings from our restructuring efforts. We reduced capital expenditures by more than 40% sequentially while still accelerating the launch and development schedules for new mass capacity products, and we adjusted our factory production output to support strong supply discipline as demand recovers. These actions, we believe, put Seagate on solid footing to weather the near-term industry dynamics while continuing to make the technology investments to meet our customers' evolving needs and thrive over the long term. Relative to market conditions, three primary external factors have been impacting our business over the past several months. The COVID-related economic slowdown in China, the work down of nearline HDD inventories among U.S. cloud and global enterprise customers under a more cautious demand environment and macro-related disruptions primarily impacting our consumer-facing markets. These factors remained at play during the December quarter and weighed heavily on the mass capacity markets, resulting in a 10% sequential decline in mass capacity revenue. Having said that, we are already seeing some encouraging indicators. Within China, we believe first steps toward recovery are being implemented through government policies aimed at improving economic conditions including the faster-than-expected reversal of zero COVID restrictions and a show of confidence following the policy shift several major banks raised their 2023 outlook for China's GDP. We expect it will take time for consumers and businesses to work through disruptions related to the COVID policy pivot and for the economy to fully reopen. Based on our customer conversations, we anticipate regional sales into the VIA and nearline markets to remain subdued in the March quarter and gradually improve as the calendar year unfolds. We will continue to monitor demand signals and expect to gain a better picture following the Lunar New Year celebrations. Turning to the U.S. cloud and enterprise markets. Customers have focused on working down the HDD inventory levels that were built up during the pandemic as non-HDD component shortages created inventory imbalances. We believe some progress has been made in recent months supported by an improvement in non-HDD component availability. While inventory adjustments are customer-by-customer event, and ongoing macro uncertainties have led to more cautious near-term buying decisions, we expect nearline sales will improve slightly in the current quarter, particularly for our high-capacity drives. Our view is supported by the ongoing adoption of our 20-plus terabyte family of nearline products, which represented close to 60% of nearline exabyte shipments in the December quarter and is expected to trend even higher in the current quarter. Relative to our products, we are seeing a wider variety of nearline capacity points and configurations being adopted across our customer base, depending on their specific data center architectures, workloads and application needs. Seagate is well equipped to address these individual unique requirements with our deep customer relationships and broad technology portfolio, spanning traditional perpendicular recording technology or PMR drives to performance-oriented dual actuator products to TCO enhancing SMR technology. In addition to our device portfolio, Seagate's Systems business offers cost-efficient, scalable petabyte solutions for both enterprise and cloud customers. While system sales were down sequentially off of a very strong September quarter, we captured a record number of new customer wins with our CORVAULT products. CORVAULT offers features such as self-healing, autonomous drive regeneration, which increases productivity while reducing electronic waste. The momentum that we're seeing across the systems business supports revenue to move higher in fiscal 2023. Our strong product pipeline is underpinned by the technology advancements we're bringing to market. We are leveraging our technology leadership to scale drive capacities through aerial density gains rather than additional heads and disks. As a result, we can deliver our trademark TCO advantages to customers with attractive margin opportunities for Seagate. Our 20-terabyte product features 2 terabyte per disk capacities and we have started to ramp the volume of 22 terabyte products deployed on 2.2 terabyte per disk capacities. The 20-plus terabyte platform is based on traditional PMR technology. And some customers are choosing to enable SMR technology as an additional feature that slightly increases the drives capacity for certain applications. In the December quarter, about 35% of our nearline exabyte shipments were deployed as SMR drives. We are executing plans to deliver another 10% gain in per disk capacity for this PMR platform to offer drives in the mid- to upper 20 terabyte range. However, I'm most excited made on our HAMR technology. It was nearly four years ago to the day that I first shared our lab results demonstrating 3 byte per disk capacity. And today, we have demonstrated capacities of 5 terabytes per disc in our recording physics labs. In the current market environment, we've been taking advantage of our reduced factory utilization to accelerate cycles of learning around HAMR productization. We are meeting or exceeding all product development milestones and reliability metrics, and we will be shipping prequalification units to key cloud customers in the coming weeks. As a result of this progress, we now expect to launch our 30-plus terabyte platform in the June quarter, slightly ahead of schedule. The speed of the initial HAMR volume ramp will depend on a number of factors, including product yields and customer qualification time lines. However, we plan to use our systems business to quicken the pace of learning and time to yield. Our tremendous progress reinforces my confidence in HAMR products and our ability to execute. These innovations were only possible through the hard work and dedication of our global team, and I would like to thank them for their many efforts. Our multi-decade focus on HAMR R&D and our innovation across all facets of drive production have resulted in a development advantage that we believe is measured in years, and we're excited by our collaborations with customers on HAMR capabilities. The technology innovations driving aerial density higher will deliver strong and consistent cost reductions at the highest drive capacities and enable future cost-efficient refreshes of our midrange capacity drives. We believe these products serve as the foundation to expand our margin profile back into and possibly beyond the long-term target range. Wrapping up, Seagate is executing with speed and agility through the near-term macro challenges. We've made meaningful improvements to our cost structure and balance sheet while steadily advancing our product and technology road maps. With signs starting to emerge that market conditions could improve as we progress through the calendar year, Seagate is well positioned with an industry-leading mass capacity portfolio that we believe supports the return to our long-term financial model over time. Thank you, Dave. Seagate is navigating through the near-term macroeconomic cross-currents and executed to plan in the December quarter. We delivered top and bottom line results that came in slightly above the midpoint of our guidance ranges, revenue of $1.89 billion and non-GAAP earnings of $0.16 per share. Our actions to reduce costs, strengthen the balance sheet and improve long-term profitability have yielded desired outcomes, including a continuation of positive free cash flow generation, without sacrificing investment necessary to extend our technology leadership. Total hard disk drive shipments were 113 exabytes in the December quarter, down 5% quarter-over-quarter, with HDD revenue declining 6% sequentially to $1.7 billion. Multiple factors led to an expected decline in the mass capacity business, including the inventory correction among cloud and enterprise customers, COVID-related disruption in China and Seagate own action to reduce production. Mass capacity sales were offset by a slight seasonal improvement in the legacy market. Shipment into mass capacity markets totaled 97 exabytes, down 7% quarter-over-quarter. Of this total, roughly 82% were derived from nearline products, shifting to cloud and enterprise OEM customers. Nearline shipments of 80 exabytes were down 6% sequentially and roughly 30% of our recent high. We believe the actions we have taken to quickly adjust our production output have aided customers to start making progress in working down their inventory levels. The degree of progress vary from customer to customer and notwithstanding the current macroeconomic uncertainties, we would expect it will take a few more months to reach more normalized inventory level across the customer base. On a revenue basis, mass capacity sales were down 10% sequentially to $1.2 billion, reflecting the nearline trend that I just described as well as lower demand in the VIA market. As we expected, the prolonged economic slowdown in China continued to impact sales of our VIA products, and we did not see the typical seasonal pickup in sales during the December quarter. As Dave mentioned earlier, the Chinese government is taking action to boost the country economy, including the rapid reversal of COVID policy restriction. It will take time for these changes to take effect. And while still early, emerging customer dialogue support these encouraging leading indicators. As a result, we anticipate conditions to gradually improve over the next couple of quarters. Within the legacy market, revenue was $421 million, up 8% sequentially, primarily driven by a seasonal uptick in consumer demand, although a more subdued level compared to prior year. Finally, revenue for our non-HDD business was $224 million, down 15% sequentially, reflecting the expected decline in our enterprise system business following a very strong September quarter. Overall, we are making great strides in growing the system business, increasing sales of our branded channel products and building customer momentum with our CORVAULT self-healing technology. While we are continuing to navigate lingering supply constraint for a couple of system components, we expect non-HDD revenue to improve through the remainder of the fiscal year. Moving to our operational performance. Non-GAAP gross profit in the December quarter was $403 million. Embedded in that figure are the underutilization costs associated with lowering production output to support inventory reduction, both as a customer and on our own balance sheet. Underutilization costs of $79 million were somewhat higher than we had projected at the onset of the December quarter and translated into a 420 basis point of margin headwind. Accounting for risk costs, non-GAAP gross margin was 21.4%, down from 24.5% in the prior quarter. Based on our current outlook, we are planning to begin ramping production output in the March quarter, sometime after the Lunar New Year. Cost and efficiencies associated with restarting and ramping of production are expected to largely offset the benefit of lower underutilization costs for the March quarter. However, as demand recovers in the coming quarters, we expect both gross profit and gross margin to move higher. We significantly reduced non-GAAP operating expenses to $294 million, down $20 million quarter-over-quarter due to savings associated with our restructuring plans and proactive expense management. We expect quarterly non-GAAP OpEx to remain around the $300 million level through the balance of the fiscal year 2023. Moving on to the balance sheet and cash flow. We executed planning action to strengthen our balance sheet over the near term. We ended the December quarter with a liquidity level of approximately $2.5 billion, including our revolving credit facilities, flat with the prior quarter. We believe these levels are sufficient to support our strategic plans and meet customer demand. We drove a significant reduction in inventory to approximately $1.2 billion, down $400 million from the prior quarter, reflecting our effort to work down strategic inventory and finished goods. We expect inventory to remain around this level over the next couple of quarters, but we'll continue to focus on aligning our supply chain and finished good level to the prevailing demand environment. We reduced capital expenditures to $79 million, down 41% quarter-over-quarter. CapEx is expected to trend lower through the second half of the fiscal year with total fiscal year expenditure below the long-term target range of 4% to 6% of revenue. Free cash flow generation was $172 million, up 54% sequentially with lower capital expenditure and a $51 million improvement in working capital. We expect free cash flow to remain positive throughout calendar year 2023 and more than sufficient to support our dividend program. We used $145 million for the quarterly dividend. And as previously communicated, we paused our share repurchase program, exiting the quarter with 206 million shares outstanding. We are not currently planning to repurchase any share for the balance of the fiscal year, consistent with our near-term focus on optimizing cash flow through the current macro environment. Returning capital to shareholders remains an important aspect of our financial model, and we will assess resuming our program in fiscal 2024, depending on business conditions. We lowered overall debt by approximately $220 million, largely through a debt exchange, requiring minimal cash outlay. Additional, we successfully renegotiated our debt covenants to temporarily increase the leverage ratio to 5x. Our debt balance exiting the quarter was $6 billion, and adjusted EBITDA for the last 12 months totaled $1.6 billion, resulting in a gross debt leverage ratio of 3.8x. Interest expense in the December quarter was $77 million and is expected to be approximately $82 million for the March quarter, reflecting higher interest rate associated with the new debt. We continue to evaluate options related to debt structure and reducing interest expense. Turning to our outlook for the March quarter. The broader macroeconomic and geopolitical uncertainties continue to impact the business environment and shape of recovery. However, as indicated earlier, we are encouraged by the actions being taken to improve economic condition in Asia and the early indication with cloud and enterprise customer inventory levels are trending lower. As a result, we expect March quarter revenue to be in the range of $2 billion, plus or minus $150 million, up about 6% quarter-over-quarter at the midpoint. We project incremental improvement in the mass capacity business from cloud and enterprise customers and higher system sales to offset seasonally decline in the legacy market. At the midpoint of our revenue guidance, we expect non-GAAP operating margin to be in the mid- to upper single-digit range, which includes both underutilization costs and inefficiencies associated with the resuming production output. And we expect non-GAAP EPS to be in the range of $0.25, plus or minus $0.20. Thanks, Gianluca. Seagate continues to demonstrate resilience in the most dynamic of times. We are executing on what is within our control, generating positive free cash flow and advancing our product road map. As I indicated earlier, we expect mass capacity market conditions to gradually improve as we progress through the calendar year, which supports stronger revenue and profitability in the back half of 2023. Longer term, we remain excited by the secular trends driving demand for mass capacity storage, and Seagate unique capabilities to capture these future growth opportunities. We are leveraging our aerial density leadership to increase capacity per disk, which we believe enables the most cost-efficient product solutions for mass capacity storage. We will begin shipping products based on 3-plus terabyte per disk capacities in the coming months, which is up to 35% more than comparable drive capacities available today. Amid a challenging macro and industry backdrop, I'm incredibly proud of the partnerships and hard work from our suppliers, customers and our employees. Earlier this week, we published our fourth annual diversity, equity and inclusion report, which highlights how Seagate aims to build and support its global team. The principles outlined in this report are foundational to Seagate's technology innovations and long-term success. I encourage you to read the report in full on our website. I will conclude by thanking our shareholders for your ongoing support. Our objective remains taking the decisive steps to best position Seagate for long-term value creation. My first question is just on the nearline market. You're talking about a slight recovery from a unit perspective in the March quarter, you may refer to exabytes. I guess you could clarify that first? And then can you just talk about what you're seeing there that gives you the confidence that, that's inflecting. In the December quarter, clearly, you saw other mass capacity accelerate pretty robustly based on the numbers you gave. But what are you seeing on the nearline side? And what gives you the confidence that the March and June quarters are going to be sequentially higher? Yes. Thanks, Tom. So it's a fairly tricky math, I think, is coming off of the back of last summer, where things we're going down, we actually turned off our factories and particularly biased ourselves against the older generation programs, and we're really more biased towards the higher capacity points of the 20 terabytes and so on, right? So there is -- I won't talk about units, but we'll talk about exabytes. We think that there's going to be some exabyte growth and that will flow through into revenue. It's still a fairly low time right now, historically, of course, but we are seeing traction, and we are having discussions with customers about what exactly they need. I think the way I think about the CSPs is there's very different business models across the CSPs. And even within each CSP, there's different application spaces and workloads and therefore, inventory, I'd say it that way. So it's fairly tricky. But what we really want to do is make sure that we're not building too much of the old products and really biasing towards the new products. I think to the extent that we have good visibility into the stuff that the CSPs are actually building through then that's what gets us the confidence towards a recovery in the second half of the calendar year. And then my second one is for Gianluca. You described, I think, $79 million of underutilization cost in the December quarter. When you look at the midpoint, I kind of know where guidance is, I'm getting gross margins slightly up, but you would expect with a better revenue, maybe a little more leverage. Can you just talk -- you talked about some costs associated with ramping up the factory post Lunar New Year. Would those costs kind of offset the comedown in underutilization costs? Just walk me through the puts and takes there, so I understand the gross margin implication? Thank you, Tom. Yes, the March quarter is a bit complicated from a cost standpoint because we are starting the quarter with a fairly low level of production, so we will generate underutilization cost for the month of January and maybe also a little bit of February. After that, we will start ramping production. That is a good news. But for who is familiar with manufacturing, they know that ramping production has some inefficiencies. Now you need to restart the line, you need to recover those equipment, you have some additional scrap, lower yield. So for the first few weeks of a reramp has some costs associated. So when we put the two costs together, right now, we are assuming to come out fairly similar in terms of additional onetime cost of what we had in December. The improving the gross margin, of course, is coming from the VIA revenue and a little bit better level of production. This is Eddie for Krish. Congrats on the strong results. [Indiscernible] is more short-term. First, your deals on HDD exabyte shipments were down year-over-year and Q2 well below the structural growth rate of 30%. At what point do you expect year-over-year growth above thisâ¦? Your exabyte shipments were down nearly 30% year-over-year and Q4. At what point do you expect that growth rate to turn positive year-over-year? I think I understood, and we'll go from here. The underutilization charges are the ones that are hurting us the most, I'll say, relative to turning of our factories and things like that. From my perspective, we're going to -- we took down the factories intentionally to make sure that didnât build too much of the old stuff. So it's a 16 terabytes or 18 terabytes that where people are still consuming and then we're focused more on 20s and 22s and 24s and 30s and so on and so forth, like we talked about in the script. And that fills back up the factory. So I think that's the answer. You get more exabytes out and it's a better financial return as well. I think that answers your question. Yes. And do you guys have any color on when we should expect HAMR manufacturing yields to become close to corporate average? Is second half of calendar '23 reasonable? Yes. I won't speculate on that right now other than I'll say that we're now in a position on HAMR that, that's exactly the problem we're working. No longer is it a question of whether or not the technology is viable, the parts that are out of the oven. And from our perspective, this is what we do really well as well, which has ramped high-volume production. We've got everybody and the team is focused on it, and we'll get there as fast as we possibly can. Dave, just for you, great to see confidence in the June HAMR launch. I'd love to know just kind of what the feedback is that you're getting from prospective customers. Clearly, we're in a more cautious macro environment we've heard the term like optimizing cloud spend more often. And so is this a technology and a capacity size that they're really pushing for now despite the slowdown that we're seeing in the market? Or are there other factors driving the timing of the launch? I would just love if you could unpackage that question. Yes. Thanks, Erik. I would say that the onus is really on us. It's a control of ours to make sure that we can drive the transition exactly to Eddy's question about get the yields up and get the production capability to where we want it. I like to think that somebody making a decision to build out a data center would much rather have a drive with 3x terabytes instead of 2x terabytes. And because that's such a great TCO proposition for them over the long haul. We have deep customer relationships, obviously, on this front. This is not a surprise to them. The results that we're showing in our labs are not a surprise either. So they're very well connected with us on it. Where their spending profile might be muted, say, in the first half of this year because of all the issues that CSPs are going through, and they've shared some of those with us and they're the tough problems themselves. I do think that the secular demand for mass capacity in those data centers is still going to be huge. And we want to make sure that we're staging the absolute best value proposition for us and for when we get there. So it's really ours to go drive. Super. That's really helpful. And then Dave or Gianluca, I'm not sure. Can you just remind us exactly how we should think about the potential margin impact of launching HAMR and ramping that platform just as we think about, again, the next 12 months? And that's it for me. Yes. Thanks, Eric. I'll pass it over to Gianluca in a second, but it really does come down to yields and scrap. I mean, we're going to be targeting most of this at the highest capacity points, although there are opportunities in lower capacity points if we can take disks and heads out of already existing platforms in the 20s or teens, then we'll go do it. And we have to go work that through qualifications with our customers. That's how we get margin oxygen, if you will, back into the system. And so yields, scrap, our ability to go through the cycles inside of our factory, that those are the relevant parameters. Yes, and more new products. So we need to go ova little bit of the learning curve, something different from what we have done in the last several years. But as Dave said, Seagate is very good in the operation, in manufacturing. And therefore, we are very confident now we can have very good results, results that at a certain point will be similar to the PMR, but exactly when it's a bit difficult to say right now. So we are going step by step. But we are actually growing faster than what we were expecting. And as Dave said, we are ready for launching the product in the June quarter, but is a little bit before what we were discussing just three months ago. Yes, I think the data coming out of -- just to pile on a little bit. The data coming out of the labs is really good, really encouraging. And to stave off some other comments or something that I would say that there's -- while there's added features in a HAMR drive versus a garden-variety PMR drive. Even PMR drives are fairly complicated themselves, there's no tectonic shift that causes major cost resets or things like that. There's things we have to go work, and that's what we do really well. We've worked these kinds of things over time to make sure we can stage other technology transitions, and we're all over this. We've been planning this for a long time. Yes. Two questions, if I may. As it relates to the March quarter guide, it's great to see an improvement in revenue in March because seasonality is usually down a few points. But of course, nothing is seasonal at this point in time. But I guess, as it relates to that, you spoke about improvement within nearline. And so two-part questions to that. I guess, are cloud customers increasing or LTA baseline orders today going into March? And then second, are you beginning to see cloud customers procure orders for HAMR, would say, new or existing LTAs because I'm also curious how you look for signposts regarding the uplift of HAMR demand in anticipation of your launch? It's a really interesting question, Karl. Let me try it this way. Usually, when supply is behind demand considerably, then you're having LTA discussions. But I think in the case of this, obviously, our suppliers have got challenges, we've got challenges. Even our customers have challenges. So I think it's really an entire supply chain that needs to co-plan together. And we've -- demand is low right now. There's plenty of supply. But I think we're all very mindful of cash and mindful of the financial outcomes that we want. Indeed, we are having LTA discussions still. The levels of the LTAs may not be reminiscent of what they were when you had demand for above supply. But I think the predictability is what we need to keep our factories running, to keep our people employed, getting paid and actually keeping the reinvestment so that we're out there with the right products and the right costs in those right times. Specifically to your HAMR question, I would say the answer is no at this point, but I think we could get there soon where we say HAMR is -- this is the volume ramp of HAMR at this customer, and then that becomes part of the LTA, but we're not there yet. We will have to go through the call. And then after the call, we start discussing about volumes with customers and eventually doing LTAs. Understood. Thank you. If I may ask one more. I was -- one of the impression, your SMR drives were closer to 25% of your mix, you're suggesting it's close to 35% of your mix today, which is quite impressive. So I'm hoping you could discuss what sequential improvement you've seen in SMR drives this quarter and whether you are seeing better economics within this area of mass capacity? Yes, thanks. I think there's a lot of confusion in the space on this, so let me try this. We've been shipping SMR since I think 2014, into the cloud. We also have shipped hundreds of millions of SMR drives on the client side. So SMR is a great technology add. If you can adopt it for very specific cloud applications, it can be quite complex. And so some places, people choose not to do it. Redeployment of drives, for example, from application becomes limited or there's a lot of inertia around it if you try to do that. So we have great SMR solutions. We've been working on this for years and years and years. If customers ask and if their applications desire, then we'll go there for them. And so I really look at this as a customer by customer, sometimes application by application, specific ask for, say, a business unit or something like that, and we just react to it. And that's I don't think there's any big shift towards more SMR out of the Seagate portfolio. I think there are customers who, over time, are adopting more SMR, so that may be part of the reason for the trend that you talked about. But it's not something that's, I'll say, deliberately being pushed on our front. We look at it more as letâs just solve the problem for the customer. Yes, I would say on a quarterly basis, the percentage change based on the mix of our customers. So depending in which quarter, one customer can be a bit higher than another one, we can have a bit more SMR or less. But for us, as Dave said, we have both is actually a fairly easy way for us to convert the PMR into an SMR. So just a matter of where the demand is in the specific quarter. Yes, two if I can as well. I guess the first question, you mentioned, obviously, in the numbers that you're shipping about 30% below what was the peak level seen a year or so ago. As we think about the efforts that you've made on rationalizing your production capacity, is there any way to gauge how we could think about what kind of fully utilization looks like on an exabyte ship basis as we move forward? Just trying to think about the trajectory based on that number relative to gross margin? What's kind of the capacity footprint that you guys have normalized to now? Yes. Hi, Aaron, I think there's a couple of different answers to that question. Obviously, from an equipment perspective, all the equipment is still there. As a matter of fact, as we go through transitions to say, 2.2 terabyte per disk or 2.4 terawatt per disk to a 3 terabyte per disk, we get a lot more efficient out of our parts that we have accessible to us and out of that same equipment, some penalties with process content. But generally speaking, our capacity footprint goes up. In the current -- to directly answer your question in the current state, we did have to scale back in our factories, and that will take just a little bit of time, not a lot of time to scale back up because that's about people. It's been a tremendously painful time for our people, for the people in the supply chain for the people and the customers for that matter. So I would say that our theoretical capacity is still as high as it is, but we can't react on a dime to go get there. We need to plan for it. And once upon a time, we did 165 exabytes. We could get back there fairly with all the technology transitions, we can also go beyond. Yes, yes. That's helpful. And then as a quick follow-up. I think last quarter with the headcount reduction effort, you had talked about I think it was getting to realizing the annualized expense savings of about $110 million starting in this current quarter. How do we think about the effect of that on a net basis in this current fiscal quarter? Yes. We realized a big part of that saving already starting in the December quarter, as we were discussing beginning of November. The majority of our restructuring actually happened at the beginning of November. So we had basically two full months out of the three where we could take the benefit of the cost reduction. And now in OpEx, there are always few other items that impact the cost of the quarter. In the script, I said we expect this quarter and even next quarter to still be around the $300 million. This is Jason on for Tim from UBS. I have a couple of questions. So the first question is on December quarter. Sorry if I missed, but I see that there's about $100 million purchase order cancellation fees in December quarter. Could you guys help us understand what that line item really is? And also, would there be any possibility of this repeating in a similar magnitude next couple of quarters if demand remains weak? And I have a follow-up. Yes. That is really through our reduction in production. Of course, we had some commitment with some of our suppliers that, of course, we want to comply with. So on those cases, we had to stay for take-or-pay products that we didn't need, and we decided not to take based on our focus on reducing our own inventory on top of reducing customer inventory. I think we have taken all those liabilities into the December quarter. So I don't expect at this point this those liabilities to come back in the March quarter. Got it. Yes. My second question is on your debt paydown schedule and cash level. So on the back of your recent debt exchange, how are you guys thinking about the pace and magnitude of debt pay down in the next few quarters? And in light of that, how can we think about the new cash level you guys are comfortable operating under going forward? Yes, we are generating still a fairly strong free cash flow. In the December quarter, we generated $170 million, I think this quarter will be higher than that. We have note that will mature at the beginning of June that we want to repay and we will not refinance, that is about $540 million. So we will use our cash. We have actions going on to optimize our cash between now and June. But I would say, right now, our focus is actually on reducing the debt and reducing the full amount of those notes. Congrats on pulling in the launch schedule of HAMR drives. A couple of questions here. How are you thinking about the adoption of HAMR drives in the back half of the year into '24? Is it more broad-based? Or is it focused on a few customers -- and I know it's early, but do you expect -- when do you expect unit or exabyte crossover for HAMR drives? And lastly, on this subject, just to be clear, are you planning to dual track with PMR products in the 30-terabyte range? And then I have a follow-up question. I appreciate all the positive momentum that's going on. It really -- there's a lot of people inside of our company and outside of our company that deserve accolades here making this technology work believed in it for the last 20 years and so on. And I think it's great that the world is going to be able to double nasty points and things like that over time. I've got a lot of confidence based on where we sit right now. We're not talking about exactly what the schedule is going to be, but we're going to be as aggressive as we possibly can. Specifically to your question, yes, I think the first drives will probably go out into a couple of different channels, some we can control like we've talked about maybe using our systems business in the prepared remarks. And then some big customers are -- want to be early adopters so that they understand the technology and what to take. It's I would say at the highest capacity point, the integration always the trickiest because these are things that the world has never seen before. To the extent we can turn around and make cheaper capacity points that are midrange like 20 or 16 or whatever they happen to be because we have fewer heads and disks in them. That's a great answer for us as well, and we'll get working on that. So I don't think the once we get out the heads and disks, I think we'll be able to find homes for them, and we're going to be very, very aggressive on the ramp over the next few years. Okay. Maybe a follow-up question. You and your competitors have both in quite in terms of production cost in this down cycle. Curious if you're seeing any less rational behavior in terms of pricing given the high level of inventory in the channel and the customers in the December quarter, but more importantly, going forward, do you think the pricing environment will still be okay? Yes, I do think the way to control the long-term outcome, the best is to cut your production and make sure you're not pushing out too much of the wrong stuff. I'm encouraged to see the way that the industry is actually behaving on that front. I don't -- to your point, I don't look at things like market share and any individual deals as long-term trends at this point in time. I think it's more just what discipline does the industry have. And I do think that over the long haul, especially for Seagate, I can speak, having the ability to go add a better value proposition, lower our costs and so on and so forth. I think we use that to think about how do we get back into our margin range or beyond. Hi, Dave, and Gianluca. Great quarter and a good control on the inventory side. Just a quick question on how you see broad inventories in the channel. Like if you look at China and U.S. enterprise hyperscale, any thoughts on where inventories are broadly? Yes. I think we said that we -- from our vantage point, the inventories at hyperscalers generally went down or the right directions, and we were encouraged by it. I mean, obviously, we'd like to see it faster because we'd like to ramp our factories back up quicker. I think it would help us. And then, of course, our owned inventory, what we were able to do by not putting anything out, especially the legacy capacity points, I'll say, in the nearline space, we're not putting anything else out into the market that's encouraging as well. I think from a distribution weeks on hand, it's high, but not super high historically. And you all know that depending on how you're measuring it 4 weeks or 13 weeks, it could be it's really based on a baseline. And I think that, that baseline now has become this macroeconomic reality. I do think that as we started to see some kind of macroeconomic recovery in certain geos, Europe, Asia and so on. The absolute value of the inventory is not super high. And so it's not a whole lot of weeks on hand. And I think there, again, we could react to that. So I'm not super worried about the inventory there. Great. And you mentioned HAMR ramping here. Good to see that. A exit the year, any thoughts on what that mix would be of your mass capacity at nearline of revenues or units? Yes. We haven't really talked about it. I think this year, it will probably still be relatively low. And then the faster we can get the yields in scrap and all the costs that we can control down on the heads and media then the faster will be accelerating. I think that will happen in calendar year '24 and calendar year '25 will just continue to accelerate. The highest capacity points will be addressed, but also these midrange capacity points. And how successful we are with all that stuff we'll determine how broadly we can penetrate all those different individual market. Two quick ones, if I could. Just going back to Aaron's question, Dave and Gianluca on the utilization. So Dave, you said you're 30% below peak your gross margins are actually down 30% from that same peak. Is that a coincidence because pricing has been stable? Or is it really sort of that simple? And then I guess the ramp back up kind of higher cap drives sort of takes up more capacity. And so is it really as simple as on sort of the ramp back up sort of the same indexing on capacity ship, is like a little bit more of a slope up, just given the mix? And I have a quick follow-up after that. Well, I would say, for sure, the majority of the gross margin decline is coming from the underutilization charges, so the lower level of production that we have. Last quarter, we were discussing it a bit about some price pressure in the low-capacity drive. But we have seen a little bit in the quarter of December. But in general, especially considering that we see a fairly strong down cycle. We are -- in terms of pricing stability, we see this as a positive. And we expect as soon as we are back into the same level of production and same level of revenue we had a year ago, we think our gross margin will be at the same level or even better. Gianluca, is it -- can we kind of model the gross margin more or less calibrated with where we see capacity increases to be going forward? Okay. Cool. And then just a real quick follow-up. $300 million OpEx through the June quarter, how do you want us to think about modeling out past that, the puts and takes? But we are staring to discuss about the next fiscal year, but I would say part of the lower OpEx is coming from variable compensation that is very low in the current fiscal year. So you will have to think about adding some cost for variable compensation in the fiscal '24. Yes. I think Ananda, we reacted, obviously, very early on some of this when we saw it. And I think we're going to be asking the same kinds of questions throughout the course of this year, what's the new trajectory, the new normal, if you can. When some of the normal demand cycle comes back, where is the world from an economics perspective and we'll address factory footprint and things like that when those times come. I apologize jumping across calls if this has already been answered. But I'm wondering if you could talk a little bit about the trajectory that you see in exabyte growth. It's kind of been a little bit all over the place given so many moving pieces with both demand slowdown as well as inventory and if you could maybe calibrate for calendar '23, that would be great? Yes. It depends also, if you where you reset to. I think we've taken a big step down, of course, and then we could talk way back on the 30% growth. I don't -- I think it's a little too early to tell that. But we do think that by the fact that we're putting out 24 terabytes and 30 terabytes and so on and so forth, that's going to help the exabyte growth substantially. I think a couple of years ago, we were at 80-some percent from nearline drive. So that was reflective of not only high great value proposition from 1 capacity point to another, say, maybe 25% bump in capacity point, but also the fact that a lot of people are investing at the time. I do think that the demand side for data is still there. There's AI, machine learning, a lot of new applications coming. I think we're going through something that's fairly temporary where people are just getting their legs underneath them and then they'll figure out what their investment profiles are. And our job is to go put a better value proposition from an exabyte perspective out there in front of them to kind of incentivize that. So we do think the back half of this year gets better from an exabyte perspective. I don't -- maybe a little early to tell exactly what the number is. And maybe you already covered this, but if you wouldn't mind, if you have covered it, then we don't need to go in. But I was wondering if you could address if there's anything abnormal that you're seeing within pricing in the competitive environment, is there especially within the channel, anything that you're seeing that might be abnormal? And when do you think if there is something when that would normalize? At a macro level, no, I think everybody is seeing about the same demand environment. People are reacting fairly similarly, making sure they're preserving their cash, not building things that they're uncertainty of going out into the market. And so I think the industry has actually done a pretty good job of scaling way back over the last three, four, five months on our production capacity. It's very, very painful for ourselves and our suppliers, of course. But -- and our customers, I think I said this earlier, our customers understand that. But at a macro level, I don't see that. I don't see people building too much of the wrong stuff and trying to get into the market. There may be little pockets. But again, big picture, I don't think that's super relevant. Maybe just first, within the context of recent export restrictions and macro headwinds in China, I'm curious if you have -- if you can share any color on your TAM assumptions for the VIA market, both in the near term and longer term, which I believe you previously said the longer-term market outlook remains intact, but just curious on those dynamics? Yes, I'll start and I'll let Gianluca speak as well. I think the VIA market is changing quite a bit globally. There's a lot of applications A few years ago, we would have talked about surveillance. Now there's a lot of applications about consumer behavior and inventory management. A lot of people are worried about inventory. And so -- the people are using all these new, say, smart edge applications in a very creative way. So globally, it's an exciting market. I think the drivers in China, in particular, over time that's been very muted for the last year, and we were kind of waiting for a recovery. And I think the recovery just hasn't come. I think it will recover, but it's going to be slow. And I think there's new opportunities around the world in various geos as well happening. In the very short term, we see possibly a decline in the March quarter, mainly because of seasonality. March is always the quarter where we have the lower revenue from VIA and from some of the legacy markets also. So not a lot of increase in the short term. But in our view, the rest of the calendar year, we should see sequential improvement. And VIA is an important segment for us. And in a segment that is also generally generating a very good gross margin. Great. That's very helpful. And then maybe just a follow-up. Within the context of the operating margin target that you outlined last year, 18% to 22%, assuming this is still the right framework, can you just walk us through some of the levers and the time line for reaching that range and maybe thoughts on medium- to longer-term OpEx growth or intensity within that context? Yes. I think to find the long-term demand, we're still kind of assessing that. So I won't be -- I won't predict it just yet. But I will say that this management team's goal to get back in those models as fast as we possibly can. Obviously, demand is the fundamental driver to that. We've made operational improvements by cost reductions. And we've, unfortunately, had to cut some things that we're working on. So there is a reason to suggest that we have a little bit more oxygen than we had going into this thing. But I think fundamentally, it will still be the demand driver. And one of the reasons we're trying to transition products is as aggressively as we can is because we think we intercept that demand with a better value proposition that comes back to us faster, but we also go off and work our own internal operational metrics and then we get the best cost at the time, and that helps as well. Gianluca, could you discuss how you're thinking about working capital for the second half of the year? Our inventory days came down pretty substantially. Obviously, if you took production down. But they're still above the year ago levels. And then as you launch HAMR, is there anything we should consider within that number? And then I have a follow-up. Yes. In the December quarter, our working capital was positive by about $50 million. We decreased our inventory by a lot, but we also paid a lot to our suppliers. So I think that is part of the positive working capital that will actually impact the March quarter. And after that, probably is fairly stable for at least a couple of quarters. . Okay. And then, Dave, you kind of touched on this in a prior question, but AI has become a much more common topic in the last few weeks. And I'm wondering how Seagate thinks about that opportunity, not just from data creation, but your product lineup? And is this coming up in customer conversations? Is it something that they're asking for your help on? Yes. Thanks, Ashley. So it's underneath all of the demand for data growth that we see, I think this is 1 of the big trends that we're watching because it affects not only what's going on in the cloud, but it also affects what's happening at the edge. And so that -- I do think that over the long haul, we're very bullish on this. If you think about it, early days of AI or training models and things like that, that needed access to big data sets. But I think as time goes on, big data sets have to be very real time to make decisions that are relevant in the moment. And sometimes they need to be kept at the edge because you have a lot of video data, for example, at the edge to make good decisions on consumer behavior or inventory, like I talked about before, all these new applications that are coming. So our customers are quite excited about it. The good news, and I've been saying this for the last couple of years is that I see a lot of innovation that's happening on that front because of the unsure footing that a lot of people have in the macro condition, people aren't really leaning into it, but I really look forward to the days that they are and these applications come online because I think it's going to contribute a lot to the data growth. Just following up on some of the questions on pricing. I understand that controlling production is a way to get back over time to your utilization rates and gross margin target. But is the price decline in NAND that we've seen recently impacting some of the pricing that you're looking at for HDDs? Or is there basically a possibility of share shift toward demand given the pricing that net is undertaking currently? And how do you react to that? Tristan, I think that back in the day that the legacy markets went through some transitions because of this. There may be some happening in the consumer markets, that's relatively small. The impact is relatively small. We still have a pretty good value proposition in the consumer markets as well. In the mass capacity markets not really. I mean I think the people running big mass capacity rigs either they understand both technologies and they use both technologies. They're not really making a trade-off of one versus the other. I think NAND, we can all see that the business is tough over there. I think everybody is in tough shape and I feel for some of those guys because the world needs their technology, I think we need their technology as well to make sure that they do their part and the layers they're relevant in, but I don't think it affects mass capacity long term. And this will conclude our question-and-answer session. I'd like to turn the conference back over to management for any closing remarks. Thanks, Cole. As you heard today, Seagate is acting with speed and agility to manage through a tough near-term market environment. At the same time, we're executing our strong mass capacity product road map that makes us well positioned to enhance customers' value and Seagate's financial performance. I'd just like to close by thanking all of our stakeholders for their ongoing support, and thanks for joining us today.
|
EarningCall_1116
|
Good morning, ladies and gentlemen, and welcome to Trustmark Corporation's Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation this morning, there will be a question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded Good morning. I'd like to remind everyone that a copy of our fourth quarter earnings release, as well as the slide presentation that we will discuss this morning, is available on the Investor Relations section of our website at Trustmark.com. During the course of our call, management may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We would like to caution you that these forward-looking statements may differ materially from actual results due to a number of risks and uncertainties, which are outlined in our earnings release, and our other filings with the Securities and Exchange Commission. Thank you, Joey, and good morning, everyone. Thank you for joining us. With me this morning are Tom Owens, our Chief Financial Officer, Barry Harvey, our Chief Credit and Operations Officer, and Tom Chambers, our Chief accounting officer. Trustmark had a solid fourth quarter, as reflected by record loan growth, expansion of the net interest margin, solid performance in our insurance and wealth management businesses, and strong credit quality. As we previously disclosed, Trustmark agreed to a settlement that, pending court approval, will resolve all current and potential future claims relating to litigation involving the Stanford Financial Group that began in 2009. In the fourth quarter, Trustmark recognized litigation settlement expense of $100.75 million. With this charge, Trustmark reported a fourth quarter net loss of $34.1 million or $0.56 per diluted share. The settlement reduced fourth quarter net income by $75.6 million or $1.24 per diluted share. For the full year, Trustmarkâs net income totaled $71.9 million, representing diluted earnings per share of $1.17. We believe the settlement is in the best interest of Trustmark and our shareholders as it eliminates risk, ongoing expense, and uncertainty. With this issue behind us, we're focused on the future and the opportunities ahead. Excluding the litigation settlement expense, Trustmark's net income in the fourth quarter totaled $41.5 million, or $0.68 per diluted share, and $147.5 million for the full year 2022, representing diluted earnings per share of $2.40. Now, let's look at our financial highlights in a little more detail by turning to Slide 3. At December 31, loans held for investment totaled $12.2 billion, an increase of $618 million linked-quarter, and $2 billion or 19.1% from the prior year. Deposits totaled $14.4 billion, an increase of $12.5 million from the prior quarter, and a decrease of $650 million or 4.3% year-over-year. Revenue in the fourth quarter totaled $191.8 million, up 1.6% linked-quarter. For the year 2022, revenue totaled $700 million, an increase of $60 million or 9.3% from the prior year. Net interest income totaled $150 million in the fourth quarter, an increase of $11 million or 7.9% linked-quarter. Non-interest income totaled $45.2 million, and represented 23.6% of total revenue in the fourth quarter. Non-Interest expense in the fourth quarter, excluding the litigation settlement, totaled $130.5 million or 3% increase linked-quarter. For the year, non-interest expense, excluding the litigation settlement, totaled $502.5 million, a 2.7% increase from the prior year. Credit quality remains solid this quarter as net charge-offs represented six basis points of average loans. The allowance for credit losses for loans held for investment represented nearly 400% of total non-accrual loans, excluding individually evaluated loans. Non-accrual loans declined 2.9% in the fourth quarter, and total non-performing assets declined 4.1%. Including the impact of the settlement, we continue to maintain strong capital levels, with a common tier one capital ratio of 9.74%, and a total risk-based capital ratio of 11.91%. The board declared a quarterly cash dividend of $0.23 per share, payable March 15th to shareholders of record on March 1st. I'll be glad to, Duane, and thank you. Turning to Slide 4, loans held for investment totaled $12.2 billion as of 12/31, an increase, as Duane mentioned, of $618 million linked-quarter, or 5.3%, and $2 billion or 19.1% for the prior year. We're extremely excited about the Q4 loan growth that occurred in almost every category. We do expect to continue solid loan growth through 2023. Our loan portfolio continues to be well diversified based upon both product type, as well as geography. Looking at Slide 5, Trustmarkâs CRE portfolio is 93% vertical, with 61% existing and 39% construction land development. Our construction land development portfolio is 81% construction. The bank's owner occupied portfolio has a nice mix between real estate types, as well as industries. Turning to Slide 6, the bank's commercial portfolio is well diversified, as you can see across numerous industry segments, with no single category exceeding 12%. Moving now to Slide 7, our provision for credit losses for loans held for investment was $6.9 million in the fourth quarter, primarily attributed both to loan growth and the weakening in the macroeconomic forecast. The provision for credit losses for off balance sheet credit exposure was $5.2 million in the fourth quarter, primarily driven by increases in unfunded commitments and the macroeconomic forecast. At 12/31/2022, the allowance for credit losses on loans held for investments totaled $120.2 million. Looking at Slide 8, we continue to post solid credit quality metrics. The allowance for credit losses represents 0.99% of loans held for investment, and nearly 400% of non-accrual loans, excluding those that are individually analyzed. In the fourth quarter, net charge-offs totaled $1.7 million or 0.06 of average loans. Net charge-offs for the entire year totaled only $920,000, or 0.01%. Both non-accruals and non-performing assets remain near historically low levels. Duane. Thank you, Barry. Now turning to the liability side of the balance sheet, I'd like to ask Tom Owens to discuss our deposit base and net interest margin. Thanks Duane, and good morning, everyone. Looking at deposits on Slide 9, deposits totaled $14.4 billion at December 31, a $12.5 million increase linked-quarter, and a $650 million decrease year-over-year. The linked-quarter increase was driven by an increase in public fund balances, more than offset by a decline in non-personal balances, while personal deposit balances were essentially flat. The year-over-year decrease was driven primarily by decreases in non-personal and public fund balances, with only about 10% of the decrease driven by personal deposit balance suits. So, the granularity of our deposit base remains strong. Our cost of interest-bearing deposits increased by 51 basis points from the prior quarter to 71 basis points. We continue to maintain a favorable deposit mix, with 28% of our balances in non-interest-bearing deposits, and 64% in checking accounts. Turning our attention to revenue on Slide 10, net interest income FTE increased $11 million linked-quarter, totaling $150 million, which resulted in a net interest margin of 366, representing a linked-quarter increase of 16 basis points. Higher loan balances and yields contributed about $24 million and $6.2 million, respectively, of lift linked-quarter. That was partially offset by a $13.3 million increase in deposit costs, and a $6.6 million increase in net borrowing expense. Drivers of the continued expansion during the quarter in net interest margin included continuing lags in realized deposit betas, ongoing Fed rate increases, and a continued shift in earning asset mix. Turning to Slide 11, the balance sheet remains well positioned for higher interest rates, with substantial asset sensitivity driven by loan portfolio mix, with 49% variable rate coupon. During the fourth quarter, we continued implementation of the cash flow hedging program to manage our asset sensitivity by adding up $150 million notional of interest rate swaps, with a weighted average maturity of 4.1 years, and weighted average receive fixed rate of 3.64%, which brought the portfolio notional at year-end to $825 million, with a weighted average maturity of 3.4 years, and a weighted average received fixed rate of 310. The year one increase in NII to immediate interest rate shocks, remains asset-sensitive at about 2% for a 100 basis-point shock, about 3% for a 200 basis-point shock, and about 5% for a 300 basis-point shock, with the benefit in years two and beyond increasing as the balance sheet continues to reprice. Turning to Slide 12, non-interest income for the fourth quarter totaled $45.2 million, a $7.4 million linked-quarter decrease, and a $16.8 million decrease full year. The linked-quarter and full year changes are principally due to lower mortgage banking revenue, which was substantially offset by increases in other line items full year. Service charges on deposit accounts totaled $11.2 million in the fourth quarter, a linked-quarter decrease of $156,000, while increasing $8.9 million or 26.8% full year. Bank card and other fees totaled $8.2 million in the fourth quarter, a linked-quarter decrease of $1.1 million, while increasing $1.4 million or 4.2% full year. And insurance revenue totaled $12 million in the fourth quarter. That's a normal seasonal decline of $1.9 million, while increasing $5.2 million or 10.7% full year. For the fourth quarter, non-Interest income represented 23.6% of total revenue, continuing to demonstrate a well-diversified revenue stream. Now, looking at Slide 13, mortgage banking. Mortgage banking revenue totaled $3.4 million in the fourth quarter. Thatâs a $3.5 million decrease linked-quarter, driven by a $1.3 million decrease in gain on sale, and a $1 million increase in negative hedge ineffectiveness, which brought negative hedge ineffectiveness for the quarter to $3.6 million. For the year, mortgage banking declined by $35.4 million, driven by reduced gain on sale. Mortgage loan production totaled $391 million in the fourth quarter, a decrease of 23% linked-quarter. Reduction for the full year totaled $2.1 billion, a decrease of 24% year-over-year. Retail production remained strong in the fourth quarter, representing 83% of volume or about $325 million. Loans sold in the secondary market represented 46% of production, while loans held on balance sheet represented 54%. The majority of loans going into the portfolio consist of 15-year and hybrid arms, while we've continued to sell, rather than retain our conforming 30-year loan originations. Gain on sale margin increased by about 8% linked-quarter from 181 basis points in the third quarter, to 196 basis points in the fourth quarter. Thank you, Tom. Turning to Slide 14, you'll see a detail of our non-interest expense broken out between adjusted, other, and total. Adjusted non-interest expense was $129.8 million in the fourth quarter, a linked-quarter increase of $4.3 million or 3.4%. We had non-recurring expenses during the fourth quarter totaling $3 million related to severance from the FIT2GROW organizational restructuring initiative, early lease termination expense related to closed branch offices, and legal fees. Excluding these non-recurring expenses, non-interest expense increased $1.2 million or 1% linked-quarter. As noted on Slide 15, Trustmark remains well positioned from a capital perspective. At December 31, our capital ratios remain solid, with a common equity tier one ratio of 9.74%, and a total risk-based capital ratio of 11.91%. Trustmark did not repurchase any of its common shares during the fourth quarter. During 2022, Trustmark repurchased $24.6 million or approximately 789,000 shares of its common stock. The Board of Directors previous previously authorized a new stock repurchase program, under which up to $50 million of its outstanding common shares, may be acquired through December 31, 2023. This authorization replaces the prior stock repurchase program, which expired on December 31, 2022. While our capital ratios declined linked-quarter, driven by the combination of robust loan growth and the Stanford litigation settlement, our capital ratios remain substantially above well-capitalized, and our capital position is ample to implement our corporate priorities and initiatives. Although we maintain $50 million of authority during 2023 under our board-authorized stock repurchase program, we are unlikely to engage in stock repurchase in a meaningful way. For the time being, our priority for capital deployment is through organic lending. Back to you, Duane. Great. Thank you, Tom. Turning to Slide 16, let's review our outlook. Let's look first at the balance sheet. We're expecting loans held for investment to grow mid to high single digits for the year. Note, our Atlanta office is now staffed with a very solid production team, including our equipment finance organization, will start to contribute in coming quarters. Security balances are expected to decline by high single digits based on non-reinvestment of portfolio cash flows. Deposit balances are expected to grow mid-single digits full year, driven by promotional campaign activity. Moving on to the income statement, we're expecting net interest incomes to grow low to mid-single digits, reflecting flat full year net interest margin based on current market-implied forward rates. The provision for credit losses, including unfunded commitments, is dependent upon future loan growth and current macroeconomic forecasts, and is expected to be above 2022 levels. Net charge-offs that require additional reserving, are expected to be nominal, based on the current outlook and portfolio. From a non-interest income perspective, we expect service charges and bank card fees to remain stable, reflecting elimination of consumer NSF fees, and the implementation of a transactional de minimis levels on consumer checking accounts as we previously announced, as well as by reduced customer derivative activity. Mortgage banking revenue is expected to stabilize at the prior year level. Insurance revenue is expected to increase high single digits full year, with wealth management expected to increase mid-single digits. Non-interest expense is expected to increase mid-single digits for the year. This reflects general inflationary pressures, and is subject to the impact of commissions in mortgage insurance and wealth management. We remain intently focused on our FIT2GROW initiatives, as discussed throughout 2022. As noted, we've expanded our team of talented production staff, added a significant new line of business, expanded in growth markets, all of which will begin to contribute in 2023. Additionally, we've invested in technology across the franchise to better serve customers and become more efficient. We've continued to optimize our retail franchise, with the closing of 12 offices and the deployment of new ATM and ITM technology. We believe this focus and investment positions Trustmark to provide profitable growth into the future. Finally, we will continue a disciplined approach to capital deployment, with preference for organic loan growth, potential M&A, and opportunistic share repurchases. We will now begin the question-and-answer session. [Operator Instructions] And the first question will be from Catherine Mealor from KBW. Please go ahead. Thanks. Good morning. I wanted see if we could first just dive into the lower NII guide. If you could just provide a little bit of commentary on how you're thinking about cumulative deposit betas and maybe the trajection of the margin over the course of the year to get to that lower NII guide. Thanks. Sure. So, good morning, Catherine. This is Tom Owens, and thank you for the question. So, as I think we indicated on last quarter's call - well, let me say it this way. With respect to our plan for deposit growth for â23, we're approaching it. We're building that - we've built that plan from the bottom up based on the team here internally. As we said on last quarter's call, we continue - our forecast is based on market-implied forwards, which continued at the Fed Funds Rate topping out about 5% here by the end of the first quarter, and basically staying there for the remainder of the year. We're continuing to model a full cycle beta by the time we get into late third, early fourth quarter of 2023, of about 50%. And so, that means our interest-bearing deposit costs that we're modeling for later in the year, rises to about 2.5%. And as I said, we've built that from the bottom up, the plan. And when I look at it from the top down, it is consistent with our historical actual experience. I mean, it's been a long time now since the Fed Funds Rate was at 5%. But when I look at the historical experience for our company, as well as the broader industry, the results make sense. The other aspect of it is, we had very robust loan growth in 2022. We anticipate continued follow-through momentum per the guide that Duane gave. And our loan to deposit ratio in the quarter rose to 85%. So, we're really focused on maintaining strong liquidity. We really would rather that loan to deposit ratio not go above 90%. And with the trajectory of loan growth relative to deposit growth, we're really focused on beginning to accelerate deposit growth. We essentially were flat for the quarter. We would like to accelerate deposit growth as we come here into â23. The other thing I'll say, I'll state the obvious, which is, it's really an unprecedented environment in terms of you look at the headwinds facing the industry in terms of if you look at the Fed H8 report and you see continuing month-over-month declines in the aggregate deposit base in the United States, it is a challenging environment as the Fed continues to reduce accommodation and withdraw liquidity from the system. So, there's a lot of uncertainty obviously in the forecast. The other thing I'll say is, here in the first quarter is when we're really beginning to launch promotional deposit campaigns in earnest. We started to do that a bit in December, and that was a contributor, the promotional activity to us being able to maintain essentially flat personal deposits during the quarter, which we're very encouraged by. And so, when you look at the competitive landscape right now for deposits, liquidity is obviously top of mind in the industry. And so, this is our best estimate at this time in terms of those increases in interest-bearing deposit costs, and thereby the pressure on net interest margin. And so, obviously what it implies is, you think about the pattern of linked-quarter increases in net interest margin in 2022, what our forecast implies, the guide implies is, we're going to experience linked-quarter declines in net interest margin here in â23. And as you think back to - I feel like the perception, or at least looking at the margin trajection for our estimates and consensus, still had not a lot of expansion from here, but still a fairly stable margin, which assuming you were more asset-sensitive then, it seems like you are. What do you think is the biggest surprise or the biggest change to this NIM trajectory versus maybe where you were last quarter? And is there - begs the question, is there anything else besides just the funding costs coming in higher? Is there anything else just to kind of think about as you've changed your perception of asset sensitivity? Well, it's a good question, and I don't know that we have changed our perception of asset sensitivity. So, for example, if you look at our loan yield beta, which continues to be in the neighborhood of 50%, and when you look at the numbers that we publish and that we file in the call report in terms of our NII at risk, those numbers reflect the kind of betas that we're talking about here as our baseline scenario. So, Catherine, there really hasn't been a change in perception internally. I would say the change fundamentally, again, in the industry, I mean, if you look at the broader industry, I go back to the H8, what you see there is, the run rate is for double-digit growth in loans in the industry. And we are part of that and experiencing very robust loan growth. You have seen a flatlining and now an outright decline in the deposit base in the industry. So, to me, the difference, if there's a difference in perception externally about Trustmark, the difference is us really wanting to be proactive as we come into â23 here to make sure that we have a trajectory on deposits that can keep pace with loan growth and maintain strong liquidity. Yes, Catherine, I would add in - this is Duane. I would add in just what Tom's last comment is. I do think that loan growth that continued in the latter half, or really accelerated in the latter half of 2022, and what we look out into 2023, still have expectations, and like noted earlier, with some of the investments we made in new talent and new business line, we think we have still solid expectations on the loan growth side, which I think then that emphasizes the need to keep pace on the deposit side. And it's an extremely tight - it's a tightening liquidity and a competitive environment for deposits. And I don't know that I would term that necessarily a surprise, but we're certainly monitoring, and that's what we're expecting as we move into 2023. Yes. The last point I'd make, Catherine, again, I would just reemphasize how challenging the environment is and the uncertainty, right? I mean, it's just that - it's that confluence of unprecedented set of circumstances really. So, we're like a lot of our peers in the broader industry, kind of figuring out a tactically, as well as strategically on the deposit side as we go. And you could argue last cycle, if you looked at your last cycle beta of the proxy, you didn't have this level of growth last cycle. And so, that intuitively makes sense that your beta is higher, just given your growth outlook is higher as well. Yes, and I think I've said this before, and I'll make this point again. I think it's really important. I talked about the last time the Fed Funds Rate was at 5% in â06. I mean, I can argue both sides of it, right? If you look back then when the Fed Funds Rate was 5%, it was a much longer cycle, and it took longer to get to 5%. And so, when you think about it this way, this is a much shorter cycle. You could certainly argue that, well, hey, don't you think your effective beta is going to be less? And I think that's a legitimate argument. The flip side is, the what now 16 years that have passed since the last time the Fed Funds Rate was at 5%, and the changes in technology that we all hold in the palm of our hands, and the ability to frictionlessly and you could do it quickly, you could do it cost effectively, essentially moving your funds around in search of higher yield, and when I think about that, that argues for a higher realized beta. So, to me, you put those two things together, and I think that our estimates are reasonable. But again, I'd emphasize, those are our best estimates at this point in time. Got it. That's all really helpful. And then maybe just one other question on service charges. I was surprised that your guidance for service charges is to be stable year-over-year. I was expecting more of a decline just with the NSF fee changes. Any - so I just want to clarify that kind of stable over the full year 2022 level of service charges. No, I think, I think you accurately reflected the NSF changes and do minimis change, reflects about 3-ish million, maybe a little more than that. And what we're seeing, if you'd note in the fourth quarter, we were stable to down slightly, but feel with increased activities and what we're seeing economically, weâre still fairly positive on a stable outlook, Catherine. Hey, good morning, everyone. I was hoping to - on the expense guide for mid-single digit growth, I was hoping, number one, to just clarify what the base for that is. Is it - would I look at this adjusted non-interest expense for full year â22 of about $498 million? And then digging into a little bit, because it sounds like other than the $100 million settlement, it seems like there was some lumpiness this quarter, which maybe we don't pull out and flag when we're talking about core, but maybe is not going to be run rate going forward. So, I'm just trying to look at expenses from both of those angles. Thanks. So, Kevin, this is Tom Chambers. If you look at what we're expecting going forward, yes, you're right, we had had a little lumpiness in the fourth quarter. Our core or our adjusted non-interest expense, we typically pull out significant non-recurring, non-routine items, which obviously was the litigation settlement this quarter and ORE and some amortization of intangibles. So, what we feel next year is mid-single digits with continued investment in technology and salary and benefits, that we have a competitive environment with, and those type of line items going forward. And, Kevin, I'd add a little bit to the fourth quarter, and as we noted in our comments, there were some things that cumulatively are significant, but individually, like legal expenses and some severance costs, some branch closure costs and that sort of thing, that individually are probably not material, but as - on a cumulative level, did impact the fourth quarter. And so, as we look into the start of 2023, we in our minds feel that those are non-recurring items. And then the flip of that is general inflationary kinds of things that we've commented on and everybody seems to be commenting on, higher employee costs and other general inflationary things. So, it kind of takes us to that mid-ish, lowish to mid-ish single digit kind of increases for the full year 2023. Okay. Thanks, Duane. And just to clarify, is that - is the base for that, that 498.4 million roughly for full year? If you don't have it handy, that's fine. Good. Okay. And then just one follow up for - we had a lengthy conversation a few minutes ago about n NII and how you're being proactive on deposits and you don't want to take loan to deposit ratio over 90%. It's an unprecedented environment, and I totally recognize all that. Can I - like, have you all looked at the alternative of maybe dialing - like dialing back the loan growth a bit so that you don't have to chase as aggressively for the deposit and still keep the loan to deposit ratio where you're at? And I recognize that you're not seeing a lot of credit stress right now, but you've acknowledged that it's a pretty uncertain economy and environment. And so, there's - when we look at loan growth outcomes for next year, there's obviously a demand issue, but we've also heard some banks just saying, hey, weâre stepping away from areas like commercial real estate or certain sectors. So, I know that's a lot to throw at you, but I'm just - how did that conversation go in amongst yourselves about, hey, we want to grow NII, but one way do it is the marginal of our stable and just grow loans less aggressively? Thanks. Yes, so great question, Kevin. This is Tom. I'll start and then I'll ask Barry to weigh in a little bit. We have absolutely had that discussion internally. We have absolutely looked at that. I'll let Barry speak to the lending side, but it's an environment that creates opportunity, as you just said, where you have some of our peers, some of our competitors, pulling back a bit. And so, of course, we're evaluating each of those loans, loan by loan, on a return basis. And of course, we're thinking about our marginal cost of funds and the potential of repricing the deposit base to a certain extent as we really lean in here to try and accelerate deposit growth. So, yes, we have discussed that. We have thought about that. We continue to think about that. One of the things that we're doing is, there's always going to be loans at the margin. When you look at the return on them, they are truly marginal, right? And in this kind of environment, we're absolutely being disciplined. And what that means is that some of that marginal growth is not going to happen, right? But for us, it creates opportunity. And I think the other thing Barry will talk about too is probably relationship continuity. In this environment where we have existing relationships or prospective relationships where they have their current bank or banks that they work with are pulling back, creates opportunity for us. So, I'll just let Barry kind of pick up from there. Yes, and Kevin, I'll just echo some of the thoughts that Tom referenced. Every day, when we're looking at deals, we are scrutinizing those deals, not only from a credit standpoint, but probably more closely than ever from the standpoint of from a return on investment and from an ROE perspective. We are passing on deals that are lower on the pricing spectrum that were maybe acceptable 12 months ago, that in our environment today for what we're challenged with trying to raise deposits and a little bit of uncertainty, by knowing what it's going to take to get there and how quickly the deposit growth can keep up with loan growth, weâre trying to be very selective in terms of the, from a profitability of the transaction standpoint. Obviously, always the credit aspect of it is first and foremost. We don't expect to grow as we've been, and Duane indicated, we don't expect to grow as fast loan growth wise in 2023 as we did in 2022 for a variety of reasons. Being more selective on prices is definitely one of those. We do have categories that we've been avoiding. Those are the same categories that we've been avoiding for quite a few years, just because of some uncertainty around those. They're - on the flip side of those situations, there's the little bit lessening of competition in some categories of lending. Pricing is getting better. Structure has definitely gotten better. Those things are all positive. And we view this somewhat similar to what we saw in the middle of 2020, where there was lessening of competition. And because of that, the deal structure itself improved greatly and the pricing improved, and we see that going on today. And we want - for the right customers, we want to make sure we take full advantage of that. Also, as has been alluded to, we do have a new line of business equipment finance out of our Atlanta office, along with some additional CRE and C&I lending staff that we've added there that are doing a great job. And with that in mind, there's going to be some additional opportunity coming our way that we'll need to manage. So, there's a combination of things. One, we're trying to be more selective from a ROE or return on investment standpoint, with every deal we look at. And we do expect there to be a little less growth, but we do have a little less competition. We do have relationships to manage, as Tom alluded to, and we do have a new line of business and some additional resources and existing lines, both CRE and C&I. So, there's, as Tom said, a convoluence of all those things at one time. So, we do expect to have good solid loan growth as we've guided, and then - but we're trying to be as selective as we can be, making sure that the pricing is in line with what we're paying for those deposits to fund it with. And Kevin, I would just add one other point, again, and I just - I'm going to try and reemphasize this point. In this environment, it is such an unprecedented environment, we have a team internally that we meet every morning at eight o'clock, and we're looking at reports on yesterday's activity in terms of deposits and how we're doing in terms of our promotional deposit activity, both in terms of volume and cost, and the extent to which we're attracting new funds versus repricing the back book. And so, today is January 25th. We're obviously early in the quarter. We're early in the year. Weâre going to continue to evaluate and recalibrate as we go. And I just want to bring it back to the point that Barry just made, right? I mean, we're obviously considering the marginal cost of growing the deposit base versus the returns of continuing to grow the loan book at a robust pace. And we're evaluating that in real time and will adjust, and I'll just reemphasize, the guidance that we're giving you today, reflects our best estimates today. What I emphasize to that team every morning is the need to be nimble and to recalibrate accordingly. So, I just want to make that point again. Hey, good morning, gentlemen. Turning to credit for the guidance there, just curious, I know a lot of it is data-dependent in terms of the macroeconomic forecast, but when we talk about the - or you talk about the provision for loan losses, should we think about that just in terms of as it relates to loans held for investment, or inclusive of trends in terms of unfunded commitments? Just some clarification in terms of how that guidance, what that incorporates. And Dave, this is Barry. Yes, definitely both, because this quarter's a good example. We had a lot of good production on our CRE side. And so, within that commercial construction bucket, there's a variety of obviously types of projects we have there. But nonetheless, within that commercial construction bucket, as we put on those new opportunities, we do reserve for them fully based upon the eventual - based upon exposure. So, with that in mind, there is an impact immediately to those projects going on the books. And as we are able to continue with a nice solid level of production, we'll continue to have both a need for reserving, obviously, on the funded, as well as the unfunding funded aspect of it. I mentioned earlier loan growth, the macroeconomic environment, portfolio mix in terms of the types of credits we're putting on the books, the level of unfunded commitments, and the length of maturities. As the speeds pick up - as the speeds diminish or pick up, obviously that has an impact on the provisioning as well. So, all those different aspects will, in fact, impact not only the provisioning for the funded book, but for the unfunded book as well. Okay, great. Appreciate that clarification. And then in terms of the outlook for securities, it sounds like those are going to be down a bit. Just curious what you're thinking of in terms of quarterly cash flows, and maybe how small that becomes as a percent of overall asset base. Thanks. So, this is Tom. So, the portfolio is throwing off about $25 million to $30 million per month. So, let's call it 20 to 25. So, you're between $360 million to $400 million or so. I would say a $300 million decline in the book value. Of course, you get some twinges in the carrying value because of changes in AOCI for the FS portfolio. But again, given the loan growth that we've had, our intention at this point is to run off the portfolios through year-end to generate liquidity to pay down wholesale borrowings. We had grown the securities portfolio substantially during â20 and â21 with our abundant excess liquidity. And now, obviously, with the very robust loan growth we've had, we'll continue to run that off for the time being. Hi, good morning. Thank you for taking my questions. Most of them have already been asked, but I'll ask a couple of follow-ups. Just in terms of either guidance or margin, do you have maybe an embedded assumption for the non-interest-bearing concentration, or how low that could get? I noticed it was down this quarter, probably almost a couple of hundred basis points. Yes, it was down - this is Tom Owens. It was down this quarter, and weâre projecting modest continued decline there. As I said, one of the big wild cards I think this year, and again, not just for Trustmark, but for the industry, is the extent to which we experienced that mix change from non-interest-bearing into time deposits. Historically, by the time you get up to a Fed Funds Rate of 5% historically in the industry, and here at Trustmark, you end up with your deposit mix being somewhere in the range of 40% time deposits. And so, we came into the year high single digits. I would think it will easily double that, if not more, over the course of the year. And it remains to be seen how much of that comes out of non-interest-bearing. The other thing about it, Carl, is, as I said in my prepared comments, most of the decline in deposits in 2022 was a function of non-personal or business accounts. And we saw tremendous increase in just businesses holding liquidity. And so, it seems like a fair amount of that has run its course now in terms of reversal, and that was certainly part of what you saw in the fourth quarter. So, it remains to be seen how that plays out as well. It seems to be stabilizing a bit. All right. Thank you for that. And second one, I think last quarter you noted that you typically expect large payoffs, both anticipated and unanticipated in 4Q. With the robust loan growth this quarter, could you talk about what the payoff and paydown activity was in 4Q, and how is it looking now? Carl, this is Barry. I'll be glad to, and you're exactly correct. We did give that guidance. That is what we've been experiencing. And matter of fact, when we got into the first part of December, obviously credit and treasury were having a lot of conversations about, is it going to manifest itself or not, because it hadn't at that point to the degree we anticipated and how we had kind of thought Q4 would work in terms of actual long growth, specifically in CRE. And we had about - just in round numbers, we had about $250 million worth of projects that when we resurveyed the lenders in the middle of December, they indicated there was a little bit of delay, and they would be leaving us not in Q4 of 2022, but during 2023 for the most part. There may have been one project that was going to be extended out a little farther. And - but so those projects are going to leave us and they are baked into our loan growth assumptions for 2023, but they did slide a quarter or two into 2023. So, that resulted in a much stronger fourth quarter than we anticipated, but it really didn't change our outlook for 2023 because they do like - they're going to resolve themselves and leave us during 2023 based upon the last information from the ballroom. All right, perfect. Thank you. And then maybe one last thing for me, just, I think, obviously you paused the share repurchase activity in 4Q, and I'm assuming it's due to the settlement. Just how active do you plan to being going forward? So, Carl, this is Tom Owens. As Tom Chambers said in his prepared comments, it's really unlikely given the present circumstances as best we can foresee, that we'll be engaging in meaningful share repurchase activity. The robust loan growth that we're experiencing is really our preferred form of capital deployment. Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over Duane Dewey for any closing remarks. Well, thank you again for joining us this morning. We hope this information has been helpful, and we look forward to connecting again at the end of the first quarter, and are very excited to move into 2023 and tackle the challenges ahead. So, we'll talk to you again at the end of the first quarter.
|
EarningCall_1117
|
Good day and welcome to the Lam Research December 2022 Earnings Conference Call. Todayâs conference is being recorded. At this time, I would like to turn the conference over to Tina Correia, Corporate VP of Investor Relations and Corporate Finance. Please go ahead. Thank you, operator, and good afternoon, everyone. Welcome to the Lam Research quarterly earnings conference call. With me today are Tim Archer, President and Chief Executive Officer; and Doug Bettinger, Executive Vice President and Chief Financial Officer. During todayâs call, we will share our overview on the business environment and we will review our financial results for the December 2022 quarter and our outlook for the March 2023 quarter. The press release detailing our financial results was distributed a little after 1:00 p.m. Pacific Time this afternoon. The release can also be found on the Investor Relations section of the companyâs website, along with the presentation slides that accompany todayâs call. Todayâs presentation and Q&A include forward-looking statements that are subject to risks and uncertainties reflected in the risk factors disclosed in our SEC public filings. Please see accompanying slides in the presentation for additional information. Todayâs discussion of our financial results will be presented on a non-GAAP financial basis unless otherwise specified. A detailed reconciliation between GAAP and non-GAAP results can be found in the accompanying slides in the presentation. This call is scheduled to last until 3:00 p.m. Pacific Time. A replay of this call will be made available later this afternoon on our website. Thank you, Tina and Happy New Year to all that are joining us today. Lam ended 2022 on a strong note. We posted record revenues and earnings per share for both the December quarter and the calendar year. Systems revenue growth in our Foundry Logic segment exceeded foundry logic wafer fabrication equipment growth, demonstrating our continued progress launching new tools and winning applications in that space. In our installed base business, our CSBG revenues expanded faster than the growth in installed base units. We also generated more than $3.5 billion in cash from operations and returned over 100% of free cash flow to stockholders in the form of dividends and share buybacks. Overall, Lam executed well in 2022. We delivered solid results in an environment of acute supply chain constraints and strong inflationary pressures. Still, there are elements of our performance where we recognize the opportunity for additional focus, and with the pressures of the COVID pandemic and the global chip shortage of abating, our attention this year is on the actions needed to hit our long-term growth and profitability objectives we laid out in March 2020. Beginning early in the COVID pandemic, Lam and others throughout the supply chain quickly ramped investments in infrastructure and resources to meet unprecedented demand driven by remote work trends and the accelerated digitization of the global economy. As seen in our results today, these investments have enabled Lam to achieve revenues of greater than $5 billion per quarter, approximately 70% higher than what we saw in the last up-cycle. As we look forward into 2023, however, we see a substantially weaker demand environment and the corresponding need to make prudent changes to our near-term operations and priorities. Customers across all segments are exercising caution, especially those in the memory markets. Inventory levels in both NAND and DRAM remain very high, and customers are not only reducing new capacity additions, but also lowering fab utilization levels to bring excess inventory into balance as quickly as possible. In addition, the U.S. governmentâs new restrictions on sales of equipment, parts and services for specific technologies and customers in China are further impacting equipment demand in a declining market. In 2022, WFE spending ended the year in the mid-$90 billion range, slightly higher than our prior view due to easing supply chain constraints. As we indicated in our last earnings call, we expect calendar year 2023 WFE to be in the mid-$70 billion range. Given the decreased business levels expected this year, we have made the difficult decision to reduce our overall workforce by approximately 1,300 employees by the end of the March quarter, about 7% of our global employee base. While the reductions are broad-based across the company, we have taken special care to preserve, and in some cases, increase our investments in the critical R&D efforts which I believe are key to Lamâs long-term growth and competitiveness. Despite reductions in overall company spending, we expect R&D as a percentage of operating expenses in 2023 to increase compared to 2022. We will also be taking specific actions to transform our business processes and enterprise systems to ensure that with stronger WFE spending returns, the company is well-positioned to scale quickly and efficiently across our global infrastructure. These actions will contribute 100 basis points of improvement to our gross margin from March quarter levels as we exit calendar year 2023 and we expect the operating margin benefit to be slightly higher than that. Over the past few years, we have been executing on a set of strategies that we believe strengthen our ability to capitalize on the robust secular demand trends we see ahead in our business. In just the past 2 years, we have opened a state-of-the-art engineering center in India, brought online a new technology development center in Korea, and ramped our new manufacturing operation in Malaysia. These strategic investments place critical Lam capabilities closer to customers and ecosystem partners, a benefit for stronger collaborations, greater scalability and increased resilience, all of which would be of greater importance as we see more than 50 new fabs being built over the next few years globally. They also provide wider access to talent critical to supporting Lamâs growth longer term. We have also been drawing on learnings from our rapidly growing installed base to support our customersâ manufacturing roadmaps. Our installed base of approximately 84,000 chambers is more than 30% larger than in the prior down cycle. A solid installed base business not only provides a platform for stable revenue growth long-term, but also delivers data and learnings that are key to an efficient product innovations process. At this scale, there is a tremendous opportunity to extract value for our customers and for Lam. The data we generate from our installed base helps drive fab productivity improvements and the capabilities of our equipment intelligence products are helping us migrate from standard service offerings, like engineer onsite labor, to more comprehensive results based contracts and predictive smart solutions. The number of chambers [Technical Difficulty] in 2022 with another strong growth year expected in 2023. We have been strategically focused on technology inflections, notably in foundry logic devices, with the goal of broadening Lamâs positioning in a market segment where we have been under-indexed. In 2022, we continued to make progress. We have doubled our conductor etch share node to node at a leading Foundry Logic customer through the success of our Kiyo product, which uses equipment intelligence to deliver best-in-class uniformity and improved yield. In the selective etch business, our recently released Argos, Prevos and Selis tools, are gaining increasing traction. Our Argos product is in roughly 20 applications and a leading foundry logic customer, and in adjacent selective applications at another customer, our Prevos and Selis tools, our production tool of record for gate-all-around applications. Continued scaling of foundry logic devices from existing nodes is expected to increase etch and deposition intensity around 25% to 30%, thus creating tremendous opportunity for us to gain share through new innovations for future devices. Lastly, we have continued to make both organic and inorganic investments to expand our market. Lamâs innovative Driver Assist fabrication technology has won development tool of record positions at multiple customers for key steps in the patterning process and we are actively engaged with customers across both the memory and foundry logic segments. We expect to announce more on this in 2023. In Advanced Packaging, our recent acquisition of SEMSYSCO, we have expanded our capabilities within the leading-edge logic and chiplet segments. We are rapidly integrating SEMSYSCO technology with Lamâs market-leading capabilities in plating and wet processing and we have already achieved a key win in this area. Customers view advanced packaging solutions in both wafer and substrate formats as critical to enabling future high-performance computing and AI applications and Lam is well positioned to benefit from this trend. So to wrap up, 2022 presented many challenges. With our teamâs focus and strong execution, we were able to meet our customersâ needs, deliver record revenues and expand our product and technology portfolio. This coming year represents a reset in the market and in our business, but itâs also an opportunity for us to make the changes needed to accelerate our strategic priorities. I am confident that by taking the difficult actions we have announced today, we are putting Lam in a stronger position to capitalize when industry spending growth returns. Great. Thank you, Tim. Good afternoon, everyone and thank you for joining our call today during what I know is a busy earnings season. We had a record financial year in calendar 2022. Our revenue came in at $19 billion and we delivered an all-time high for earnings per share of $37.31, which was a 15% growth in earnings per share over calendar year â21. Overall, I am pleased with the operational performance we achieved this past year delivered while navigating a challenging business environment with global supply chain constraints, significant inflationary headwinds and fluid regulatory restrictions. Lam also achieved record levels of performance in the December quarter across multiple metrics, including revenue, operating income dollars and earnings per share. Revenue for the December quarter was $5.28 billion, an increase of just over 4% from the prior quarter. We delivered higher levels of system sales in deposition and etch offset somewhat by a decrease in CSBG revenue. Deferred revenue at the end of the quarter was $2 billion, a decline of $770 million from the September quarter. Supply chain constraints have improved and we were able to fill shipments of many critical parts thatâs required for revenue recognition. Our expectations are that the deferred revenue balance will continue to decrease in the March quarter as we fully complete shipments related to outstanding backordered systems. The deferred revenue balance decrease I just spoke about was partially offset by some increases in deferred due to customer cash and advanced deposits, which I also noted last quarter. As we sit here today, I expect to have some level of these type of deposits in the deferred balance throughout calendar 2023, keeping deferred revenue at somewhat higher levels than we have historically seen. I anticipate that the deferred revenue from backorders will be at a normalized level as we exit the March quarter. Letâs turn to the revenue segment details for the December quarter. Memory represented 50% of systems revenue, which is slightly down from the prior quarter level of 52%. Included in memory, the NAND segment represented 39% of our systems revenue, flat with the September quarter. The spending was primarily focused on 192-layer and above class devices. The DRAM segment concentration decreased sequentially from the prior quarter, coming in at 11% of systems revenue compared to 13% in the September quarter. The DRAM investments were mainly targeted towards 1z and 1-alpha nodes. I expect that we will see both NAND and DRAM revenue decline meaningfully in the March quarter. For calendar 2023, I expect NAND spending to decline more than DRAM. We continue to see strength in the Foundry segment with the December quarter concentration comprising 31% of our systems revenues. While this percentage is a little bit lower than September quarter level of 34%, the dollar amount was flat with a mix of investments in both leading and mature node devices. The Logic and Other segment revenue came in at a high watermark for the company, contributed 19% of systems revenue in the December quarter compared with 14% in the prior quarter. Investments were focused on microprocessor, image sensor and advanced packaging technologies. Lam had strong momentum in Logic and Other throughout calendar 2022. I expect we will continue to perform well in this segment. Iâd mention that this was a record revenue level for us in microprocessor related revenue. We have been talking about momentum here for a while and itâs clearly showing up. With respect to the regional composition of our total revenue, the China region was 24% of the total, down from the prior quarter level of 30%. This reduction was due to the U.S. government sales restrictions for certain domestic customers which were put in place in early October of 2022. Rounding up the top region of revenue locations, Korea comprised 20% of total revenue, up from 17% in the prior quarter and Taiwan decreased to a concentration of 19% compared to 22% in the September quarter. The customer support business group results in the quarter were approximately $1.7 billion, which was down 9% from the September quarter, though it was 16% higher than the December quarter of calendar 2021. As I have noted in the past, CSBG revenues will fluctuate on a quarterly basis. And in the December quarter, we experienced declines in the CSBG product lines with reductions in utilizations and system spending. Going into calendar 2023, we have the impact of China regulatory restrictions in addition to memory spending at well below historic levels and elevated customer device inventory. These factors are resulting in customers having underutilized factories and taking actions to manage their supply levels in 2023, negatively impacting our spares and services business. While we continue to believe the mature node segment will perform better than overall WFE spending, we are in an unprecedented business environment and expect the CSBG business could be down somewhat in calendar year 2023. Let me now pivot to our gross margin performance. The September quarter came in at 45.1% over the midpoint of the guided range, but down from September quarterâs gross margin of about 46%. The decrease from the September quarter was tied to customer and product mix. With the decline in business volumes in March 2023 quarter, we expect lower factory and field utilizations to unfavorably impact our gross margin on a sequential basis. Operating expenses were $686 million in the December quarter, up 6% from the prior quarter amount of $647 million. The higher spending was mainly in R&D projects, which comprised nearly 67% of our total spending. Supporting our customersâ roadmap continues to be a top priority for us while we focus on managing other areas of discretionary spending within the company. December quarter operating margin was 32.1% over the midpoint of guidance due to the higher level of revenue and gross margin. Our non-GAAP tax rate was 11.9%, in line with expectations. Looking into calendar 2023, we believe the tax rate will be in the low to mid-teens with some fluctuations quarter-by-quarter. This rate estimate does not include any impacts from potential U.S. or global tax policy changes. Other income and expense came in for the quarter at $38 million of expense, approximately $9 million higher from the prior quarter, mainly due to negative foreign exchange fluctuations which was somewhat offset by higher interest income because of increasing returns on our cash and investments. OI&E will continue to be subject to market-related fluctuations that will cause some level of volatility quarter-by-quarter. On the capital return side in the December quarter, we allocated approximately $483 million to open market share repurchases. Additionally, we paid $236 million in dividends in the quarter. For the 2022 calendar year, we returned 119% of our free cash flow, totaling $3.5 billion which was somewhat higher than our long-term capital return plans of 75% to 100%. December quarter diluted earnings per share, was $10.71, which was at the high-end of our guidance range. Diluted share count was 136 million shares, which was lower than the September quarter and in line with our December quarter expectations. During 2022, we lowered share count by nearly 6 million shares through our share buyback program. Now moving to the balance sheet. Our cash and short-term investments, including restricted cash, were up to $4.8 billion versus the prior quarter level of $4.6 billion. Operating cash flow of $1.1 billion in the December quarter was offset by cash allocated to share repurchases, dividend payments and capital expenditures. Inventory turns were 2.4x. Days sales outstanding were 70 days, a decrease from maybe 2 days in the September quarter due to strong collections and improved linearity within the quarter. I would point out that we expect 2023 to be a strong cash-generating year as working capital comes down with lower business levels. Our non-cash expenses for the December quarter included approximately $73 million for equity compensation, $73 million in depreciation and $12 million in amortization. Capital expenditures for the December quarter were $163 million, a slight increase over the September quarter spending of approximately $140 million. The expenditures were in R&D and manufacturing, including our Korea Technology Center and our Malaysia factory. We ended the quarter with approximately 19,200 regular full-time employees, which was an increase of approximately 500 people from the prior quarter. Our growth was in the factory and field to support the manufacturing as well as installation of tools at our customersâ fabs. Also included in this headcount growth were 150 employees from the SEMSYSCO acquisition that was completed in the December quarter. As you heard from Tim and saw in our earnings release, we will be reducing our regular full-time headcount by approximately 1,300 employees. We expect these reductions to be largely reflected in our June quarter ending headcount. In addition to the full-time reductions, we expect to be lowering our temporary workforce by approximately 700 people in the March quarter. Weâve already adjusted our temporary workforce down by 700 people in the December quarter. Let me now turn to our non-GAAP guidance for the March 2023 quarter. Weâre expecting revenue of $3.8 billion, plus or minus $300 million. Iâll also just mention that we currently think revenue will be somewhat first half weighted this year as we consume the reduction in deferred revenue in the March quarter. Gross margin of 44%, plus or minus 1 percentage point. The decrease in this is the result of lower business volumes. Operating margin of 27.5%, plus or minus 1 percentage point; and finally, earnings per share of $6.50 plus or minus $0.75 based on a share count of approximately 135 million shares. We will be taking a charge of approximately $80 million in the March quarter from headcount reduction. Including this impact, and the other near-term actions that Tim spoke about, we are anticipating a total of $150 million to $250 million in charges to be incurred over the next 12 months. In addition to headcount, we anticipate potential charges from facilities restructuring, business realignment and transformation and product rationalization. On top of the cost savings activities, we are driving a greater focus from our senior leadership team through inclusion of additional profitability metrics in our annual incentive compensation structure. Currently, weâre at low volumes given the business environment. These initiatives will structurally improve our profitability. As Tim already laid out, we expect gross margin to be higher by roughly 1 percentage point and to expand operating margins by a little more than that as we exit the calendar year and complete these activities. Over many years in cycles, Lam has established a proven track record of successfully managing this business. With the actions we plan to execute throughout the year, we expect to strengthen our operations and technology leadership and further enhance our profitability profile with the companyâs returning growth. When business improves, and we know it will, Lam will be a stronger, better positioned, more efficient company. Good afternoon. Thanks for taking my question. Given the 20% pullback in WFE spend this year, significant memory spending pulled back within that, does the team still believe that the memory mix and spending expansion in memory will accelerate exiting this year? Whatâs your view? And then whatâs your view on the supply-demand environment in memory and normalization of excess inventories in the industry? Yes. Harlan, Iâll start on that one. I think that the memory market and our market in general is difficult to predict from a timing perspective. So when you try to put a ending the year kind of time on it, itâs hard. But as Doug laid out, there is a couple of points. I mean, one, weâve seen extraordinary measures within the memory market in terms of reductions, not only in spending but also cuts and fab utilization, and in some cases, even delays of technology investments. I think these are somewhat unprecedented in terms of trying to bring this market into balance. We also see memory as a percent of the total WFE mix thatâs at levels that we havenât seen in 25 years. And so I guess what we walk away with is a lot of confidence that memory spending will accelerate, but weâre not at this point ready to put an exact time frame on that. A lot of the actions that we talked about that weâre taking in the company are to ensure that in the next up cycle, will actually be far more nimble to respond to changes in demand than we were when we were impacted by the ramp that came around the COVID pandemic. So thatâs really where weâre spending a lot of our time thinking about, less on timing but more about how is the company going to be prepared to respond to that ramp in memory spending, when it inevitably comes, and how do we ensure we can do that in the most efficient and profitable way positive. Perfect. And then on the impact from China regulatory and export controls, YMTC was formally put on the entities list in mid-December. Did this move change your prior view of a $2 billion, $2.5 billion impact to revenues this calendar year due to the China restrictions? No. When we put out the $2 billion, $2.5 billion fundamentally comprehended an inability to ship to the customers that at that point were operating at the technologies that were restricted by China, so it didnât change it. I would say today, our view is still in that $2 billion to $2.5 billion range impact. Great. Thank you. I guess I wanted to ask about the deferred. And if you draw it down to sort of normal levels in March, it implies shipments that are kind of well below the revenue level. I guess with CSBG running at close to $1.7 billion, it doesnât seem like the June quarter could fall that much. But can you just kind of give us a little bit more clarity on what it means that youâre drawing down that much deferred in March? It just means there is no more left at the end of the March quarter, Joe. I donât really have any more than that to tell you. And yes, shipments are lower than that revenue number as we get the deferred kind of back to, what I would describe as, normalized level from a back-order standpoint. Okay. And I think youâve described normal in the past as being around $700 million, and you said it would be a little higher than that? Is that the right math? Yes, thatâs right, Joe. What I see happening right now is weâve got, I call them customer cash and advanced deposits, which we havenât yet shipped the tools. And I think as we go through â23, itâs going to stay at a slightly higher level from that category than itâs been in the past. So I think itâs a little bit higher, somewhat higher than that number that you just mentioned. Hi, thanks. Doug, I had two questions. First of all, is sort of on Joeâs question that you just asked. And it sort of is the profile, not in your revenue, but more in your system shipments through the rest of the year. You said slightly first half loaded from a revenue perspective, but I would assume that your system shipments are going to be â like March is probably the bottom and it sort of like flattens off from there. Is that fair? Yes, thatâs fair, Tim. I think maybe Iâll answer a slightly different question. When I think about WFE in the mid-70s that Tim described, I think itâs fairly balanced through the year. Revenue somewhat first half weighted because weâre drawing down that deferred revenue balance. So I just wanted to point that out, which is why I scripted it that way. Perfect, Doug. Thanks. And then just on that point, you guys are usually 13%, 14% of WFE and your system shipments in March would imply that WFE is sort of 16% to 17% in March. So thatâs more like mid-60s versus the mid-70s number for the year. So is the answer that lists making up the difference because, obviously, all of us heard SML today and systems are up 20% plus this year. So is the story this year really that youâre going to get to mid-70s predominantly because youâre adding an extra xxx billion is of litho year-over-year. Is that the math? Thanks. Yes, Tim, I think thatâs part of it. When I look at WFE down more than 20% this year, memory is down a good deal more than that. Foundry Logic, a lot less. Litho is a heavier percent of the Foundry Logic spend. And I want to specifically point out the biggest decrease from a segment standpoint is in NAND, which, as you guys all know on this call, is our strongest segment and position at Lam. So thatâs kind of important to understand, I think, and why I specifically pointed to that as I went through the commentary. Hey, good afternoon. Thank you for taking the question. I guess first question, I was hoping you could provide perhaps a little more granularity on the restructuring. You talked 100 bps gross margin and a little bit more than that. Is there any way to kind of give a sense of how we should see that play out throughout calendar â23? And what kind of leverage should we see specifically on the OpEx side? Yes. There is some in OpEx, Tim. Obviously, weâre taking reductions in every spending category. So youâll see everywhere. Thatâs why Tim and I said operating margin would be more than the improvement in gross margin. Thatâs all weâre going to give you right now, C.J. I mean the other thing you can back into, obviously, is the implied spending guide in the March quarter comprehends some of this headcount activity that weâre describing. So thatâs â youâre seeing some of it in the March quarter, I think, if you go â decompose the guidance. Okay. Great. I guess a follow-up question. As you think about the moving parts for CSBG, obviously, youâve got a year-over-year China headwind, you talked about Reliant. I guess, how do you see the rest of that core business? Does that core business grow? And is there a way to maybe perhaps rank order whatâs doing well and then whatâs doing worse? Yes, C.J., let me take that. Just to remind people, four segments in CSBG spare, service, upgrades and Reliance. And so I think kind of in terms of your impact really, if you think China impacted both spares and service, it made it impossible for us to provide spares and service to customers that previously had a pretty sizable chunk of tools in their installed base. So impact on both of those product lines from China. Those same two product lines impacted by memory customers cuts in utilization. So youâve seen and heard from our customers talking about the number of tools they have taken offline in their DRAM and main fabs. Obviously, if youâre not running the tools, you donât need spares and you donât need service, so again, those same two product lines impacted by those changes. The Reliant business, obviously, just in that trailing edge Foundry Logic, I would say, weâre pretty comfortable with that business that we see continued strength there, maybe not enough obviously to offset the other the other two impacts, and thatâs why I do said. Weâre in a little bit of extraordinary times and that we would have previously thought that, that business couldnât go down, but the combination of both China plus utilization hit those two product lines harder. Now we know that as customers begin to spend again, the first thing to do is to bring the tools that they already have in their installed base back online. And so we would expect that the spares and service business that was impacted by utilization cuts to recover quickly and we could immediately service that as soon as the business starts to improve. Yes. Hi, thanks for taking my question. I have two of them. First one, either for Tim or Doug and thanks for the color on calendar â23 WFE and I understand itâs too early to talk about â24. But if you look at some of your memory customers, they have publicly spoken about taking the utilization rates down. So could there be a scenario where next year, they could improve the utilization rates, improve wafer and bit output without necessarily adding WFE? Or do you think on a quarterly basis, WFE bottom sometime this year, and next year, hopefully, is a better year? And I have a follow-up. Yes. Okay. Iâll start and let Doug add I think that, obviously, there have been utilization cuts. I mean I think right now, if you look â at least by our estimate and listening to what our customers say, weâre at very low levels of supply growth this year as a result of the lack of additions and utilization cuts, so I donât think you could quite get to the scenario youâre talking about where you just bring utilization â unutilized tools back online. There is a second factor though, which is, remember, I mean, customers make investments also to move their technology forward. And thatâs a pretty substantial portion of why WFE gets spent, not often just about capacity addition. And so I think that customers are going to only go so long before you have to invest in the technology to move to that next node and gain the efficiencies that you do there. So I think that, of course, we will work with our customers to bring tools back online and get utilization work on productivity, but I think thereâll be â I think spending will return at some point. Got it. Got it. Thanks for that, Tim. And then a quick follow-up for Doug. I just â thanks for the comment on the back-half revenue as first half. How do you think about gross margin, given the fact that the top line is decelerating youâre also ramping up Malaysia, China seems to be a mixed bag. So Iâm just kind of wondering how to think about gross margins or how to think about where they could potentially draw. Thank you. Yes, Chris, I hope weâre kind of bouncing along the bottom right now. I canât guarantee that, but specifically, what we try to describe both Tim and I, is that with these actions weâre taking, we believe there is upward momentum to gross margin as we exit the year. Weâre trying to get kind of capacity right staffing of the capacity rights so that as we exit the year, we think there is a point of gross margin upside, plus or minus where weâre at. Hi, guys. Thanks for taking my questions. My first one, I just wanted to touch on the deferred again. I just want to make sure I have it right. So youâre running $2 billion now. It sounds like you think normalized deferred might be $1 billion. So you got $1 billion thatâs potentially coming out in March? Is that the right way to sort of think about the underlying demand, like where it is just like $1 billion like short of where we are or short of where the guide is and then going forward⦠Stacy, I think deferred is going to be higher than that $1 billion because of these cash invented payments I was referencing. Itâs not going to go that well, I donât think. And I think itâs going to stay. I think Iâve previously led everybody to believe deferred revenue would be in that high multiple hundred-million-dollar range. I think itâs decently above $1 billion now because of this other category of stuff I see. Okay. Thatâs helpful, thanks. My follow-up, I just â I do want to ask a little more philosophical question on the workforce reductions. And maybe as it relates to WFE, I mean, like we probably did, I donât know, $40 billion in memory WP in â22 and itâs going to be down a lot in â23. Like, even if it grows in â24, how long does it take to get back to that sort of â22 level, like if ever? And do the cost cuts that youâre doing, are they in some sense, a function of how you might view like that long-term sort of steady state WFE for memory versus where weâre coming off in â22? Yes, Stacy, maybe it combines a little bit maybe the last question we had as well, which is, weâre making these cuts and taking this action to make the company efficient and profitable at this level of business. And so therefore, weâre not really looking and saying we need a big increase or rapid increase in business to justify what we keep afterwards. But I did mention the focus that we have on ensuring that as we make cuts and as we reposition, especially the global operations infrastructure, we think about how quickly we can ramp up because we know when memory comes back, it often comes back much faster than people expect. And so I canât tell you when it gets back to these numbers. But what I want to make sure is that when it does return to stronger spending in the memory side, weâre able to ramp that up and do it efficiently. So we donât have a lot of the profitability headwinds that weâve been talking about for the last really 12 to 18 months. And so thatâs the way I think about it and get the company to the right size now for this level of business. But with the idea that we have, the infrastructure and the business systems available to us and the supply chain infrastructure to ramp more quickly, more efficiently should the market overshoot where our estimate is. But why donât you need to cut more than because the cuts only take you back to where headcount was like six months ago, right? Stacy, I am comfortable at the profitability levels of the business at these revenue levels. We are getting things structured in the right way so that the P&L looks acceptable. I think Stacy, not all those heads were added in the volume side of the business as well. And so I talked about â and I think you will see when you look at the P&L, where we are trying to preserve what is strategic spending on the R&D side and the products that we think are important for the future growth of the company and competitiveness of our business. We are still committed, as I have said at the beginning, through our model of gaining market share in both the memory and the foundry logic side of the business and some of the spending is there as well. So, these are the cuts we think that are appropriate for how we think the business seems to be run through this cycle. Great. Thank you so much. I had one clarification and then a follow-up question. On the clarification, last quarter, I think you guys sized the potential impact from China export restrictions to your business in calendar â23 at $2 billion to $2.5 billion, I believe three quarters on the systems side, a quarter in services. Are those numbers still your expectation for calendar â23? Any change there? Got it. And then my question probably for Doug in terms of gross margin, last year, you talked about freight and component costs being a headwind and you also talked about pricing as a potential lever to offset some of the headwinds. How should we think about those dynamics as we progress through â23, any progress? Thank you. Yes. Toshiya, I guess what I describe is in some of the inflationary buckets I have been talking about for over the line talking about it, some of itâs getting somewhat better. And some of it, I think will get better, but we are not seeing it yet. So, thatâs in what we have been talking about. And then relative to pricing activity, we continue to work on that. There are some things thatâs already showing up in the P&L in the March quarter, but we continue to have ongoing conversations with customers about the right level of pricing, and that will continue as we go forward. And when you talk about the 100 basis point improvement exiting the full year, is that an all-in number, embedding all those factors? Yes. To the best of our reception as we sit here right now, yes, thatâs all in of the pluses, the minuses, from business going down and the adjustments we are making in terms of the footprint of the company. Thanks for taking my question. I am trying to gauge what is kind of your trough quarter of this year conceptually, right? I understand that you donât give exact forecast. But if I go through this deferred revenue math, so letâs say another $500 million comes out suggest that your March shipped revenue conceptually is about $3.3 billion. Does that reflect all the China and memory CapEx cuts so that is sort of pure trough revenue quarter, or do you think there is more to come? So, the trough revenue quarter might be later this year, closer to $3 billion or some other number. I am just trying to conceptually gauge what is the trough quarter for this year, so we can get a sense for what trough earnings power could be. Toshiya, I guess sorry â Vivek, the best I can do is just say what I have already said. Revenue is somewhat first half weighted, largely because we are pulling the deferred down in March. In March, itâs pulled down to where itâs going to be. And so you got to kind of think about that plus the fact that I told you, we think WFE is fairly balanced first half, second half. And I think if you think that through, you will get it pretty close to where it should be. Got it. And then second question that I have is, China sales were 24%, I believe of total in December. But could you give us a sense for how much of that was China domestic? And then what do you expect China to be as a percentage of your sales in March and if you have a number roughly for calendar â23? Yes. In December, trying to remember the number. More than half of it certainly was domestic China. I forget the exact number, Vivek, to be honest with you, but more of it was domestic China. As we go through, China is going to be impacted to the $2 billion to $2.5 billion from the customers we canât ship to. I think â when I think about China WFE, that means China WFE is going to be down somewhat in â23. Okay. So, this $2 billion to $2.5 billion, is that kind of run rate reflected in your March outlook? Thatâs what I wanted to just get a sense for. Yes. The things that we have kind of lost from that $2 billion to $2.5 billion, there is nothing in the March quarter. So, thatâs part of the $2 billion to $2.5 billion. There isnât any more reduction from March as we go forward. I am not sure I am making it clear to understand it, but Vivek, there is always timing of different customers spending money. Itâs not that China is going to be up and China will be up and down as we go through the quarter, I expect. But the impact from the regulations is already fully in effect in the March quarter is what I am trying to describe. Got it. So, basically, Doug, just to kind of let it down. If I take the March ex deferred $3.3 billion, right, and kind of assume quarterly run rate is at level, thatâs sort of how the shape of calendar â23 revenue should be, right? Listen, we only guide revenue one quarter at a time. I will guide June when we get to the next quarter earnings numbers. Hi. Thank you for taking my questions. Doug, is the equipment demand now below the supply that you can receive from your suppliers? Yes. Well, as we said, we saw a significant improvement in the supply chain constraints in the December quarter, which is partly why we were able to deliver higher than the anticipated revenue. So, I would say that supply chain constraints are easing. There is always â and remain in some parts of the supply chain that are still not fully recovered. But I would say that if you went back and compare where we are today versus 12 months ago, dramatically improved. I think that we will continue to work on that through probably the remainder of this year on those remaining issues. Got it. And Tim, in your prepared remarks, you talked about conductor edge market share doubling node-to-node at one logic maker and gate all around, presumably is a big technology infection that should help you guys. Can you talk about the timing of the production ramp for gate all around? Is it second half, next year story, or is it more like a 2025-year event? Yes. I think that â I mean you see customers starting to talk about and announce kind of limited production. Yes, obviously, there is a qualification cycle, probably better for them to talk about their own timing. But itâs not a material issue for our 2023 numbers, letâs just say. So, itâs a 2024-and-beyond event. But those are the types of things that, again, if we think about where we want to take this business. Part of this is about increasing our exposure into that market where there is tremendous need, and I talked about the increasing intensity for etch and deposition in that space and foundry logic. And most of those big technology inflections where our tools are most suitable, things like selective etch, things like high-aspect ratio critical edge. The use of those tools are just increasing in these new 3D architectures. The increased use of advanced packaging in foundry logic and AI applications, those are, again, areas where Lam can bring our etch technology to bear. So, timing again, hard to predict, but we are making great progress of the development tool record and early production tool of record stages. And I think that as we see those markets ramp, thatâs good for Lam. Hi. Good afternoon. Thanks for taking my question. Zaman Khan [ph] for Sidney. And just on CSBG, I apologize if I might have missed this, but can you guide us on how you see each of the buckets that play into CSBG? How these will contribute to the segmentâs overall performance in 2023? And I have a quick follow-up. Sure. Yes. I kind of hit on that a little earlier, but it was basically the four segments spare, service, upgrades and Reliant. And again, in a normal year, we would actually always see spares in particular, expanding with the growing installed base. I talked about the fact that our installed base is substantially larger than it was during the last down cycle. We just grow the installed base, spares grow along with that. And the impact this year to that business was somewhat unique, in that, the China restrictions did pull spares business immediately out of our revenue plan given that we cannot sell spares to certain customers and technologies in China. So, thatâs a unique reset to that business. And then the second thing that impacts spares is when customers cut utilization, those tools are idled, obviously, donât need spares. So, I would say the spares business is impacted by those two impacts. Service, similarly, we canât service the tools in China that are restricted customers and technologies and also utilization customers tend to look to save money by doing the service themselves during these times or when tools are offline, they donât need service. And so those two product lines are kind of the most impacted, I would say, by these changes, reliant, again, growing because trailing edge still grows and upgrades. While I said some people might be delaying again, just to â from a CapEx sensitivity perspective, some upgrades I would say there is a less impact in that part of the business. Got it. Thatâs pretty helpful. And then one more of a long-term question for me. I guess one of your major customers noted like very elevated infrastructure cost, roughly 4x to 5x when they build out fab capacity outside of Asia. I guess what are the implications to equipment spend as customers try to obviously diversify capacity across the regions? Itâs a good question. I mean obviously, there is â all customers are cost sensitive regardless of where they are building fabs. I mean we certainly know as people move into costlier regions, I think the story is the same. We compete and we win business based on building tools that deliver excellent technology with high productivity. And I think that if I thought about what probably that means from an equipment trending perspective, I talked a lot about equipment intelligence. You think about it, if you are moving into a region where already some of the base costs are higher, you are going to want tools that require less human interaction, less servicing tools that can do predictive work in order to try to keep them up and utilize more at a higher rate. And so I think that you will see those types of customers pull for some of our smart solutions where you can kind of pull some of that labor content down if you can keep tools up and running more often and therefore, extract more from the capital that you have invested. Hey. Thanks for squeezing me in. I had two questions. One, I just wanted to â obviously, a lot has transpired over the last 12 months and clearly a huge correction in memory. You are saying foundry logic down something less than the group the overall is. I am just kind of curious how you are thinking about that. I mean obviously, memory had to work through low utilizations and now they are pulling back on the capacity odds and same end markets. So, kind of just how are you thinking about foundry kind of progressing over this year or next? Yes. I guess right now, obviously, we still see, as we said, memory or foundry logic being down substantially less than the memory this year. We have also made the comment that as a percent of total WFE memory is at levels that we havenât seen in 25 years. And so therefore, I guess we look at it and itâs either we see strong founder logic spending, but we actually think that with that foundry logic spending in the devices and applications that are created, that will be another one of the drivers that pulls through memory usage and causes and perhaps accelerates a memory recovery. And so I think that the two are intricately tied in terms of the end applications, but sometimes the timing of the capacity additions and such are absent I think thatâs what we see right now. I was just going to say at the end of the day, you need all of this in the system architecture. When you look at hyperscale architecture, you donât just have logic devices and accelerators without memory, right. Itâs all got kind of all go on the same motherboard, if you will. What we have got going on, at least my perspective right now is we are should on excess inventory in the memory area to a significant extent, and itâs just got to get consumed. We are at a different point in the classic cycle is what I was going to describe Blayne. Okay. I guess â I mean itâs a question â I am going to â I want to follow on to my own question, but itâs also one for yourself. I mean you look across the industry in semis inventories are going up. I think you have seen this in memory, but also with semiconductor companies and your inventories as well, right? So, it suggests capacity exceeds demand, right? So, I guess one, I guess thatâs why question why foundry logic can kind of continue and I think memory might be leading the show there. But I guess as it relates to you, inventories are at a very high level. So, I am just kind of curious as another play on gross margin, where do you think your inventories need to go? And if you have to dial back your production, is there any kind of headwinds to gross margin to think about? Yes. Blayne, our inventory is going to go lower, I guess is what I would describe, right. Business is coming down. We will need less inventory to supply a lower level of business, it will come down, that I can tell you for sure. Yes, a little bit. But when I describe an expectation, I mean I describe an expectation that as we exit the year, gross margin is a point higher, that contemplates the fact that factory absorption, utilization and so forth is going to be lower, and we will be bringing inventory down. Yes. Thanks for taking the questions. Last quarter, you had talked about the Reliant business or kind of one does with the decline in WFE and just kind of weakness in consumer electronics that, that business could also be negatively impacted. And it sounds like maybe this quarter, you are a little bit more constructive on that business. Is that, I guess the right way to think about it? And then two, maybe whatâs driving that? Yes. No, Joe, we didnât mean to describe it any differently. I think last quarter and this quarter, we said we expect that segment of foundry and logic to be somewhat better than overall WFE. I think we said that last time. I am pretty sure we did and we are saying that again. I think they may have come across â Joe, just a little bit â maybe a little more constructive than the other product lines that were within CSBG, I think why I think there was a question about kind of ranking them or stacking those. Itâs the least impacted by the changes like time restriction and utilization. That was â that was maybe why it came across that way. No intention to send a different message from last quarter, though. Got it. Thatâs helpful. And then just in terms of the total CSBG business, when we think about the impact from the China export restrictions, obviously, the utilization coming down just across the board is a negative impact. But would that business be, I guess closer to flat, itâs just kind of like-to-like without the China export restrictions? Itâs certainly being doing better and we described it as likely down somewhat. And historically, I have always said, this is a business that should grow every single year. I wish I wouldnât have said that because I couldnât envision the environment we are in with utilization in China and so forth. So, we are just giving you kind of the lay of the land right now, Joe.
|
EarningCall_1118
|
Thank you for standing by and welcome to the Heritage Financial Corporation Q4 2022 Earnings Conference Call. My name is Sam, and I will be your moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. [Operator Instructions] Thank you, Sam. Welcome, and good morning to everyone who called in and those who may call in later. This is Jeff Deuel, CEO of Heritage Financial. Attending with me are Don Hinson, our Chief Financial Officer and Bryan McDonald, our President and Chief Operating Officer; Tony Chalfant, Chief Credit Officer, will not be joining the call today due to a personal commitment. Our Q4 and full-year 2022 earnings release went out this morning pre-market, and hopefully, you have had an opportunity to review it prior to the call. We have also posted an updated fourth quarter investor presentation on the Investor Relations portion of our corporate website. We will reference this presentation during the call. Please refer to the forward-looking statements in the press release. We are very pleased to report another solid quarter and year. We had good organic loan growth. We are pleased with the positive trend we have seen in the number of new commitments and new loan closings from our existing production teams as well as the newer members of our team in Southwest Washington and Oregon. Net interest margin continues to improve with rates moving higher together with careful management of our deposit relationships. We continue to manage expenses. As mentioned in previous quarters, we are experiencing the impacts of inflation-driven expense increases, together with the additional expense related to the new teams who joined us in May. You will recall, we guided to non-interest expense in the $40 million range, which is where we came in for the quarter. Notably, our long-standing focus on credit quality and actively managing our loan [indiscernible] for us. Staying focused on our conservative risk profile has enabled us to continue to report improving credit trends, and it provides us with a solid foundation as we phase into a more difficult economic environment in 2023. We will now move on to Don who will take a few minutes to cover our financial results and credit quality metrics. Thank you, Jeff. As Jeff mentioned, overall financial performance was very positive in Q4, and I'll be reviewing some of the main drivers of our performance. As I walk through our financial results, unless otherwise noted, all of the prior period comparisons will be with the third quarter of 2022. Starting with net interest income, there was an increase of $3.8 million or 6.4% in net interest income, due mostly to a higher net interest margin. The net interest margin increased 41 basis points to 3.98% for Q4. This was due mostly to improved yields on earning assets while maintaining a relatively low cost of deposits. We continued the trend of solid loan growth in Q4 and finished the year with loan growth of $380 million or 10.3% ex-PPP loan repayments. In addition, yields on our loan portfolio were 4.86% in Q4, which was 35 basis points higher than Q3. Bryan McDonald will have an update on loan production and yields in a few minutes. The impact of higher yields on loans and other earning assets was partially offset by a decrease in total earning assets during the quarter due primarily to a decrease in deposits of $313 million or 5% in Q4. Most of this decrease was due to rate-sensitive customers seeking higher-yielding investments in addition to a significant portion of customers using excess cash for other purposes such as asset purchases and owner distributions. Of those seeking higher rates, most are going to brokerage firms to invest in higher rate bonds and T-bills. As an example, the Wealth Management division at Heritage Bank added $125 million in funds under management from Heritage Bank deposit customers during the quarter. We continue to strategically increase our deposit rates and develop attractive deposit products as well as working individually with our customers to maintain relationships. As a result of the current rate environment, we expect to continue to experience an increase in the cost of deposits as well as a decline in some deposit balances. As we have in the past, we may supplement core deposits with broker deposits. However, as of the end of 2022, we did not have any broker deposits on our balance sheet. All of our regulatory capital ratios remain strongly above well-capitalized thresholds. Our TCE ratio is at 8.2%, up from 7.6% at the end of Q3. Although the AOCI impact has decreased, it is still significantly affecting the TCE ratio. As of the end of Q4, AOCI had a 130 basis point negative impact on the TCE ratio. In addition, with a loan-to-deposit ratio of 68%, we have plenty of liquidity to continue to grow our loan portfolio. You can refer to Page 31 of the investor presentation for more specifics on capital and liquidity. Non-interest expense increased $1.2 million to $40.4 million in Q4. This was due mostly to increases in compensation expense resulting from continued inflationary pressures as well as higher FTE levels as we have been able to reduce the amount of our open positions over the last couple of quarters. Moving on to credit quality. I am very pleased to report that we ended the year with very strong credit quality metrics across our portfolio. During the quarter, we saw continued loan losses and had further reductions in our non-performing assets and criticized loans. As of December 31, non-accrual loans totaled $5.9 million, and we do not currently hold any OREO. This represents 0.15% of total loans and 0.08% of total assets. We moved one C&I relationship to non-accrual in the fourth quarter in the amount of $605,000. This was more than offset by $933,000 in loans that were either paid in full, made payments that were applied to principal or returned to accrual status. While non-accrual loans declined by a modest $320,000 during the fourth quarter, we have seen a significant reduction of $17.8 million or 75% since December 31, 2021. Our delinquent loans, which we define as those over 30 days past due and still accruing remains low at $5.4 million or 0.13% of total loans. While this is slightly higher than the previous quarter, most of the difference was connected to three mortgage loans that were part of a loan pool purchase in December, where there was a delay in receiving the payments from the original servicer. Those payments were received in early January. Page 23 of the investor presentation highlights the positive trends in our level of non-performing assets. Criticized loans, those risk-rated, special mention and substandard, declined approximately 10% or $15.6 million in the fourth quarter and are now down 26% from year-end 2021. It is worth noting that over the past 12 months, loans risk-rated substandard have declined by $47 million or 42%. As of December 31, criticized loans totaled $135 million or 3.3% of total loans. At year-end 2020, criticized loans were $291 million, and our current level represents a decrease of 54% from what we consider to be the high point of this credit cycle. While still high at 25% of criticized loans, our hotel portfolio continues to improve. In the fourth quarter, we saw a reduction of approximately $12 million in criticized loans in this category, primarily from the payoff of one loan. We continue to closely watch our portfolio of office loans. Through year-end 2022, we saw very little deterioration in credit quality. Criticized office loans totaled approximately $23 million or 4% of our total portfolio of office loans. For more detail on our criticized loans, please refer to Page 24 of the investor presentation. During the fourth quarter, we experienced very low charge-offs of $151,000, all from our consumer portfolio. These consumer losses were low when compared to historical norms and were primarily tied to auto loans, small unsecured lines of credit and credit cards. The losses were more than offset by recoveries of $359,000, leading to a net recovery of $208,000 for the quarter. A significant portion of the recoveries in the quarter came from the completion of a successful long-term workout strategy for a commercial real estate land development loan. For the full-year, we had net recoveries of approximately $1.2 million. This compares favorably to the net charge-offs of $526,000 that we experienced in 2021, also a very strong year when compared to historical performance. As we have stated in previous calls, our average annual net charge-offs for the three-year period, 2018 through 2020, was approximately $2.9 million. In 2022, our disciplined credit approach delivered excellent credit quality across portfolios while still realizing solid loan growth. While we recognize that 2023 may present a more challenging economic environment, we remain very well positioned with strong credit quality and a well-diversified loan portfolio. Thanks, Don. I'm going to provide detail on our fourth quarter loan production results, starting with our commercial lending group. For the quarter, our commercial teams closed $329 million in new loan commitments, up from $277 million last quarter and the same as the $329 million closed in the fourth quarter of 2021. Please refer to Page 19 in the fourth quarter investor presentation for additional detail on new originated loans over the past five quarters. The commercial loan pipeline ended the fourth quarter at $536 million, down from $604 million last quarter, and up from $462 million at the end of the fourth quarter of 2021. The pipeline decline was due to the strong volume of loan closings during the fourth quarter and the moderating demand for loan opportunities we have been reporting in the last two quarters. New commercial teams hired during 2022 have been adding to our loan pipeline and producing strong results as reflected on Slide 10 of the investor presentation. Loan balances in Eugene and the Portland MSAs increased 33% during 2022 and grew at a 54% annualized rate from June 30 through the end of 2022. The reported pipeline does not include any loan opportunities from our new team in Boise as this branch did not open until early January. I hope you have had a chance to read our January 10 press release where we announced our new Boise, Idaho branch. Loan growth was $50 million for the quarter or 5% annualized, which is below the growth rate we experienced earlier in the year. Although new loan production during the quarter was higher than any other quarter and we purchased a small residential mortgage pool, this was offset by a higher mix of unfunded construction loans and a decrease in the utilization rate, which led to a $20 million decline in net advances this quarter versus a $55 million increase last quarter. Please refer to Slides 20 and 21 of the investor deck for further detail on the change in loans during this quarter. Consumer loan production, the majority of which are home equity lines of credit, was $21 million during the quarter, which is down from $29 million last quarter and $23 million of production in the fourth quarter of 2021. The mortgage department closed $18 million of new loans in the fourth quarter of 2022 compared to $26 million closed in the third quarter of 2022 and $45 million in the fourth quarter of 2021 with mortgage rates remaining at higher levels. We anticipate volumes will continue at the relatively low levels we saw in the second half of 2022. Moving to interest rates. Our average fourth quarter interest rate for new commercial loans was 5.72%, which is 85 basis points higher than the 4.87% average for last quarter. In addition, the average fourth quarter rate for all new loans was 5.51%, up 62 points from 4.89% last quarter. Although the marketplace continues to be competitive, we are seeing a portion of the rate increases translate into higher quoted rates on new loans. Thank you, Bryan. As I mentioned earlier, we are pleased with our performance in the fourth quarter and for the full-year 2022. We are seeing solid organic production across the bank with deals coming from existing customers and new high-quality prospects. Additionally, we are seeing multiple new business opportunities coming from the new teams in the southern part of our footprint, and we expect the new Boise team to start contributing to the revenue line soon. Based on our current pipeline, we expect Q1 loan production to be in the mid single-digit range based on current deal flow. We will continue to focus on expense control with little or no increases in staffing in 2023 other than opportunistic hiring to strengthen our production teams. We have also maintained a focus on our technology strategy, which is designed to support more efficient operations, enabling us to do more with the same people and provide a more consistent customer experience. This also positions us well to pivot as bank technology continues to evolve and we continue to grow. Please see Slides 6 and 7 of the investor deck for more detail on our tech strategy. We are prepared to pursue acquisitions in our three-state region when we see the right opportunities for us. In the meantime, we continue to focus on opportunities to add new teams like we have done in Oregon and Idaho, as well as add individual producers throughout the footprint. Please see Slide 13 in the investor deck for a historical look back of our M&A and team lift-out activities. As Don mentioned earlier, our capital levels and our liquidity position provide us with a strong foundation to address unforeseen challenges and to take advantage of opportunities in the current environment. We are grateful to all of our employees for the constructive collaborative team environment we work in and for everyone's hard work and focus as we've contributed to the â as that has contributed to the success of the bank in 2022. That is the conclusion of our prepared statement, Sam. So we are ready to open up the call for any questions that people may have. Absolutely, Jeff. We will now begin the Q&A session. [Operator Instructions] Our first question today comes from the line of Matthew Clark with Piper Sandler. Matthew, your line is now open. Maybe just around the margin, trying to get some better visibility going into the first quarter here. The spot rate at the end of the year on interest-bearing deposits or total deposits [indiscernible] and the average margin in the month of December, if you have it? I'll take that, Matthew. Our spot rate for interest-bearing deposits in December was 32 basis points, up a little bit from the overall average of 29 â or 25 for the quarter. And then also the margin for December was 406. Same as, yes, that's what I thought. That's right. Yes. Yes. Okay. Got it. And then maybe just on deposits, they were down in the quarter. I know some of it moved to the wealth management platform you guys have. But it sounds like there's an expectation that deposits continue to decline here maybe in the next quarter or two. I would have thought some of those new bankers you brought over six, seven, eight months ago would have been able to mitigate some of those industry pressures. But I don't know if rates are making it difficult for them to bring over prior relationships or not both on the loan and deposit side. Any color there? Okay. Matthew, this is Bryan. I was just going to â if you look at Slide 10 in the deck, that's where the bulk of the new team members fall into. And so you can see on the deposit side, we had a little bit of decline in that market. It went from $748 million deposits to $724 million, so a little bit of decline, but lower deposits than what we've seen elsewhere in the bank. So with overall deposits declining, just not seeing as much impact. And then, of course, on the loan side, I commented on that. We've had nice increases in loan balances. So those will come a little quicker than some of the deposit balances. But we're seeing good activity across the footprint. Obviously, those teams are out calling and we're just doing what we can as an institution to support them. But we are seeing good momentum on both the deposit and loan side. Okay. And then just maybe for Don, on the non-interest expense run rate, pretty much in line with the guidance you gave, maybe on the higher end, but what are your kind of updated thoughts on the run rate coming into the new year and how it might transition or progress through the year? Yes. I think it's going to increase. We've got a couple of factors here. Again, we added Boise right at the â basically year-end. We've had a lot of costs in Q4, and we will have costs as we develop that office. In addition, the FDIC premiums are going up this year, and that's going to be about $1 million for the year, and so it's about â if you average that out about 250 per quarter. So I think it's going to be in the $41 million to $42 million range per quarter as a result [indiscernible]. In addition to overall continue some inflationary pressures that we're feeling. But overall, I think that we're going to end up. Thank you, Mr. Clark. The next question is from the line of Eric Spector with Raymond James. Eric, your line is now open. Hey, everybody. This is Eric on line for Dave Feaster. Congrats on a solid quarter, and appreciate you taking the question. Just wondering how you think about liquidity here and potential outflows. Cash is down to around 1% of assets. We continue to see outflows. How would you look to â would you look towards borrowing or potentially sell securities? How do you kind of handle defending your deposit base? Any color on there would be great. Sure. I will answer that. Yes. So I think we're going to â we might use a variety. We might be using â although we probably won't be adding to our investment portfolio, it does draw some cash flows there. I think we will utilize possibly some borrowings. I think it's going to be a mix of instruments we use, borrowings. Possibly, I mentioned in my prepared remarks about brokered CDs and we may sell some securities also, maybe just a variety of things to meet it. Obviously, there's benefits to in the short run of selling securities, but I think it hurts you, in a way as long run. One of our strategies this last year was actually to become less asset sensitive as we reach the peak at the rates. So when rates come back down, then we will be protecting some margin. So you're going to give that up if you start selling security. So we'll use a variety of methods to manage our liquidity, which we have a lot of with â again, with a loan-deposit ratio of 68%. We have plenty of room to manage this. Okay. Sounds good. Makes sense. And then you purchased some resi mortgages again this quarter. Just curious how you think about that going forward? We'll probably be doing some of that, but probably not to the extent we did it in 2022, but we will use it to do some supplement loan growth. In addition to, again, it's kind of a higher duration paper. So I think we're locking in some rates that way. Okay. Thanks. And then I just wanted to lastly just touch on capital. Stocks pulled back a little bit. How do you think about capital now going forward? Well, currently, we're maintaining our capital for purposes of growth. As you see, we've added a lot of teams, and therefore, we're expecting a lot of production in certain areas. And so right now, our first priority is growth. There's a chance we might be â we might have some buybacks, but it's not going to be certainly a focus. Wanted to circle back to the margin. I got your comments that kind of certainly entering 2023 with some momentum, I think the industry certainly participate on the upside with earning asset yields or pricing now weâre [indiscernible] for giving it back on the funding crunch in 2023. My guess is your â if you are a little more fortunate on the deposit side, I guess it's a long way of asking, should we expect to still outpace that deposit pressure and scratch out further margin increase? I mean, I'm looking more into the balance of 2023 and what you think about margin? Thanks. Jeff, I expect there to be some margin expansion through this year, but it will be contingent on, again, how much runoff deposits we might experience because the more runoff we have, the other actions we might need to take as far as borrowings, which are obviously cost a lot higher. And our loan growth, it would be another one. I'm expecting our loan growth to continue, which will help that. So I think those factors will be important. The third is just the overall rate environment. What happens there? Are they going to do 50 basis points and stop for a long time or will they can start coming back down? So there's obviously a lot of factors. But in general, I do expect our margin to expand some this year, although at a much slower pace. Okay. And that sounds fairly sustained. If we looked at sort of last cycle and how you performed versus peers on a margin, it seemed like that was â it had more of an extended run given the deposit franchise strengths â that would â all inputs aside, that seems like a fair assumption this time around? Okay. And then on the loan growth, I may have missed it. I think it kind of pointed to mid-single digit in Q1. Did you round that out for the balance of the year in terms of full-year growth? We did say mid-single digit, Jeff, in the text and â it's just â it's hard to see too far out there. Historically, we've said mid to high-single digits. I think in a nice â a more positive environment, we might see it pick up some. I think we're also waiting to see what we're going to get in the new year from some of these teams. But you know that we always take a pretty conservative approach on our loan growth. So that's why you're getting that mid-single digit. Got it. And Jeff, I â Don kind of answered the capital question, and I'll circle back. I think you said we'll continue to look at M&A and look at team ads. Any more inbounds in terms of sellers in the region? Or has it been pretty quiet? It's still pretty quiet and has been for quite a while, as you well know. We just continue to have our conversations stay closed in the event that somebody decides to do something. But for probably the first half of next year, I don't see much happening. Apologies if I missed this in earlier comments, but did you provide the new production yields for the quarter? Just new production loan yields? Yes. Andrew, for new commercial loans, it was 5.72%, which is up from 4.87% last quarter. And then for all new loans, it was 5.51% which is up from 4.89% last quarter. Okay. Got it. Thank you. And then do you have a breakdown for how much of your fixed rate loans or adjustable rate loans repriced over the coming year? And then also just the amount of cash flow for the securities book. I'm just trying to get a sense for kind of overall earning asset repricing dynamics looking throughout 2023? Well, Andrew, if you go to Page 29, actually, of the investor presentation talks about the repricing. So we break it up into floating rate, which is under three months. And then adjustable rate and then fixed. So you see that about 16.6% of overall assets repriced at about 22% of loans, repriced in less than three months and half of that is about prime and the other half is LIBOR. So that helps you there. Yes. I guess just for the â I'm trying to get a sense for the adjustable piece, the 17%, the fixed rate of 65%, just how much of that could have a potential rate reset higher throughout 2023, just thinking about kind of longer term, if the Fed were to pause, just thinking about maybe kind of longer term earning asset repricing benefits? Okay. I would say just on kind of looking back â previously, I haven't looked it up for this quarter, but I would say probably without that adjustable rate, probably another 20%, 30% of that is probably going to reprice this year. Okay. That's helpful. And then is there a way to quantify the â I know you mentioned some rate-sensitive depositors leaving the banks that led to the deposit decline this quarter. Are you able to quantify how much the deposit decline was kind of due to rate sensitivity from your customers? And have you identified kind of what you view as maybe surge deposit balances or rate-sensitive deposit balances remaining that could be at risk of migration moving forward? Sure. So as far as the surge deposits, that's a hard one. We've had a lot of change since, you might say, the beginning of COVID. We were at, again, I think $4.5 billion or $4.6 billion in deposits. Then we peaked to $6.5 billion in early 2022, we're down to $5.9 billion. But we've also â at the same time, we added, I think maybe 1,000 customers through PPP. We've added teams of people, various producers. So where that should finally shake out, it's kind of hard to say if you talk about surge deposits. I think we're continuing to see some outflow similar to what we saw in Q4, at least in the first part of the quarter. I expect that to slow down as we get further into the year. So it's really hard to give you a number on where that's at. And Iâm sorry, what was your first part of that question? I don't have, again, a number, but from getting the intelligence from our bankers out there, I would say, 80%, 90% are probably due to rates. Some of it's asset purchases, some of it's order distributions. So there was some of that going on, but I would say most of it's due to rates. Andrew, what Don is quoting how the deposits change through the last couple of years, what also complicates it is you'll recall that we gathered up a lot of new customers as a result of our work around PPP. So they're embedded in there, too, and that includes their surge deposits, but also their operating deposits as well. So it's pretty complicated. Yes. No, understood. Well, I appreciate you guys taking the time for the questions today, and the rest of mine have been asked or addressed. I'll step back. Hi. Kelly with KBW. Thank you. Thanks for the question. Most of mine have been asked and answered at this point. But I was hoping to get a little color on your office portfolio. Your exposure is a little bit larger than some of the other banks that follow. I know you guys are really conservative on the lending front. But can you just provide any color on kind of the location of that, whether it's downtown versus suburban? And any sort of credit metrics would be helpful. Yes, Kelly, just to give you a little bit of perspective, we consider the core locations to be the ZIP codes in the primary downtown markets of Seattle, Tacoma and Portland. And if you focus on those areas, we don't have a lot of exposure there. I think it boils down to a total of 27 loans with total outstandings of just under $48 million, which boils down to 8.3% of the office CRE portfolio. And those would not be the high-rise buildings that are experiencing the highest levels of vacancy. They're probably medical facilities or whatever that might be in those markets. But if you look at our criticized office loans, for example, they totaled $23 million. And there's â I think it boils down to about 15 loans, and three of them are considered in those core markets. So our exposure is pretty limited. And while we are seeing vacancy for downtown offices, to be going up, we're not necessarily seeing a significant impact in the broader market. You might be reading about all of the tech companies would be sort of breathtaking numbers of people that they're laying off, which is something we haven't seen in a long time and that industry hasn't seen probably ever. But I think for us, those layoffs are still kind of to be determined for the Puget Sound area. And we think that the impact will be roughly proportionate to the overall size of the company's footprint and geography. So while it will have some impact as we go along, it may not be as significant as the numbers would imply. We also are seeing some of the tech companies reducing their footprints for hybrid work in addition to the headcount reductions, but we've been seeing that for several quarters now. So that's not necessarily new. And I don't get the impression this is a bubble bursting. I think it's more a correction for the tech companies. But overall, as you can see from our credit quality metrics, things are pretty benign right now. I appreciate all the color. I guess more broadly speaking, are there any other areas that you think, from our seat, we should be watching more closely? Not for us in this region. I mean, we just got some information from our chief appraiser. He gives us an update every month. And there's a little softening in industrial and multifamily not significant enough to necessarily cause concern. Retail is actually pretty good right now. And hospitality, we know the hotel portion of the market is still in recovery mode. But as we've said in some of our comments, even our hotel portfolio is improving. One of the â I guess, the metrics that I watch for is what's going on with single-family. And you know we had a pretty significant rise in values of homes in the general region, people moving around and buying new homes in different markets. But the information we have would suggest that while things have slowed down a little bit, single-family housing maybe pricing dropped back from what it was at the end of the year to what it was maybe at the beginning of the year. But there's still not a huge amount of houses available, which obviously keeps the price up. So for now, we're feeling pretty comfortable with where things are and what's in our portfolio. Thank you, Kelly. We have no further questions waiting at this time. [Operator Instructions] Seeing none, it's my pleasure to hand the call back over to Jeff for any additional remarks. Jeff? Thanks, Sam. If there's no more questions, we'll wrap up this earnings call. We thank you for your time and your support and your interest in our ongoing performance, and we look forward to talking with many of you in the coming weeks. So goodbye, and have a good day. That concludes the Heritage Financial Corporation Q4 2022 earnings conference call. There will be a replay available shortly hereafter. You may access the replay by dialing into the toll-free number 866-813-9403, and entering access code 855414. Thank you all for your participation. You may now disconnect your lines.
|
EarningCall_1119
|
Good day, ladies and gentlemen. Thank you for standing by. Welcome to Houlihan Lokeyâs Third Quarter Fiscal Year 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note that this conference call is being recorded today, January 31, 2023. Thank you, Operator, and hello, everyone. By now everyone should have access to our third quarter fiscal year 2023 earnings release, which can be found on the Houlihan Lokey website at www.hl.com in the Investor Relations section. Before we begin our formal remarks, we need to remind everyone that the discussion today will include forward-looking statements. These forward-looking statements, which are usually identified by use of words such as will, expect, anticipate, should or other similar phrases are not guarantees of future performance. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect, and therefore, you should exercise caution when interpreting and relying on them. We refer all of you to our recent SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. We encourage investors to review our regulatory filings, including the Form 10-Q, for the quarter ended December 31, 2022, when it is filed with the SEC. During todayâs call, we will discuss non-GAAP financial measures, which we believe can be useful in evaluating the companyâs financial performance. These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measures is available in our earnings release and our investor presentation on the hl.com website. Hosting the call today, we have Scott Beiser, Houlihan Lokeyâs Chief Executive Officer; and Lindsey Alley, Chief Financial Officer of the company. They will provide some opening remarks and then we will open the call to questions. Thank you, Christopher. Welcome everyone to our third quarter fiscal year 2023 earnings call. We ended the quarter with revenues of $456 million and adjusted earnings per share of $1.14. Revenues were down 49% versus the same quarter last year and down 7% from the previous quarter. When comparing to last yearâs third quarter, bear in mind that our December 2021 quarter was extraordinary. In fact, the prior year quarter was substantially higher than any previous quarter in our firmâs history, both in revenues and adjusted EPS. Furthermore, numerous external market factors have altered the typical seasonality of the M&A market globally. This year our results are consistent with the industry trends and that our December 2022 quarter was less than our September 2022 quarter. This is the first time our December quarter results were lower than our September quarter results since December 2008. While this quarterâs financial results are disappointing, we are encouraged by the fact that our nine-month year-to-date results are the second best in the firmâs history. Corporate Finance quarterly revenues were $292 million. We saw an increase in transaction closings this quarter versus last quarter offset by a reduction in average transaction fees. New Business activity remains robust as the number of new engagements was a quarterly high for this fiscal year. Partially offsetting these positive factors is that the financing market remains challenged. Mid-cap transactions can still get financing, but lenders are more selective. The cost of debt is up significantly and some lenders have opted to sit on the sidelines until they perceive better visibility on the economy. This has resulted in pent-up demand in M&A, which we believe will ultimately be a positive for our business once there is more broad-based confidence in the economy. Financial and Valuation Advisory recorded $66 million in revenues. The decline in revenues versus the same quarter last year was primarily driven by lower revenues in transaction opinion and transaction advisory services. Both service lines were affected by reduced M&A activity, especially in the public marketplace. However, our portfolio valuation service line continues to do well and in certain circumstances, benefits from a more volatile market. Financial Restructuring produced $99 million of revenues, another very strong quarter. For each quarter of this fiscal year, Financial Restructuring experiencing an increased number of closed transactions and an increased number of new engagements versus the prior quarter. Restructuring continues to see strong new business activity adding to our confidence in this business segment in the second half of the calendar year and throughout calendar 2024. New Business and Financial Restructuring is broad-based across all major geographies and most industry sectors. Our long-term focus on growing our business both internally and externally continues. We hired five managing directors this quarter. We announced the acquisition of Oakley Advisory, a digital infrastructure investment banking firm in the U.K. and we continue to have a robust pipeline of quality acquisition targets. Finally, I wanted to end todayâs comments with a recognition to all three of our business segments and the bankers that continue to deliver exceptional results to our clients and our shareholders. In calendar 2022, we continued our string of league table successes. Houlihan Lokey was ranked as the number one investment banking firm for all global M&A transactions under $1 billion and all transactions regardless of size in the U.S. based on transaction volume. We are again ranked the number one investment banking firm for all Financial Restructuring transactions, both in terms of value and volume. In addition, we were ranked as the most active fairness opinion firm by volume when measured for the period over the last 25 years. Overall, we are proud of our accomplishments in calendar 2022 and we fundamentally believe that our business model positions us effectively for long-term growth and strong shareholder returns. Thank you, Scott. Revenues in Corporate Finance were $292 million for the quarter, down 7% when compared to last quarter and 59% when compared to the same quarter last year. We closed 125 transactions this quarter, compared to 114 last quarter, but our average transaction fee on closed deals was lower. Financial Restructuring revenues were $99 million for the quarter, an 11% increase from the same period last year. We closed 28 transactions in the quarter, compared to 21% in the same period last year and our average transaction fee on closed deals was lower. In Financial and Valuation Advisory, revenues were $66 million for the quarter, a 21% decrease from the same period last year. We had 876 fee events during the quarter, compared to 901 in the same period last year. FVAâs quarter was heavily influenced by the slowdown in M&A activity for the quarter, both the transaction opinion and transaction advisory service lines were down versus the same quarter last year. Turning to expenses. Our adjusted compensation expenses were $281 million for the third quarter versus $547 million for the same period last year. Our only adjustment was $8.6 million for deferred retention payments related to certain acquisitions. Our adjusted compensation expense ratio for the third quarter was 61.5%, the same as last year. Our adjusted non-compensation expenses were $73 million for the quarter, an increase of $14 million over the same quarter last year, but flat versus last quarter. This resulted in a non-compensation ratio of 15.9% for the quarter. We believe that our non-compensation expenses have settled into a post-COVID norm relating to TM&E and other operating expenses. We still see pressure on rent with additional space supporting our growth and general inflation, and we expect to continue to invest in technology as a point of differentiation as the firm grows. We continue to believe that our long-term target for our non-compensation ratio will be lower than what it was pre-COVID given the increased size of our business. However, we are seeing some pressure on that ratio this year given the current business climate. For the quarter, we adjusted out of non-compensation expenses, $10.4 million in non-cash acquisition-related amortization, the vast majority of which was amortization related to the GCA transaction. Our adjusted other income and expense decreased for the quarter to income of approximately $2.2 million versus an expense of approximately $300,000 in the same period last year. We adjusted out of our other income and expense, $2.7 million related to the wind down of the SPAC that we co-sponsored. Given the wind down, there is no remaining asset related to the SPAC on our balance sheet. Our adjusted effective tax rate for the quarter was approximately 25%, compared to 30% when compared to the same quarter last year. Although, we received some benefits this quarter, which slightly reduced our effective tax rate, we continue to target a long-term range for our effective tax rate of between 27% and 28%. Turning to the balance sheet. As of the quarter end, we had approximately $586 million of unrestricted cash and equivalents and investment securities. As is typical during our third quarter, the cash position was affected by a November payment of cash deferrals relating to bonuses accrued in fiscal year 2022. In this past quarter, we repurchased approximately 100,000 shares at an average price of $91.65 per share as part of our share repurchase program. We continue to be disciplined regarding share repurchases as we look to maintain balance sheet flexibility. Finally, the Board approved the quarterly dividend to be paid in March and also approved a change to our Board Committee structure, where effective immediately, our Compensation Committee and our Nominating and Governance Committee will be comprised solely of independent directors, consistent with our Audit Committee. So thanks for taking the question. I would love to start on Corporate Finance. So you spoke to financing becoming more challenging from banks, and so clearly, that was impacting the December quarter. But how has that -- have you noticed any change here early in 2023, how is that continued availability trending here so far, has there been any change and how should we be thinking about the outlook for mid-market M&A? On the financing front, Iâd say, we have seen a slight improvement during the month of January versus the previous quarter in financings. I think there were some lenders who just did not want to deploy any capital on their books when they closed them out on December 31. So they were, Iâd say, slightly more open-minded in terms of finding opportunities to lend, but itâs still a marketplace thatâs rather challenged out there. Okay. And should we therefore keep our expectations toned down so long as the financing markets remain challenged as far as Corporate Finance goes in M&A? Iâd say thereâs a dichotomy going on, which for the last several months, the last few quarters, Iâd say, the amount of new business, the size of our prospects, pipeline, backlog, however, you might count it, actually continues to grow. Thatâs the very positive sign. But really have not seen a definitive turn in the marketplace yet, whether itâs willingness by buyers and sellers or lenders and borrowers to come together. So the transactions are occurring. They are just not occurring at the pace that we would think is typical for the size business that we have already got signed up. So I think we are all still waiting for eventually that improved pipeline to ultimately turn into revenues, but just havenât seen a definitive turn in the marketplace at least as of yet. Okay. All right. Thanks for that. Thatâs appreciated. Iâd love to use that as a segue to my follow-up question, which would be, if we do see continued challenging climate and environment, particularly for M&A and Corporate Finance, is there a point where your normally, very predictable, very reliable and very boring 61.5% comp ratio begins to see some upward pressure, maybe it becomes a little bit less boring? How should we be thinking about that and is there any point in which maybe it starts to become a bit more of a concern for you at least in the short-term? I think all we can point to is, since we have gone public, we have had a very tight range and I believe itâs almost as tight as anybody in terms of what our payout ratio is and itâs typically not very much year-to-year or within the year. And as we see the marketplace as we see the results of our business, I think, we are still comfortable with the 61.5%. I donât think you can ever say that it will never change, but thereâs nothing sitting here in our minds right now that suggests itâs going to change in the foreseeable future. And Iâd say, Brennan, even pre-public in the two recessions that occurred early 2000s and kind of 2008, thereâs precedence of us managing to a fairly tight range as well. So I think we certainly have history to help us answer that question, but I agree with Scott, nobody knows what the next six months is going to look like. Hey. Good afternoon. You noted that the average transaction fees were lower this quarter. Is there anything specific driving that? Is it just a lower size of deals? Is it more competition? Can you talk about how we should think about that going forward? I think itâs hard to think about it going forward. It is really going to be a little random quarter-by-quarter. We kind of think about average transaction fee on an annual basis, and Iâd say, if you look back over the last 15 years, we have pretty consistently increased our average transaction fees over that time period. Itâs just sometimes in the quarter, you will have swings based on size. Iâd say, there was no store here at all and you will unfortunately continue to see some swings quarter-by-quarter, but the long-term trend is obvious if you look at the numbers. Great. And you also spoke about the pent-up demand in M&A. So is it really just the financing market thatâs holding things back? Can you talk about what you are hearing from clients as we get closer to the Fed maybe stopping their rate hikes and how -- where buy and sell expectations on the bid ask right now? Yeah. I think itâs a combination, interest rates and financing availability is one thing, where people think the economy is going, where a companyâs near-term earnings, expectations are different peopleâs views on valuations, all of that is impacting the decisions and the speed of which people are able and willing to close transactions. I just have one on the Restructuring cycle. Hi. How is going? Just last quarter you expressed some optimism overall that this Restructuring cycle could be elevated for what feels like a prolonged period of time. Just wanted to take your pulse on that, just kind of given where that the sentiment stands today, just given that thereâs been maybe some shifting of expectations for maybe a soft landing more recently? And I guess even from like a headline standpoint, I think, a lot of the large activity you have seen at least from news flows related to the crypto space. But curious in terms of what impacts you guys, what you are seeing as challenged areas in industry verticals and regions that more directly impact Houlihan? So, overall, Iâd say, we are more optimistic on what we see going forward with Restructuring than we were a quarter or two quarters ago as it just continues to build. Iâd say, if you think of it as kind of a water spigot. It just keeps opening up a little bit more and more, itâs not fully open and we donât expect to see a full flush out like we saw maybe in Spring of 2020 or the Great Recession of 2008, but it is a kind of a full-fledged increased Restructuring environment globally. So not only in the United States, Western Europe and Asia, but really almost all other parts of the world and itâs impacting a whole litany of industries. I donât think there is a particular leading industry. Crypto, which has obviously gotten some news, but itâs just one of many, many pieces out there and we continue to see a build of our business and whether itâs on the debtor side or credit or side, U.S. or outside of the U.S. among a variety of different industries. So the expectations and just where the marketplace is, kind of where interest rates are, where financing is, kind of the never ending movements in the maturity wall, all that leads us to believe that it will be a good, and probably, better environment for Financial Restructuring for at least the foreseeable future. And just going back to Brennanâs question, which was kind of the million-dollar question, which how should we think about M&A over the next 12 months and thatâs probably not just for Houlihan but for anyone in the industry is, we are in an unusual circumstance where we are seeing increased activity in Corporate Finance relative to the last quarter and increased activity in Restructuring relative to the last quarter, which is unusual. It just normally does not happen that way and so there is, call it, half the population out there that believes in the soft landing and half the population out there that thinks itâs going to get ugly. And so very hard to go back and answer Brennanâs question until we really see some inflection point that shows a direction. Yeah. Makes sense. And then kind of just switching gears, just thinking about kind of your capital priorities from here. I know this quarter, you guys announced that you would be keeping the dividend flat for this coming quarter and the second quarter of relatively light buybacks. So just coupling this with the comments you made last quarter kind of citing a pickup in conversations with acquisition, targets, as well as the announced Oakley Advisory acquisition. I guess how should we think about the M&A outlook from here, I am assuming thereâs still more by way of conversations, but just kind of curious on any updates there on capital priorities overall, as well as M&A specifically? So I will let Scott handle the M&A question and I will just start with the capital priorities. I think with respect to the dividend, if you just go back in time, our normal cadence is our Q4, which is next quarter and so it would be unusual for us to increase the dividend this quarter or have any effect on the dividend this quarter. With respect to share repurchases, I think, we have called out for the last couple of quarters that we are going to be conservative with respect to share repurchases. As you saw during COVID and as you heard from Scott in his comments, we do tend to see a bit more M&A activity during periods like this and making sure that we have balance sheet flexibility, I think, is prudent, going through a dislocation in the market, so not dislocation, itâs probably too strong a word, but stubbornness in the markets like the way we are going through -- like what we are going through now. And then I think with respect to M&A activity, I think, I have kind of answered that question. That is an important component of capital allocation for us. We feel like it is the most accretive to shareholders and thatâs going to continue to be a priority for us to put money to work through our acquisition strategy. I think with respect to what we are seeing out there, Scott, can highlight some of what he talked about. I think we are experiencing still a relatively active marketplace for us as a principal to acquire interesting and hopefully additive businesses to our organization. We never know whether everything we are talking to will close or none of them will close and they all take a different time line. So as Lindsey had said, we try to factor in the magnitude of what we are looking at, maybe some probability assessment of what we are looking at in closing kind of what other of our cash needs are, and I think, thatâs probably. Itâs a combination of a variety of factors that have tempered a bit our repurchases over the last quarter or two. Great. Thanks. This is Brian McKenna for Devin. So the syndicated credit markets are still largely shut, but the private credit markets are functioning and are filling this fold in a pretty meaningful way. So how has this impacted your capital markets business and what kind of opportunities does this create near-term and over the longer term for this business? So short-term, the reduction in total number of players that are able or willing to provide financing and the total number of deals that you have got willing buyers and sellers is down, so that puts some negative pressure on our capital markets business. On the long-term, we think, in fact, whatâs occurring is going to be good for us and the rest of our industry participants. Effectively, when itâs harder to find capital, we have always said our typical competitor here is not another investment banking firm, itâs the CFO who believes that he or she can do it themselves or itâs a private equity firm who believes they can do it themselves. So as things have gotten a little more difficult over the last year, we are seeing more people turning to institutions like ourselves to go raise that financing for them. So like I said, short-term, still probably is a little rocky compared to a year ago, but long-term, we think actually whatâs happening much like what happened in the 2008, 2009 time period will result in a more positive trend for aging of a financing in the private marketplace, which is what we specialize in. Helpful. Thanks. And then just bigger picture, thinking about the next leg of growth you clearly have deep relationships with sponsors and continue to expand related capabilities. But what else can you do with sponsors longer term that could drive some incremental growth across the business? So, first of all, I think we have been very dominant and successful in our financial sponsored arrangements out in the U.S. and we are growing rapidly in Europe and then we will continue that pace in the Middle East and Latin America and Asia, et cetera. So thereâs some geographical expectations that we have. And we continue to find incremental types of services that we can provide to many of these financial sponsors. So part of it is learning what they need and what they want as long as it fits the kinds of services that we have or could continue to expand, thatâs part of the growth strategy. I just wanted to start with the sponsors versus strategic point here. Maybe you could just talk about the differences in -- among your clients across strategic sponsors, where they are seeing roadblocks to engaging and closing transactions, and what this might mean for the mix of sponsor versus strategic deal making over, letâs say, the next two years or so? Yeah. I donât think we see or expect major changes in what we have experienced over the last couple of years in any given small quarter trend at times you see sponsors more active in our book of business than financials and vice versa. But the financial sponsors are still incredibly important. There continues to be more of them. They are still raising money. They are still deploying it. They are probably just taking more time in deciding what they want to do or when they get started or when they are waiting for a particular key point of when they want to approach the marketplace, whether itâs on the sell side or buy side. So we still think itâs an important part of our business and for the industry at large. Okay. That makes sense. And then just on the Restructuring business, is there any ability to sort of contextualize where you are seeing most of these new mandates you talked about being announced? Is it on the debtor side, creditor side and then are they more liability management or traditional Restructuring assignments? Itâs really in everything that you have mentioned. In different parts of the globe, we tend to be maybe slightly more active debtor oriented and creditor, a quarter ago, probably, had a little more better type of work recently. Itâs been maybe a little more creditor oriented, depending upon the particular company situation, sometimes it starts in the liability management side, sometimes itâs right into a transaction that might immediately lead into a bankruptcy filing. I wouldnât say that there is a particular unique trend out there. Itâs -- really, I think, just a lot of its catch up, companies that probably just donât have the right business plan. You still have some technology disruptors. You obviously have higher interest rates and the ability to refinance any of the situations that you could have done 12 months or 18 months ago is not the same today. And therefore, thatâs why we have got a -- Iâd say, in some regards, itâs just a pent-up demand for Restructuring that maybe the ordinary course should have occurred over the last one year or two years, had the central governments not be as helpful in providing liquidity in the system. So, Scott and Lindsey, I wanted to try and set out some guidance on how we should be thinking about the FVA business. And now this was a business that was growing at a relatively consistent, letâs call it, like mid single, high single-digit type clip up until COVID and then you saw this meaningful step function higher, where you have been running somewhere in like the $75 million plus or minus type per quarter zone and this is the first quarter where we have actually seen like a decent step down, even more acute than what we saw in Corp Fin, which was merely a bit surprising. You have been gaining share in that business fairly steadily. You talked about some of those things on the last quarterâs call. I was hoping to get some perspective on how we should think about the jumping off point for this year, recognizing the M&A environment remains challenged, but your franchise continues to gain pretty strong momentum. Whatâs a reasonable expectation for revenues for that business? It is historically the most steady of our businesses. You are correct, statistically, it took a bigger drop than some of our other business segments over time. Occasionally, this group does end up with some, for its business, some sizable projects just didnât have many of those in this particular quarter. So you will occasionally get a little bit of a lumpiness. I think the diversification that we have in the service lines is still the right mix that we have. But it is being impacted negatively to some extent, like, Corporate Finance and at least in the public M&A space, which has come down from where it was a year ago. But we think the ultimate trend lines in terms of growth potential is still there. We have got more senior bankers in there as we ever have. We have the biggest staff that we have ever had there. We are more global in our reach than we have done in the past. We continue to introduce kind of some sector expertise into what historically was probably much more just service line oriented and kind of would just chalk it up things didnât fall into place in that December quarter and would expect to continue to see some growth from that standpoint. What is a normalized level? Probably be a little better now after another quarter or two recognizing, like you said, that we did have a decline this quarter. I think we will all know a little bit more in the next quarter or two on how those quarters shape up to be able to give you a little more guidance on what should be the normalized level and running off from there. No. Thatâs great color, Scott. And just one follow-up on the comments regarding the myriad of factors impacting deal activity. What I wanted to suss out is whether you still expect to see the inflection in M&A activity sooner relative to peers? I know, historically, your franchise tends to feel the pain first when the environment slows, but also typically recovers more quickly as activity picks up? Yeah. I think we still believe that, thatâs the nature of the mid-market business. It is going to draw down a bit and speed up quicker than others. I think what we would all like to see is a consistent trend instead of things like almost every two months, the market tone goes from, oh, yeah, we are definitely going to have a soft landing to, oh, yeah, a definite recession is occurring, oh, yeah, interest rates are going to stay up higher and longer than we thought to maybe now they are not, all of that. Look, we have had a better month in the stock market and bond market during January, but February could be a reversal of that or it could be a continuation trend. I think we have commented in the past that as time goes on and we are not in either a decreasing stock market or at least not a significant decreasing, buyers and sellers are getting closer and closer to hitting that point of equilibrium, so I think that is improving with time. Thereâs probably some impatience level by the private equity firms to eventually start deploying capital. And then the question we answered earlier, Iâd say, the financing marketplace at least in the mid-cap space, slightly better in January, but not enough to say, yeah, we are back into an environment where we can finance meaningfully more deals than has been occurring in the last couple of quarters. That just hasnât happened yet. Thatâs great color, Scott. Thank you. And if I could squeeze in one more quickly, just given you have had 12 months of GCA results under your belt, I was hoping you could speak to how the business performed this year and whether you are seeing any evidence of those revenue synergies coming through, whether thereâs any tangible examples that you can cite in that regard? So, as you said, we have been with GCA for a year. We donât break out the GCA business, and as you know, a good chunk of GCA was nontechnology. So we have merged essentially all of the GCA operations into the individual industry group. So hard to tell from our publicly disclosed numbers how GCA is doing. We are thrilled with the acquisition and how itâs come together. I would say, especially in Europe, we have seen the revenue synergies that we see on every transaction, where we see a meaningful increase in average transaction size and average fee, and as you know, Europe was more than 50% of their business. So we have lost very few individuals since we did the transaction, so the workforce is still in place. So I mean we are excited about the acquisition a year out, and as you know, technology has been one of the more affected industry groups. GCA has seen that in their results. But again, the important thing to us is that we have the workforce in place that we acquired a year ago. We are seeing those revenue synergies that you alluded to, especially in Europe and the collaboration among the deal teams across really all three product lines has been as good as we have seen on any acquisition. Yeah. I would just further say that the interaction between the bankers, the interface with the clients has been probably better than we would have ever mapped or thought out the negative is taking a little longer and a little bit more money to do some of the back-office consolidations and synergies, just different IT type of systems, different payroll systems, different geographies, all of those things just certainly take a little bit longer. We will get to it and we feel we have made a lot of headway. Itâs taken us a little longer on the back office stuff and on the front interrelationship on the client-facing side, we think itâs been actually very excellent. Hi. Good afternoon. I think most of my questions have been asked and answered. Maybe just a follow-up on FX and the impact that the euro, the pound and the yen movement are having on revenue and expenses. We are seeing a fair amount of volatility both up and down in FX. So what is sort of the flow-through on currency movements through revenue and expenses? So itâs been negative on the revenue side. I mean overly simplistic, you can look, call it, roughly a quarter of the business is non-U.S. and exchange rates, while they have gotten a little better, depending on what perspective you got here, but the dollar has still strengthened against almost every other currency and so itâs put some negative elements into the amount of revenues that we are ultimately presenting when it gets converted into U.S. dollars. You are going to have the same thing on the expense side. But, ultimately, we have got more revenues and expenses. So the currency exchange marketplace in calendar 2022 has negatively impacted our revenues. Not enough to explain the decline that we or the industry in general have seen, but itâs added just one extra equation to it. Yes. We donât have any -- we are pretty much perfectly hedged with respect to our expenses and our revenues, both compensation and non-compensation. Revenues in theory are coming in periodically and bonuses get paid, in our case roughly two times a year. So you are not necessarily perfectly matched from a timing standpoint, but Lindseyâs correct for the most part, where our revenues and costs country by country are reasonably close. Hey. Good afternoon. I will just maybe follow up on the new deal activity. I am just trying to wrap my head around how you are talking about record backlog and new business activity remaining quite robust, but financing markets being mostly shut. It doesnât seem like thereâs any hesitation from your client base to at least engage in new, at least discussions or transactions. So I am just -- why do you think that is? Whatâs driving the, I guess, the urgency to at least have dialogues or sign new deals today if they are worried about financing and macro uncertainty? Yeah. Good question. Iâd say that the M&A process, given the length, which is, call it, nine months on average, a lot of private equity groups are betting, strategics are betting that there will be a soft landing and so why not sign us up, get it started, put your materials together, get ready to go to market and then at the appropriate time in the next one month, two months, three months, five months, we will go to market. So it is really just the groups that are signing us up generally believe that we will see improvements in the economy and they just want to be prepared to take advantage of it. I mean I think thatâs the dynamic. If you -- if we end up falling into a deeper recession over the next six months, I think, you will see some of those new engagements probably unwind. But Iâd say that, thatâs why you have got this -- going back to Brennanâs question, you have got this difference between half of the clients are probably optimistic about the next several months and half of them are a bit more pessimistic. Right. Okay. No. Thatâs helpful. And then just maybe circling back on the Restructuring, we have seen a pretty big pickup in debt issuance at least in the investment grade and even high yields in the public markets. Do you have to worry, I mean, you seem very confident in the Restructuring outlook. But if that continue -- that spigot continues to open up, does that start to dampen things or are you pretty agnostic that, hey, thereâs a lot of at least liability management that has to happen given the change in rates and we are not so concerned about whether they go to bankruptcy or not? Yeah. In Restructuring when you get hired, the probability of getting to a closed conclusion is very, very, very high, much, much higher than the classical M&A. So we are obviously looking at the amount of business that we have signed up and even if interest rate environment improves, even if the economy improves, even if certain things happen, these are usually companies with a variety of issues. Part of it is their capital structure, part of it is their business model itself and so we have, Iâd say, a reasonably good confidence level that a lot of that work will end up in a closed transaction in some normal time period and you typically do get paid along the way as well as a transaction fee. So I think the things you are talking about once again are on the margin and donât appear to be altering the opportunity in the Financial Restructuring marketplace for ourselves and our competitors. Hey. Thanks for taking my follow-up. Just maybe a little -- similar to my initial question, but a bit more tactical approach. In your prepared remarks, you spoke to the typical December quarter seasonality not really being there. So how should we think about your fiscal fourth, time lines are stretching, which is a bit similar to your -- the prior setup, but the financing has loosened marginally a little. So how are you thinking that, that could play out and should we count on some seasonality here in the March quarter? So I will give you the positives and negatives, and then the positive, in theory, any of the deals, as I mentioned, where some lenders potentially just didnât want to have something on their books by December 31st might be inclined to get something done in this March quarter. Houlihan Lokey, which is a March fiscal year-end, so we tend to have an internal push different than some of our other peers for December 31st. So all thatâs a positive fact pattern. The negative fact pattern is, unfortunately, I think, for most of calendar 2022, our expectations starting in the beginning of the month. We are always a bit optimistic relative to where we ended up at the end of the month and in contrast, just the opposite happened in calendar 2021. So just donât have enough conviction yet to say, oh, yeah, we have finally brought down the expectations of our internal bankers in the marketplaces heading us to a brighter future. So net-net, we think things are, Iâd say, slightly better moving forward, but just havenât had enough, Iâd say, consistent months where we would say, yeah, we have hit that inflection point and things should definitely be growing from here. Thatâs, I guess, as much clarity we can give ourselves and you at this juncture. And with no other questions in queue, I would now like to turn the call back over to Scott Beiser for any additional or closing remarks. Well, I want to thank you all for participating in our third quarter fiscal year 2023 earnings call and we look forward to updating everyone on our progress when we discuss our fourth quarter and full year results for fiscal 2023 this coming spring.
|
EarningCall_1120
|
Good day, ladies and gentlemen, and welcome to Northrop Grumman's Fourth Quarter and Year-End 2022 Conference Call. Today's call is being recorded. My name is Norma, and I'll be your operator today. [Operator Instructions]. I would now like to turn the conference over to your host today, Mr. Todd Ernst, Treasurer and Vice President, Investor Relations. Mr. Ernst, please proceed. Thanks, Norma. Good morning, and welcome to Northrop Grumman's Fourth Quarter 2022 Conference Call. We refer to a PowerPoint presentation that is posted on our IR web page this morning. Before we start, matters discussed on today's call, including guidance and outlook for 2023 and beyond, reflect the company's judgment based on information available at the time of this call. They constitute forward-looking statements pursuant to safe harbor provisions of federal securities laws. Forward-looking statements involve risks and uncertainties, including those noted in today's press release and our SEC filings. These risks and uncertainties may cause actual company results to differ materially. Today's call includes non-GAAP financial measures that are reconciled to our GAAP results in our earnings release. On today's call are Kathy Warden, our Chair, CEO and President; and Dave Keffer, our CFO. At this time, I'd like to turn the call over to Kathy. Kathy? Thanks, Todd. Good morning, everyone, and thank you for joining us. The Northrop Grumman team delivered another year of strong performance in 2022, positioning our company for the coming year and beyond. A growing global demand environment and the team's success in capitalizing on competitive opportunities drove exceptional bookings. Top line growth accelerated throughout the year, driven in part by improving labor trends. I'll note that we set our sales and EPS guidance ranges at the beginning of 2022, and even in a dynamic macro environment, we navigated the challenges to deliver at or above the high end of those ranges, and then importantly, to deliver capability for our customers. This performance highlights our solid operating execution, our ability to win new business and the alignment of Northrop Grumman's portfolio to our customers' priorities. We enter 2023 with a backlog of more than 2x our annual sales. This strong backlog, along with increasing demand and rising global defense budget supports our expectations for continued growth. Given this and supported by robust headcount growth, we have increased our 2023 sales guidance range from our October outlook. We are projecting solid segment margin performance that takes into consideration inflationary pressures and supply chain disruptions, consistent with the expectations we outlined on the October call. And we expect a greater than 20% compound annual growth in our multiyear cash flow outlook that supports continued investments in the business and significant returns of capital to shareholders. Before providing more details on our outlook, I'm going to highlight a few notable achievements from the previous year that underscore the tenets of our long-term strategy and illustrate our positioning for the future. In 2022, the James Webb Space Telescope proved its status as the world's most powerful space telescope and an engineering marvel. It achieved full operational status, shared first images in July and continues to discover and inspire with its incredible insights into distinct galaxies. This project is just one example of the technology innovation and leadership our team brings to our customers. And it has provided an excellent platform for attracting talent to our industry and our company. In 2022, we continued to win new competitive awards across the company, achieving a book-to-bill ratio of 1.07. Two notable new awards are the space development agencies tracking and transport layers. As our customers look to expand their resilient national security space capabilities, these programs leverage our advanced space solutions for low earth orbit and showcase our ability to compete and win programs across a range of missions. We also completed over 40 successful launch and space missions in the year, exemplifying our end-to-end capabilities in the space market and our ability to perform at scale. Further, our solid rocket boosters helped propel NASA's base launch system as part of the Artemis 1 mission with the largest human-rated solid rocket boosters ever built. We also received a $2 billion award for GEM 63 solid rocket boosters in support of Amazon's Project Kuiper. Together, SLS and Kuiper validate the robust investments that we've made in solid rocket motor capabilities. We also delivered advanced architectures that integrate sensors to provide unprecedented situational awareness for our customers. One example is our IBCS solution. After successful testing in the fourth quarter, IBCS is poised to transition from LRIP to full-rate production in 2023. IBCS integrate systems that weren't designed to work together, creating a seamless air and missile defense network and allowing customers to better utilize their defense assets. This capability is needed more than ever to address advanced threats and it's one where we've seen a significant increase in interest across our global customer base with 10 additional countries expressing interest in obtaining this system. We continue to keep our focus on innovating and leveraging our strong position in advanced technology. This includes the development of a new radar for the F-35. This radar is capable of defeating current and projected adversarial air and surface threats and is compatible with variants of the F-35 aircraft. And we capped off a strong year with the historic unveiling of the B-21 Raider. The B-21 is a multifunctional platform with unmatched range, stealth and survivability, and it will be the backbone of future U.S. air power for decades to come. We continue to perform well on the program and remain on track for first flight later this year. As the program transitions into low rate initial production, we are working to address macroeconomic conditions, especially related to inflation and their impact on material, suppliers and labor. Importantly, I want to highlight that our B-21 unit cost projections remain below the government's independent cost estimates. The program has strong support from the U.S. Air Force, Congress and our suppliers. And in the words of Secretary Austin from last month's rollout, "This aircraft is proof of the department's commitment to building advanced capabilities that will fortify America's ability to deter aggression today, and in the future." Our 2022 achievements underscore the breadth of our portfolio across a wide range of domains and technologies and the strong performance of the entire Northrop Grumman team. As we look forward, defense budgets are on the rise, and we see our global customers continuing to seek proven solutions to address rapidly evolving and increasingly sophisticated threats. We are meeting their urgent needs in areas such as air and missile defense solutions, medium and large caliber ammunitions and armaments, advanced radar capabilities and global surveillance to name just a few. And we are partnering to expand our opportunity set and positioning our international business for future growth. We clearly saw increased demand in 2022, and we continue to expect to grow our international business over the next several years. In the U.S., we are encouraged by the continued strong support for National Security, including overwhelming bipartisan support for a 10% spending increase in the fiscal year 2023 defense budget that was passed in December. Our portfolio and the capabilities we offer are well supported by the administration and Congress. Growing security challenges will test our resolve in ways not seen for a generation, and we are confident this administration and the new Congress will find ways to work together to meet them. We expect the President's fiscal year 2024 budget request to support robust funding for the highest priority capabilities outlined in the National Defense Strategy. And our strategy has positioned us well. We're clearly maintaining our technology leadership and growing our portfolio of offerings, which is aligned to customer priorities. Another key element of our long-term strategy is keeping a laser focus on performance and driving cost efficiencies throughout the business. The current macroeconomic environment reinforces the importance of doing so. An example of our effort is the implementation of digital solutions across the company. Beyond the benefit of transforming how we design, test and manufacture the next generation of systems, our digital initiatives are streamlining business functions and increasing productivity. We are also optimizing our facilities and consolidating our real estate footprint. Every day, we seek new and innovative ways to drive performance and increased efficiency while remaining agile and meeting our customers' expectations. Our capital deployment strategy supports our business strategy. We are investing to not only drive efficiencies but also to allow our customers to stay ahead of the threat environment. In 2022, we invested over 7% of revenue in R&D and capital expenditures to provide the capability and capacity needed to address the threats of today and tomorrow. We also continue to return cash to shareholders. Last year, we increased our dividend by 10%, which was the 19th consecutive increase. And during the year, we delivered over $1 billion to shareholders through the dividend and returned another $1.5 billion through share repurchases. So looking forward to 2023, we are well positioned for continued growth, and our revenue outlook has improved from the high $37 billion range we shared in October. We now expect sales to be in the range of $38 billion to $38.4 billion, representing about 4.5% growth at the midpoint. Margins are expected to remain solid in the 11.3% to 11.5% range. We are projecting strong free cash flow growth that supports our capital deployment strategy. And we expect to return more than 100% of free cash flow to shareholders again in 2023. Our backlog, strong recent global demand growth and our ability to deliver products that address an increasingly complex security environment give us confidence in our outlook. So with that, I'll hand it over to Dave to cover the details of our financial results and more on guidance. Okay. Thanks, Kathy, and good morning, everyone. I also want to thank our team for another year of strong performance in 2022. We won several new franchise programs, delivered industry-leading top line growth and bolstered our talented workforce, with the addition of over 6,000 net employees during the year. I'll spend a few minutes on our fourth quarter and 2022 results and then discuss our future expectations in more detail, including our long-term cash flow projections. We ended the year with nearly $79 billion in backlog, reflecting strong demand for our products and capabilities. We continue to convert our backlog into revenue at an accelerating rate with fourth quarter sales growth of 16%. This was enabled by our ability to continue strong hiring in Q4 as well as a higher volume of material receipts based on the timing of program demand. The team did an outstanding job of working with our supply chain to secure program material. And for the full year, our sales grew to $36.6 billion, representing organic growth of 3% and exceeding our prior expectations. Our operating performance and margins remained solid despite the continued pressures of the macroeconomic environment. Our segment operating margin rate was slightly below our expectations at 11.3% in Q4 and 11.6% for the full year due in part to the impacts of inflation, which resulted in a lower level of net earnings adjustments. But margin dollar volume was very strong given the top line outperformance. A positive EAC adjustment in the quarter was on B-21, where we recognized a $66 million pickup on the EMD phase of the program, reflecting our latest assumptions regarding future incentives in that phase. Continuing with our Q4 results. Our transaction adjusted earnings per share were $7.50, a 25% increase over the same period in 2021. Higher EPS were driven by robust growth in our segment top and bottom lines as well as a lower effective tax rate. The lower Q4 tax rate was driven by the recognition of an $86 million benefit from the resolution of a legacy Orbital ATK tax return, which we previewed in our guidance last quarter. And corporate unallocated costs were also below our expectations due to lower state taxes as a result of the R&D tax amortization law not being deferred. For the full year, our transaction-adjusted earnings per share were $25.54, well ahead of our guidance range. Now turning to cash. We had an extremely strong fourth quarter, consistent with our historical pattern. For the year, we generated $2.9 billion of operating cash flow and $1.6 billion of transaction-adjusted free cash flow, in line with our expectations. This was inclusive of a full year of cash taxes associated with the R&D tax amortization law as well as our final payment of deferred payroll taxes from the Cares Act legislation. Moving to our pension plans. Slide 7 in our earnings deck includes our latest assumptions. After 3 consecutive years of double-digit asset returns, our plans declined by roughly 15% in 2022, in line with market trends. Our FAS discount rate increased roughly 250 basis points to 5.54%, which was the driver of the mark-to-market pension benefit of $1.2 billion reflected in our GAAP results. These factors are also reflected in our latest pension estimates for 2023 to 2025. As we previewed last quarter and updated in our slides today, we're projecting a decline in our noncash net FAS pension income and an increase in our estimated CAS recoveries. In total, our pension plans remain strong. As a result of the higher discount rate, our funded status has improved to nearly 100%, and we continue to project minimal cash pension contributions over the next several years. Now turning to 2023 guidance. Our revenue expectations have increased from our prior estimates, with the midpoint representing nearly 4.5% growth on top of the strong level in 2022. We expect Space Systems to remain our fastest-growing business. Sales are projected in the mid-$13 billion range, up over $1 billion from 2022 levels, with GBSD and NGI contributing nearly half of the growth and the rest coming from our broad space portfolio. Mission Systems sales are expected in the high $10 billion range, up mid-single digits, driven by restricted programs in our Networked Information Solutions business. And we continue to expect flattish sales at both Aeronautics and Defense Systems. While programs like B-21 and IBCS continue to grow, headwinds remain on legacy platforms as systems are retired. We expect Aeronautics and Defense Systems to return to growth in 2024. And similar to our cadence in 2022, we expect first quarter sales of approximately 24% of our full year estimate, with sales ramping again throughout the year. With respect to margins, we expect our 2023 segment operating margin rate to be down roughly 20 basis points from 2022 levels. Challenging macroeconomic conditions, including extended lead times in the supply chain and high levels of inflation continue to put temporal pressure on margins. And while higher CAS recoveries provide a modest benefit to our cash flow in the coming years that create pressure in our overhead rates and EACs. Similar in nature to what we experienced in the first quarter of 2021 when we recognized a favorable impact from lower projected CAS costs, this could lead to an unfavorable margin impact when we update our rates this quarter. We notionally expect this to have a 10 to 20 basis point impact on the full year. In regard to the B-21 program, we expect the 2023 contract award for the first of 5 LRIP lots with the LRIP phase scheduled to run through approximately the end of the decade. We're continuing to work with our customer to address macroeconomic risks and enhance efficiencies in the program. As we've described in our 10-K, we do not believe that a loss on the LRIP phase is probable and therefore, no such loss is reflected in our results or guidance. Now turning to our future outlook. We expect our 2023 earnings per share to range between $21.85 and $22.45 based on approximately 153 million weighted shares outstanding. This includes $450 million of net pension income, which represents a $4.30 per share headwind compared to 2022. Partially offsetting this nonoperational headwind is strong growth in segment performance and the lower share count, which adds roughly $0.90 of additional earnings per share and lower purchase intangible amortization largely offsets the higher tax rate. Moving to cash. We expect 2023 adjusted free cash flow between $1.85 billion and $2.15 billion, consistent with our prior outlook as adjusted for current R&D tax law. Although we expect discussions to continue on Capitol Hill, our guidance and multiyear outlook are now based on current tax law for all years and do not include any refunds for R&D taxes paid in 2022. Capital expenditures are expected to remain elevated at $1.65 billion to $1.7 billion in 2023 and a similar level in 2024 before moderating in 2025 and beyond. This is driven by investments to support several large new business wins from 2022. Our guidance assumes we will not have an extended CR, a breach of the debt ceiling or a prolonged government shutdown as this is our current expectation. Slide 12 in our earnings deck provides our long-term cash outlook, which is predicated on continued top line growth in our business generating strong and gradually expanding operating margins and converting those margins into cash. R&D-related cash tax payments should decline by about 20% per year. As I described, CapEx is expected to remain near 4.5% of sales in 2023 and 2024 before starting to decline in 2025. After investing in our business, we continue to expect to return more than 100% of our free cash flow to shareholders in 2023 in the form of dividends and share repurchases. And we plan to be in the market for new debt issuance soon to support our capital deployment plans including the refinancing of near-term maturities. In summary, 2022 was another successful year for Northrop Grumman, and we continue to deliver value for our customers, employees and shareholders. Kathy, you mentioned in your prepared remarks that the B-21 cost estimated is below the government estimates. But as Dave mentioned, there are macro and inflation cost pressures. I mean this comment really stood out to me since in the past decade, we've seen many large defense development programs exceed costs and not just by a smidge but meaningfully. Can you provide more color on what the Northrop team is doing to manage this risk and how we should think about the LRIPs through the end of the decade? And what are puts and takes in terms of potential risk? Yes. So as we noted, we are performing exceptionally well on the B-21 program, and we have continued government support for the quantities of at least 100 that are represented in the program of record. But given that this contract was initially awarded in 2015, the recent and really unprecedented macroeconomic impact of inflation, labor, supply chain disruption has affected the cost estimate to perform on the LRIP phase of the program. And importantly, we noted our projected cost per unit are still below the government cost estimates upon which the funding profile is based. And that's important because it supports the overall buy plan of the U.S. government. And just to, as a reminder on timing, the government hasn't yet exercised any of the LRIP options. So like we do on any price options, we continue to look at what the future may hold and reflect that in our estimates that complete, but those are indeed estimates of cost and future performance. So while -- as we note in the K , we don't currently consider a loss on LRIP to be probable, if it were ultimately to occur, it would spread over all 5 lots of the program. And particularly, that's important related to any cash flow impact. So as we look at 2023, we do not see that as material in our cash flow outlook. And even as we put together our 3-year cash flow outlook, we wouldn't see that as being material. So hopefully, that gives you a sense of what is contributing to B-21 cost estimates. Inflation clearly is the primary driver there. as we think about what's changed recently in our estimates, and we are working to mitigate those impacts, as you say, and we have some time as we move forward and get into production to continue to do that. Maybe my first question is on space. The performance there is better than I think anybody was anticipating. What's underlying that? And how should we think about that going forward maybe even beyond 2023? Yes, Ron, you are stating it accurately the performance there has been better even than we expected, and it's largely driven by more success in competitive wins than we had anticipated. Generally in all of our business, we project a certain amount of success, particularly in competitive environment. And here, we've just done better than we anticipated. And so that's driven sales upside and the very strong book-to-bill that we've had in that business where their backlog now is more than 3x sales and supports our projections for long-term, steady and durable growth. And then you mentioned in your -- just as a follow-on in your prepared remarks that your growth has been supported by your ability to hire folks. How has that been -- I know, I mean, it's kind of across the entire industry and your supply chains, getting labor has been difficult, particularly skilled labor that's kind of up to spec. How have you guys been able to do that? And what's underlying that? It has been a key driver to generating 16% sales growth in the fourth quarter, in particular. We noted in the third quarter of last year that we were starting to see labor trends change in a favorable way. Our hiring had improved. Our retention had dramatically improved, and we saw that trend continue in the fourth quarter. I think a few things contribute. We hire technology skills that are very akin to what the technology sector employees, and we've certainly seen softness in that sector that has led to a significant increase in applications to Northrop Grumman. But I'd also like to think it's to do to the reputation of our company as being a technology innovator and the successes that we were able to showcase last year like James Webb and the unveiling of B-21 really spiked interest in applications to -- for employment at our company. And so those 2 things in combination are certainly working in our favor in a differentiated way. Just a follow up on an earlier comment. In the past, I think you've talked about 12% margins in 2024 and the 2023 guide is 11.5% or so. As you think about sort of inflationary pressures, what are you watching? And you mentioned some of the B-21 items as an example. So what sort of offsets that to get to that 50 basis points of expansion? As we've noted, we had talked about 12% being the fundamental margin rate that we believe this business, this portfolio can perform at, and we would be working our way back to that as particularly mix becomes less of a headwind in the middle of the decade. We still see that. But we are having these temporal pressures related to inflation that are flowing through all of our programs, B-21 most notable because of its scale and that we did it very long ago. As we think about how we are offsetting those costs, we talked about some of those ways today. We are working to digitally enable our business, which reduces program costs directly and improve profitability. But we also are applying that to our back office to streamline business processes and reduce costs that flow into our overheads also making our rates more competitive. And reducing the impact of cost growth. So those things that -- real estate has been key. You saw today, we talked about a few things that we did in the real estate area already in 2022, but we have many more of those lined up as ways to continue to offset any cost growth that we see and drive towards those higher margins. Kathy, Dave, Todd, I think we probably all agree the stock right now seems to reflect the idea that defense is going to be a bill payer as we move to a period of deficit reduction. And I realize this question puts you a little bit on the spot forecasting government spending. But I wanted to know if you'd expand on your optimistic opening remarks. Talk about your macro outlook relative to what seems to be being priced into your stock? And if you think modernization might be sacrificed as part of the budget negotiations? Yes. So we look at the stock price over a longer time horizon than weeks, and we've consistently outperformed the industry on a relative TSR basis over the long term. But as you indicate, -- we've seen some pullback in the last several weeks across the sector and even more so with Northrop Grumman. I am a little surprised at the level of relative pullback we've seen given our strong continued results, our growth outlook and the relative portfolio positioning that we have in the U.S. and internationally. And to answer the second part of your question directly, I do not see the U.S. or our allies pulling back on funding their national defense strategy that is well aligned with the Northrop Grumman portfolio. So I'd sum it up by saying, with a strong backlog, growing global demand for our products, differentiated technology and the ability to attract and retain top talent, we're really well positioned to continue executing on the strategy that we have that is expected to deliver differentiated growth and a potential to generate greater than 20% free cash flow growth for at least the next several years, and we believe beyond. So I think investors are going to like that. And we've been in periods like this before following sequestration, where there was noise in the system related to the government's commitment to national security. But following that, it was one of the best periods of relative TSR growth at our company, and really, our industry has produced in a while. So I see this as a temporal speed bump in our past and yet our strategy remains strong to deliver value. Just as a quick follow-up on inflation. The comments on the B-21 that you've been making, is there a general trend here is when your contracts you're signing right now with the government, are they generally accounting for inflationary effects or are you not finding that? So our customers are engaging in conversations with industry to understand to motivate our investment in future capability and capacity, that is what they really want. And I think many of them now understand that shifting too much risk to industry doesn't support that investment, nor does it deliver the capability they need in a timely fashion. So with that, I expect we're going to see less the price development going forward. And they are specifically to inflation, the industry broadly is pushing back on accepting long-term fixed price contracts right now. And they're asking for reopeners for inflation. We expect that to continue. And as our suppliers ask us for that, we, of course, are passing that on to the government. And really, that's just common sense. So I believe it will become the norm. Last year, you had a decline in Aeronautics that we understood pretty well because you've got quite a few legacy programs that were ramping down, like JSTARS Global Hawk. When you look at this year, with your fairly flat guidance for Aeronautics, how do you look at the pluses and minuses when we look at B-21 growth but you still got some legacy programs that are declining. How do you see those offsetting each other? So Doug, this year is really a continuation of those same trends flowing through the top line. The programs that have been declining. We've seen the majority of those declines, but they do still flow into the '23, '22 compare. So it is things like Joint STARS and Global Hawk. F-35 being a big revenue contributor in AS is relatively flat. So that ties directly into the narrative about their revenues being flat. And then B-21 is an increase, but it's not a significant increase yet because we're just moving from EMD into LRIP and these 2 combined are not a significant increase in the program as of yet. Well, and then on a slightly different topic. When you look at rocket motors, and this is an important area for you. And I'm trying to picture what the growth trajectory looks like. And also just in a sense of your market share, you've got 1 competitor that is a mature player. There are new entrants coming into the space. How do you see the long-term evolution of your market share and how you're positioned in that area? So we stay focused on investing in the future capability needed and more so lately in the capacity needed. And in many ways, the reason we are being asked take on more share of the market is because we've been investing in this business and are able to take on that additional business because we have outfitted our manufacturing facilities to support the growth. As with the government is asking, we have been responsive. And so as a result, we are winning more business in that area. But we expect to be able to compete even as other new entrants come into the space because we do have a long heritage of expertise that contributes to our solid rocket motor business. And that's for all size, as I talked today and highlighted some of the larger solid rocket boosters that we build in support of SLS and GEM 63 for Kuiper. But that's true in businesses like [indiscernible] , where we are taking on more of the needed capacity because we've been investing in our manufacturing capacity there as well. I wonder if you could talk a little bit about the profitability in the space business. The margin guidance came down there, margin rate guidance came down there a couple of times during the year. And it's kind of perceived to be kind of a 10% business, I think, is what we've talked about in the past and looking to a second year in the mid-9s here in 2023. So what's changed there over the past year? Seth, it's Dave. So I think you pointed out accurately that we're now projecting a margin rate for space in the mid-10s going forward. There were a lot of puts and takes in that margin rate upward and downward throughout 2022. Obviously, it's a rapidly evolving business, a tremendous amount of backlog growth and new program activity added into that portfolio over the last couple of years. So we're really pleased with the volume we're adding both at the top line and the bottom line in that process. Obviously, a lot of new cost type work being added to that portfolio and that mix growing, but also work that will evolve toward fixed price over the next couple of years and some new fixed price programs in that mix as well. So in aggregate, we think the mid-9s is the right way to look at 2023. In the coming years, we do see the opportunity for margin rate expansion. But I think the most important takeaway for the space business is that the volume of top and bottom line growth that we've been delivering over the last couple of years and now are projecting over the next few is really adding a lot of value there. Okay. Okay. Great. And then just as a follow-up, Dave. So the working capital performance was quite good in '22. I think the way that measuring here. Working capital actually came down a bit despite the growth and despite the tough operating environment, only 6% of sales, which is below some of your peers. What's the opportunity from here? Or is there kind of a normalization at some point where actually for a growing business, the normal level of working capital is higher? So let's talk about that for a few minutes. There is not a substantial change in working capital projected in the 3-year free cash flow guide that we gave today. There is more capital intensity in 2023 and 2024 that we've signaled throughout this year, given just how much more new business we were awarded this year and the additional capital investments that we need to make to support capacity and capability there. We've talked about things like the Amazon Kuiper Award and and other areas of the business that Kathy just noted, we're making investments upfront for these long-term franchise programs. So that is a headwind to free cash flow. But we're pleased to be able to offset that and deliver free cash flow guidance for '23 that's in line with our prior expectations. That's supported by the growth of the business, both top and bottom line. The R&D tax numbers will come down steadily over the next 5 years. And then gradually, over the next several years, we'll see improvements in the CAS pension cost reimbursement based on current projections. So not much change in working capital, but there are some other moving pieces in the mix. I think importantly, when we look at the underlying fundamentals of growth and margin rate, as we talked about in our scripted remarks, we do anticipate growth through this 3-year outlook that we've provided at the top line, and we are modeling small but gradual improvement in the margin rate as well. So that's a healthy underlying condition for free cash flow. And while we're at it, as we think about this outlook for free cash flow, the foundation is set for strong free cash flow beyond this 3-year period. The second half of this decade will have more programs moving to production, fewer of these upfront investments required to do so. The foundation we've laid over the last several years of capital investment is going to pay off in the second half of this decade on many of those programs. And so that's a healthy environment for continued growth in free cash flow as well as the continuation of the R&D tax amortization rolling off as a headwind. So when you look at the second half of the decade, I think your expectation should be more of the same strong growth in free cash flow that we've been talking about in the first half. I did have a couple of follow-ups on the B-21, if that's okay. And Dave, I think you alluded that the first LRIP contracts to be awarded in '23. I'm just curious, is that sort of the triggering event or whether or not you'd know you're in the loss or not at that point? And then Kathy, I know you said the 10-K disclosure is over the 5 LRIP lots. But I'm just curious, is it tougher at the front end of those lot profiles? Is it more promises at the back end that you'd have time to fight off inflation? Anything on those 2 fronts? Sure. I'll start on your first of those questions. The award of that first lot of LRIP will be a noteworthy event but not a triggering event of any kind from an accounting perspective. We will update our projections quarterly as we have been. We'll continue to do so. And so at this time, we don't believe that a loss is probable and therefore, we have not booked one. We do believe that a loss is possible, which is why we're including it in our remarks and our 10-K disclosures. It's something we will continue to work over time. Obviously, this is going to continue for a number of years. As Kathy has talked about, we'll continue to do everything we can to mitigate inflationary pressures and work with our customers and our suppliers in the process. Kathy, anything you'd like to add? Sure. So in answer to your second question, we do expect to have a better sense as the year progresses, and we'll update disclosures as we do. And as we look at the profile, there's nothing really notable. To your point, we have more time to work cost efficiencies in the later lots. But of course, we made some more aggressive assumptions about learning curves and the like as we would on any production program. So really nothing notable in the profile and how you might think about any potential loss in spread. Dave, I've got a couple of cash flow questions for you. First of all, on basically cash taxes with the R&D tax legislation impact. What sort of tailwind are you expecting from this -- from 2023 and onwards? And then secondly, what are your assumptions for equipment sales in that cash flow guidance for 2023 or for the whole period? Sure. Thanks for those questions. The answers are pretty straightforward. As we noted, the impact on our cash taxes in 2022 from the R&D tax legislation was just under $1 billion. We would anticipate that being about 20% less per year, just under $200 million or so on average less per year. And so that is the magnitude of the annual tailwind that we'd anticipate for the next 5 years or so. Overall, cash taxes, excluding the impact of that R&D tax amortization will increase slightly over the coming years, but that's factored into our multiyear outlook. And as for equipment sales, I appreciate the question there. We received the final payment associated with the equipment sale that we booked a couple of years ago in 2022. And so we don't anticipate we're having our multiyear cash flow outlook, any continued recoveries from equipment sales. This is actually Jack on for Cai today. Just a quick question back to kind of the Section 174, Dave, I know in the past, I'm not sure if you quantified that if you could actually provide that dollar figure if you could. I know it steps down 20% each year. But looking back at your guide from last year at this time for '24, it looks like a larger delta than an implied $700 million headwind. So just to confirm, is that incremental CapEx going higher? Or if you could just provide some color there, that would be helpful. Sure. I appreciate those questions. I think you have to the air math about right on 174. It was just under $1 billion in 2022, and it will decline by just under $200 million a year on average going forward. In terms of that 2024 guide, you're right that our CapEx expectations increased a bit given the volume of new business that we won this year that we'll be investing in going forward. No other material changes to 2024. We do anticipate growth as we've seen in '24 and then a real ramp in '25 as CapEx begins to decline, and you have the tailwinds as well in '25 and beyond from R&D tax, CAS pension recoveries and the underlying growth in margins in the business. Kathy, within Aeronautics, the service mix continues to be a bigger part of the story. I guess it's now about 22%. If you finish 22 and look, that's up from the mid-teens the last few years. Obviously, there's some puts and takes on why that is. But just wondering if this trend is going to continue and how you think about the impact on margins? Yes. So we do expect the trend to continue in terms of -- as assets get into service, we continue to support. But we also have assets like Global Hawk that are coming down. So I don't see a material change in that mix as we look forward, Peter. Kathy, in your opening comments, I think you maybe called out international opportunities, perhaps a little bit more than I can remember from recent quarters. Can you help frame maybe how much of an uptick in international opportunities could be reflected or international sales could be reflected in the '23 guide, if that was all a part of any of the upward revision -- and then as you think about beyond '23, how meaningful is international in terms of an uptick for you? I know historically, obviously, it hasn't been as meaningful as part of the mix of some of your peers, but maybe you can comment on that expanding opportunity set? Yes. Thank you. So in the fourth quarter, we did see some meaningful uptick in Defense Systems, and you can see that reflected in our results, both from the areas that I outlined in this call related to ammunitions and armaments but also increased interest in IBCS, and we have the current Poland work continuing to ramp but the 10 additional countries that I've noticed that have expressed interest. So as we think about the near-term drivers, it's the things that we already have in production. But as we think about the longer-term drivers is areas like IBCS future sales. And we are seeing that interest increase across the business, but most notably in '23, I think you will see that reflected as upside opportunity in defense. As we look at the enterprise over the next several years, we do expect our international growth rate to be double-digit, low teens compared to a U.S. growth rate that more in the norm of our mid-single digits. So as we think about international, we do expect it to grow as a percent of our portfolio in the next several years. And that's all based on international demand growing as a result of increased spending confirmations made by our allied partners. Kathy, if I go back to 2018 when the group sold off quite a bit, Northrop got pretty active on buying back stock. And I think you even launched an ASR, if I recall correctly. So I'd be curious if that would still be your playbook this year if the valuation continues to come down? And whether you might lean on the balance sheet to do so just given the track record of having run a valuation-sensitive buyback program? Yes. Well, as you note, we have used ASRs as the tool in the past. And as we indicated in the call today, we do plan to put more than 100% of our free cash flow back into the deployment to shareholders. The fact that our valuation is down, really, we don't try to time the market per se. But we do think about that as we are kind of weighing our options for capital deployment this year, and we do have the flexibility to increase share repurchase from our original plan. So that is something we're actively contemplating. Dave, I had one for you. In the operating income discussion in space, you had a big gain, $45 million charge. And you said it was all -- the $96 million gain only partially offset the lower EACs. When I look at the K for the year, you had minus $38 million in space versus $134 million last year. So if you kind of just discuss what happened in the quarter and just why such a significant change year-over-year? Sure. Well, that's a great question, George. Clearly, that's an indication of the broader macroeconomic conditions that we in our industry, and frankly, most other industries we're facing in 2022, and in our business, it impacted the level of net EAC adjustments in really each of our sectors in different ways. And you see it acutely there in space, as you mentioned. A number of those EAC adjustments were in the fourth quarter. And that kind of -- the net of all those puts and takes to include the inventory adjustment on a new commercial product line that you mentioned was another downside in Q4. Those were roughly offset by the upside from the land exchange transaction in space. So a number of puts and takes, but when you net it all out, not much overall impact on the space margin rate in Q4 or for the year. We're forecasting a rate just above that level that we operated at in '22 as we now look at '23. And as I noted earlier, something in the mid-9s is our kind of going forward expectation for '23 margin rate in space. But Dave, it's still unusual to see negative EACs for the year. So I was just wondering, are there any specifics that you could point to maybe was for the year or just for this quarter? No single item was a driver of that of much more significance than any other. I think that alone, George, is an indication of the fact that this was more in line with broader macroeconomic pressures as opposed to any performance issue or contract issue in any particular program. This was broader and more widespread, but not significant on any one program in and of itself. And again, I think really just indicative here of the environment we were operating in, in a business with a lot of programs, a lot of new growth in recent years to be excited about. Okay. And then just one general one for you, Kathy. I mean, with the better sales growth you're guiding to in '23, a result of the budget or new awards won or both? And then also, with 16% sales growth in Q4 and outlay is likely to grow 7% or 8% in '23 based on the budget investment authority of 15. Why does the growth rate slow that much in '23? I mean why wouldn't it be higher than what you're suggesting? Yes. So as we noted throughout 2022, if we could break loose supplier deliveries and continue to improve labor trends, we could deliver accelerated growth. And fourth quarter exemplified a path to doing just that. As we come into 2023 with that momentum, the same holds, we are confident enough in our sales expectations as we sit here today to raise them above what we had said in October, largely because we are seeing those improvements in labor in particular. And if those trends continue, we would have opportunity to even further accelerate growth in 2024. The budget does not play into this. We had assumed strong budget growth. It, of course, came to fruition in the '23 budget, and we continue to believe the '24 President's budget will also show growth. Great. A lot of discussion on B-21 and EMD and LRIP. Just -- how should we think about what happens to AS margins over the next couple of years as I assume EMD flans out or starts to come down where you've been taking positive adjustments and LRIP ramps up from here? David, I'll start on that one. Our margin rate was particularly high in AS in 2022. That was driven in part by the strong performance on those EMD profit pickups associated with anticipated incentives on that part of the program. We projected a 10% or so level for AS margins in '23 and expect that, that's a reasonable kind of planning assumption at this point for '23. And as we look forward beyond that, a lot of the factors that are working into the '23 estimate would be those that we'd expect to continue beyond '23. So of course, we'll update you over time. You mentioned B-21 EMD program will -- a portion of the contract will continue for a number of years on LRIP. We haven't baked any margin or cash in that part of the program into our multiyear outlook or our '23 guide. So we think that 10% level is the right way to think about kind of the underlying margin rate in AS in the near term. Okay. And Kathy, maybe your thoughts on what bookings could look like this year, what you're anticipating for the book to bill this year? Yes, David. So we had projected book-to-bill to be light in 2022, and it turned out to be 1.07. We are projecting it to be light again in 2023. I've noted before, we look at this over a multiyear period. We've been running at 1.2 for the last 4 years aggregated across those 4 years. So we still expect to be well over 1 when we think about a 5-year aggregated book-to-bill, but we do expect 2023 to be less than 1. So look, 2022 was another year of outstanding performance by the Northrop Grumman team, and I want to thank them. As we reflected on our call today, we're even more encouraged with the opportunities for continued growth and value creation for our company in 2023 and beyond. So hopefully, that conveyed to you. Thanks again for joining our call today. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.
|
EarningCall_1121
|
Good morning. Thank you for joining the Sherwin-Williams Company's Review of Fourth Quarter 2022 results and our outlook for the first quarter and full year of 2023. With us on today's call are John Morikis, chairman and CEO; Al Mistysyn, CFO; Heidi Petz, President and COO; Jane Cronin, Senior Vice President, Corporate Controller; and Jim Jaye, Senior Vice President, Investor Relations and Communications. This conference call is being webcast simultaneously in listen-only mode by Issuer Direct via the Internet at www.sherwin.com. An archived replay of this webcast will be available at www.sherwin.com, beginning approximately two hours after this conference call concludes. This conference call will include certain forward-looking statements as defined under the U.S. federal securities laws with respect to sales, earnings and other matters. Any forward-looking statement speaks only as of the date on which the statement is made, and the company undertakes no obligation to update or revise any forward-looking statement whether as a result of new information, future events or otherwise. A full declaration regarding forward-looking statements is provided in the company's earnings release transmitted earlier this morning. After the company's prepared remarks, we will open the session to questions. Thank you, and good morning to everyone. Sherwin-Williams delivered strong fourth quarter results compared to the same period a year ago, including high single-digit percentage sales growth, significant year-over-year gross margin improvement, expanded adjusted operating margins in all three segments, strong double-digit diluted net income per share growth and strong EBITDA growth. Sales in our professional architectural end markets increased by a high-teens percentage. On the industrial side of the business, sales were up by double-digit percentages in North and Latin America, partially offset by softer conditions in Europe and Asia. From a cost perspective, year-over-year inflation remained significant in the quarter, but we are encouraged by a modest sequential decrease in raw material costs for the second quarter in a row. Additionally, we made solid progress on the targeted restructuring and cost reduction actions we announced on our last call, the results of which we expect to begin benefiting us in the first half of 2023. Throughout the quarter, we remain focused on customer solutions and executing on continuous improvement in business optimization activities. We also identified opportunities and prepared for what we currently expect will be a challenging operating environment in 2023. I'd like to highlight just a few of our consolidated fourth quarter numbers. Comparisons in my comments are to the prior year period unless stated otherwise. Starting with the top line. Fourth quarter 2022 consolidated net sales increased 9.8% to $5.23 billion. Consolidated gross margin increased to 42.7%, an improvement of 320 basis points. SG&A expense as a percentage of sales decreased by 40 basis points to 29.8%. Excluding onetime costs related to our previously announced restructuring actions, gross margin improved sequentially to 42.9% in the fourth quarter of '22 from 42.8% in the third quarter of '22. And SG&A as a percentage of sales decreased 110 basis points as compared to the prior year. Consolidated profit before tax increased $186 million or 60.2%. Diluted net income per share in the quarter was $1.48 per share versus $1.15 per share a year ago. Excluding Valspar acquisition-related amortization expense and costs related to previously announced restructuring actions, fourth quarter adjusted diluted net income per share increased 41% to $1.89 per share versus $1.34 a year ago. Adjusted EBITDA in the quarter increased $281 million or 52.7%. Let me now turn it over to Heidi, who will provide some commentary on our fourth quarter results by segment. John will follow Heidi with his comments on our full year 2022 results as well as our 2023 outlook before we move on to your questions. Thank you, Jim. I'll begin with the Americas Group, where sales increased 15.7% driven by mid-single-digit volume growth and continued effective pricing. Segment profit increased by $126.4 million and segment margin improved 210 basis points to 17.2%. Our pro architectural sales grew by a high teens percentage of the quarter, led by property management and followed by new residential, commercial and residential repaint, respectively. Sales in Protective & Marine, DIY and Latin America, all increased by double digits, but were below the TAG segment guided range. From a product perspective, interior and exterior paint sales were both strong, with interior sales growing faster and representing a larger part of the mix. We opened 40 net new stores in the fourth quarter and a total of 72 net new stores in 2022. Moving on to our Consumer Brands Group. Sales decreased by 2.4% in the quarter, which was better than our guidance. Sales decreased due to lower volume sales and low single-digit FX headwinds, partially offset by price increases. Sales were slightly positive in North America and Europe, but more than offset by significant continued weakness in China due in large part to COVID-related lockdown. Customers managed their inventories as inflation continued to pressure DIY paint demand from consumers for this segment. Tightness in alkyd resin also impacted our ability to produce stains and aerosols. Adjusted segment margin was 11.3%, up 500 basis points year-over-year. We also made good progress in the quarter on the China architectural and aerosol restructuring actions that we described last quarter. The actions in the fourth quarter resulted in $25.6 million in onetime restructuring costs and a $15.5 million impairment charge. Sales in the Performance Coatings Group increased 4.2% and were driven by mid-teens pricing, partially offset by a low double-digit decrease in volume. Mid-single-digit sales from acquisitions were offset by a mid-single-digit unfavorable FX impact. Adjusted segment margin increased 530 basis points to 14.2% of sales. This is the third straight quarter that this team has delivered year-over-year segment margin improvement driven by execution of our strategy, including effective pricing actions. Sales in PCG varied significantly by region. In North America, sales increased double digits against a challenging comp. Latin America sale also increased by double digits against a strong comp. Sales in Europe decreased high-single-digits against a double-digit comparison and amidst continued economic slowing. Sales decreased by a low teens percentage in Asia against a double-digit comparison and as COVID lockdowns continued to impact demand. From a division perspective, Growth was strongest in coil, which was up by a low double-digit percentage, followed by auto refinish and general industrial, which were both up mid-single digits. Packaging was down low single digits driven by negative double-digit FX impact in Europe and Asia and against an extremely strong comparison last year of over 30%. We continue to feel very good about our packaging position and expect this to be a recession-resilient performer. Industrial wood was down low teens as the housing slowdown is impacting furniture, flooring and cabinetry market. Similar to Consumer Brands Group, Performance Coatings made good progress on its portion of the targeted restructuring actions that we described on our last call, resulting in $22.2 million in onetime costs in the quarter. With that, let me turn it to John for his comments on our full year results and our 2023 outlook. Thank you, Heidi, for that color on our fourth quarter segment results. I want to thank our teams for working hard to deliver a strong finish to the year. I'm particularly pleased with the significant adjusted profit margin improvement that all three segments delivered compared to the fourth quarter a year ago. Our fourth quarter completed a strong year for Sherwin-Williams and I'd like to provide just a few high-level comments on our full year performance. On a consolidated basis, we delivered record sales, adjusted EBITDA and adjusted diluted net income per share in 2022. We generated these results in a difficult operating environment, including relentless inflation, less-than-optimal raw material availability, a war in Europe and COVID lockdowns in China. Our people refused to be deterred by these challenges and continue to do what they do best, serve our customers. Our success stems from executing on our strategy, which remains unchanged. We provide differentiated solutions that enable our customers to increase their productivity and their profitability. These solutions center on industry and application expertise, innovation, value-added services and differentiated distribution. None of this happens without the determination and dedication of our greatest asset, the more than 61,000 employees of Sherwin-Williams. Together, this team grew full year consolidated sales by 11.1% to a record $22.1 billion. It was the 12th consecutive year we have grown the business. On a segment basis, the Americas Group delivered 12.9% sales growth and grew profit before tax $197.5 million. Our largest customer segment, residential repaint, grew by a double-digit percentage for the seventh year in a row. Sales in all other customer segments were also up by double digits for the year. Consumer Brand sales were down 1.1% for the year. Sales were up mid-single digits in North America, our largest region. This was more than offset by double-digit declines in Europe and China. Although the bottom line results weren't what we expected, 2022 was a transition year for Consumer Brands Group as they completed a number of restructuring and simplification efforts to position the business for long-term success and driving operating margins back to the high teens. Performance Coating sales were up 13.2% for the year against a 22% comparison. All divisions grew with the exception of industrial wood. It was down less than 1%. Adjusted segment margin expanded 250 basis points to 14.1% for the year as we continue to recover from the highest cost inflation in the company and pursue our high-teens margin target for this segment. Adjusted diluted net income per share increased 7.1% to a record $8.73 per share. Adjusted EBITDA for the year was $3.61 billion or 16.3% of sales. Net operating cash for the year was $1.9 billion or 18.7% of sales. We returned a total of $1.5 billion to our shareholders in the forms of dividends and share buybacks in 2022. We invested $883 million to purchase 3.35 million shares at an average price of $263.64. We distributed $618.5 million in dividends, an increase of 5.4%. We also invested $644.5 million in our business through capital expenditures, including approximately $188 million for our building our future projects. We ended the year with a net debt to adjusted EBITDA ratio of 2.9 times. Additionally, we invested $1 billion in acquisitions that accelerated our strategy. I'd also like to mention our ESG efforts where we continue to work toward meeting our longer-term targets. Newsweek, Forbes and other third parties once again recognized various aspects of our program. Throughout the year, we continue to execute on continuous improvement initiatives and targeted investments to drive growth, competitiveness, efficiency and profitability. We opened 72 new paint stores and hired 1,400 management trainees. We introduced multiple new products while reducing SKUs and formulations. We expanded production capacity and enhanced procurement and logistics processes. We also continued on our digital and sustainability journeys, and we executed on our acquisition strategy. I am confident we widened the gap between Sherwin-Williams and our competitors in 2022, and that's just what we intend to do again in 2023. So turning to our outlook. We enter 2023 with confidence, energy and a commitment to seize profitable growth opportunities wherever we find them. We have clarity of mission. We have the right strategy. We're focused on solutions for our customers. We're spending more time selling products and less time sourcing them, thanks to recovery in the supply chain. We're simplifying the business, and we're executing on targeted restructuring actions. We've made the right growth investments, and we'll continue to do so. We also have a portfolio that should be more resilient than in prior recessions. And above all, we've got the right people. We expect to outperform the market just as we have in the past. At the same time, we're not operating with our heads in the sand. We currently see a very challenging demand environment in 2023, and visibility beyond our first half is limited. The Fed has also been quite clear about its intention to slow down demand in its effort to tame inflation. These factors have not changed from what we communicated on our third quarter call and our base case in 2023 remains to prepare for the worst. Based on current indicators, we believe this is the most realistic outlook at this time. On the architectural side, it's no secret that U.S. housing will be under significant pressure this year. Single-family permits have been down year-over-year for 10 consecutive months, and single-family starts have been down year-over-year for eight consecutive months. Mortgage rates also remain elevated. As a result, we believe our new residential volume could be down anywhere from 10% to 20% this year. We expect our other PRO end markets to be more resilient than this, but there are headwinds in these areas, too. For example, existing home sales, which drive a portion of our repaint business have declined year-over-year for 16 straight months. Now while we see a backlog of new commercial construction, the Architectural Billing Index has contracted the last three months. On the DIY side, we expect inflation to continue putting pressure on consumer behavior in the U.S. and in Europe. On the industrial side, the PMI numbers for manufacturing in the U.S., Europe, China and Brazil have been negative for multiple months. We have already seen an industrial slowdown in Europe and the same is beginning to appear in the U.S. across several sectors. In China, COVID remains a wildcard and the trajectory of economic recovery is difficult to map. The U.S. housing slowdown will also impact some of our industrial businesses, namely industrial wood where we have already seen pressure and coil to some extent. Our team fully understands the importance of winning new accounts and growing share of wallet in this environment, and that is where we will be focused. From a cadence standpoint, we expect year-over-year sales and earnings performance will be significantly better in the first half than in our second half, driven by several factors. Our total company comparison will be much more favorable in the first half of 2023 as we delivered a very strong second half performance in 2022, where sales were up 13.8% and adjusted earnings per share grew by over 37%. As we've often said, volume is the key driver for operating leverage in our model. In the Americas Group, which is our largest and most profitable segment, our year-over-year volume comparisons are expected to be meaningfully better in the first half versus in the second half based on the trends we are currently seeing. We also expect more carryover price in the first half of 2023, which will have the full benefit of our September 6, 2022 price increase in TAG as well as prior price increases in the other two segments, all of which will annualize in the back half of this year. Additionally, we expect new residential sales will hold up better in our first half before very meaningful deceleration of demand in the back half of the year. Acquisitions will also be a tailwind in our first half as we expect incremental sales of approximately $140 million from transactions which closed after July 1 of last year. Given these factors and the softening demand environment, we believe our expectations for the back half of 2023 are tempered appropriately at this time. As you would expect, we will gain more clarity as the year progresses, and we will provide a more finally tuned view of our second half outlook during our second quarter conference call. As we said on our last call, we anticipated the demand environment would be challenging in 2023, leading us to get out ahead on cost management with the targeted restructuring we began in the fourth quarter. We estimate the annual savings from this effort to be in the $50 million to $70 million range, with about 75% realized by the end of 2023, and we are reaffirming those estimates today. Our outlook also assumes our raw material costs will be down by a low to mid-single-digit percentage in 2023 compared to 2022. We expect to see the largest benefit occurring in the second and third quarters. We expect to see decreases across many commodity categories, though the ranges likely will vary widely. From an availability standpoint, certain alkyd resins remain a pain point, impacting stains, aerosols and some industrial products. We expect supply of these resins to continue improving through the first half of the year, in part due to ramping of our own internal production. We expect other costs, including wages, energy and transportation to be up in the mid to high single-digit range. For the first quarter of 2023, we anticipate our consolidated net sales will be flat to up by a mid-single-digit percentage compared to the first quarter of 2022, inclusive of a mid-single-digit price increase. Our sales expectations for the quarter by segment are included in our slide deck. For the full year 2023, we expect consolidated net sales to be flat to down mid-single digits, inclusive as a mid-single-digit price of carryover from 2022. Our sales expectations for the year by segment are included in our slide deck. We expect diluted net income per share for 2023 to be in the range of $6.79 to $7.59 per share. Full year 2023 earnings per share guidance includes acquisition-related amortization expense of approximately $0.81 per share and includes expense related to our previously announced targeted restructuring actions of approximately $0.25 to $0.35 per share. On an adjusted basis, we expect full year 2023 earnings per share in the range of $7.95 to $8.65. We provided a GAAP reconciliation in the Reg G table within our press release. Let me close with some additional data points and an update on our capital allocation priorities. Given carryover pricing, raw material deflation and our ongoing continuous improvement initiatives, we would expect full year gross margin expansion. We expect SG&A as a percent of sales to increase in 2023. This is similar to the slowdown in 2008 and 2009, where we continue to invest in long-term solutions for our customers that allowed us to grow at a multiple of the market when demand normalized. We'll also control costs tightly in non-customer-facing functions and execute on our restructuring initiatives. We have a variety of SG&A levers we can pull depending on a material change to our outlook up or down. We expect operating margin to modestly improve year-over-year, excluding restructuring and impairment costs and acquisition-related amortization expense. While we don't typically provide this level of color, we believe it is helpful to do so this year given the higher level of non-operating expenses impacting 2023. We expect to open between 80 to 100 new stores in the U.S. and Canada in 2023. We'll also be focused on sales reps, capacity and productivity improvements as well as systems and product innovation. We expect to complete the targeted restructuring actions we announced on our previous call, including the benefits and onetime costs we have outlined. We will continue to simplify and optimize the organization. The Latin American business of the Americas Group is now being managed and reported within the Consumer Brands Group. The change allows TAG leadership to focus more exclusively on its core U.S. and Canada stores business. While the Latin America architectural demand and service model are trending to be more in line with CBG's strategy. This business had sales of approximately $700 million in 2022. The change will be marginally accretive to TAG and marginally dilutive to CBG. You will see this change when we report first quarter results in April. Prior-year segment results will be restated at that time to reflect the change. The first quarter and full year guidance for 2023 we've communicated today does not reflect this change. Next month, at our Board of Directors meeting, we will recommend an annual dividend increase of 0.8% to $2.42 per share, up from $2.40 last year. If approved, this will mark the 45th consecutive year we've increased our dividend. We expect to continue making opportunistic share repurchases. We do not have any long-term debt maturities due in 2023. However, we will reduce short-term debt to trend our adjusted EBITDA leverage ratio towards the high end of our long-term target of 2 to 2.5 times. We'll also continue to evaluate acquisitions that fit our strategy. In addition, I will refer you to the slide deck issued with our press release this morning, which provides guidance on our expectations for currency exchange, effective tax rate, CapEx, depreciation and amortization and interest expense. Given the many variables at play, limited visibility beyond the first half and the high level of uncertainty in the global economy, we believe our outlook is a realistic one. Our slide deck further outlines the assumptions underlying our guidance and is based on our current dialogue with customers and suppliers and our reading of numerous macro indicators. As we get through our first half and we see more information, those assumptions could change. If those assumptions change for the better, we would expect to do better than the guidance we are laying out today. While we can't defy gravity, we do expect to outperform the market and our competitors in 2023. I'm highly confident in our leadership team, which is deep and experienced and has been through many previous business cycles. We've transformed our business in many ways since the last significant downturn, and we are now a stronger and a more resilient company. We also know our guidance is clearly reflective of the market pressure we are experiencing. We anticipated 2023 would be challenging. We've planned accordingly. We have and will continue taking appropriate actions. We expect strong momentum coming out of this period of uncertainty, similar to prior downturns. That momentum will stem from our strategy of providing innovative solutions that help our customers to be more productive and more profitable. In challenging environments, like the current one, we can be an even more valuable partner to our customers, while we're also earning new ones. This concludes our prepared remarks. With that, I'd like to thank you for joining us this morning, and we'll be happy to take your questions. Great. Thank you so much for taking my question. On Slide 8, you have some pretty helpful framework specifically on TAG volumes. John, obviously, you've been discussing this for a while, but can you just talk about the differences, obviously, what you're seeing in the new resi side, which is a little bit smaller but what you're hearing from your team regarding the pent-up demand on the resi repaint side. How you feel about that versus a quarter, 6 months ago and how that shapes up throughout 2023. Thank you so much. Sure, Chris. I'll start with new residential. And what I'll do is I'll talk a little bit about new res and I'll hand it over to Heidi to talk a little bit about her view. She's obviously working closely with her teams, and then I'll pick back up on res repaint we'll do the same. New res, I would start with a very important fact that over the last 10 years, we've had a 10 year compounded growth rate of about 10.5%. So this has been an area of focus for us, and it's one where we have, I think, clearly demonstrated significant success, and we are determined to continue to drive that success. Permits and starts are down as we all know. And our relationships with our national builders are strong and getting stronger. There's a lot going on, and we're working closely with them. Heidi, why don't I give that to you? And maybe you could talk a little bit about what you're working on, on the new residential side? Yes, sure. No, I think the last 10 years that John referred to has really put us in a strong position in new res. And we have every intention of aggressively pursuing share gains, especially during what we will consider to be pretty choppy waters ahead. We're going to continue to focus on growing our exclusive relationships. And I would expect that we're going to add to an already strong percentage of mutually beneficial exclusive relationship. For example, we look at our partnerships here pretty broadly and these builders that we're working with. It's really allowing us to collaborate in areas such as reducing complexity simplification and importantly, execution and utilizing our store platform, our technology, our supply chain and also importantly, our technical teams, we're really partnering to help these builders to respond to today's challenges and really helping them to reach their goals. So ultimately, reducing complexity may assist in their efforts to drive efficiency and productivity. And new products really play the key role in the help assist during some of these challenging times. For example, we're going to be introducing extreme build -- an extreme high build interior latex. And in a segment that's going to be under pressure, you may be asking yourself why we're bringing new products. But to be truthful, this is where we do help our customers win. This extreme high build lets the contractor build eight to 12 mils wet film thickness versus the more conventional four to six mils. So if you can imagine, just minimizing surface imperfections and excellent touch up, especially in an environment where labor is a challenge and an issue for these drywallers and painters. This product is helping to hide the spends of what I would call maybe less experienced drywallers and really improve the speed for painters. So essentially, everyone is winning here. So you can kind of ask what to expect. John mentioned this earlier, the rate increases will pressure our builders, and we will grow share, but we were not going to be immune to the impact of these rates. We're going to respond to these changes. And I would expect that our builders will do the same. They may adjust floor plans. Many are looking at standardization, but no one will respond like Sherwin-Williams. We're going to take this expertise. We're going to aggressively go to builders that may have relationships with some of our competition. And we're going to demonstrate these capabilities in a way that will allow us to grow share. So while in the short term, we'll likely feel pressured. We like the favorable demographics. The existing housing shortage gives us a great deal of confidence that our strong and growing position in new res will benefit our shareholders. So we look at the strong business through both a short and long-term lens. I would say in the short term, given our success and our position in the market, and we may over-index right now while we're working through some of the short-term choppiness. But in the long term, make no mistake, we do believe that this is in our best interest to continue to pursue these important gallons. I think maybe just one more point or two points maybe on new res, Chris, to Heidi's point, I think our relationships with the new residential contractors, they're reaching new highs. I mean we're collaborating and working together. She mentioned, one of the new products that we're introducing, I think there's a steady stream of introductions of not only products, but services and collaboration that we think really helps us help our customers. And the other point Heidi is really driving with her team, Justin Binns, our Group President of our TAG business is really taking this terrific work in products and services beyond the large national homebuilders and even driving that down further into the regional builders, where there is terrific opportunity for growth. And so while we expect there will be choppiness in the new residential, and I think it's important to say this beyond just new residential. We're not just reporting things are tough and low as us. So that's not who we are. We expect it's going to be tough, and we're going to come out fighting and swinging aggressively. And so yes, we do well with a lot of the large national homebuilders. We're going to be fighting like crazy after these regionals and other customers that we don't have. We expect new residential if you look at some of the information that's out there to be down in the 20% to 30% range. That's not what we're expecting for our business. That's what we see in housing starts. So actually, what we're saying is that the homebuilders are posting some of them in the 20% to 30% range, we expect to outperform that and bring in a much better number than that. But we'll feel the pressure. We get really quick to the res repaint side, and we won't go through each of the segments with such depth. But I do think that, Chris, your point is, your question is right on point, given the headlines, if you will, that these two segments will play for us this year. In residential repaint, we would say that while we continue to grow, and again, another area of focus over the 10 years, our compounded growth here has been 11% -- a little over 11.5%. We do expect to see some deceleration in the annual gains. If you look at the LIRA and the NAHB projections they are positive, but at a decelerated rate largely tied to existing home sales. But this is also an area where people continue to invest. Painting remains a relatively inexpensive investment but a very impactful project, that along with the aging housing stock and home price appreciation, we think will have a positive effect on this business. But Heidi, maybe you could talk a little bit about res repaint, and some of the work you and your team are driving there. Well, part of the fact that we've built really strong momentum here. I think this is certainly not by chance, but by design continuing to develop innovative products. John referenced some of the services, innovative solutions to differentiate ourselves and we couldn't do it without our incredible team. Our managers are reps, they play an extremely significant role in all segments, but I would argue in the res repaint segment, which really responds well to our high-touch personal service really can help to differentiate our model. We often talk about our secret weapon is our people. And I think clearly on display as we're helping our customers navigate through unprecedented challenges for them as well and challenges such as labor when res repaint, our full product line really allows contractors to step up in quality, helping to compensate for some less experienced applicators. And as we continue to see our customers do step up in quality, the results are clear that they are becoming more successful. And we're helping them prepare for some choppiness ahead, I would say, in addition to the whole product line, preparing for some new substrates. I'll give you an example here. In homes where our res painting, we're in the midst of rolling out a new kitchen cabinet refinish paint product. So if you think of the homeowners that are affected by certainly higher costs and not willing to replace entire cabinet systems, but willing to refinish their existing cabinets, we're helping contractors to serve these clients with some profitable solutions. So amongst our new products, we're going to be introducing a self-cleaning Exterior Woods capes Stain as well for the exterior, which I just mentioned. So each and every rain will have a home looking freshly painted. So literally, the dirt will wash away with every rain, which is a pretty incredible technology, and we'll look like a newly painted home. So our position in res repaint continues to improve. In fact, we continue to not only grow share but accelerate some of these share gains. So while the bid activity has adjusted, overall, it's still strong. Our average job size is increasing, and our focus continues to be and will be on new accounts and share of wallet. Just picking up the last point there is a good one. The quality of the leads in the bids, it seems like listening to a majority of our customers that while some of the bid activity may have tempered down a bit, the quality of the leads are actually increasing and the scope is actually increasing. So they're doing more there. And as she mentioned, we're trying to help them with projects like expanding into cabinets, introducing opportunities in garage floors and a lot of different areas. So even taking some of those new residential contractors that may have been primarily focused on new residential and helping them get into residential repaint. So we're really partnering very well with our customers to help drive their success and their profitability. So Chris, great question on those two segments. We think those are two really important segments for us going into 2023. Good morning, everyone. Thanks for taking my questions, as always. So you're expecting raw materials to decline in the low to mid-single-digit range in '23. Is this based off of spot pricing for petrochems as you see it today? Does this incorporate expectation for some incremental deflation in spot prices as we move through the year? I'm just asking because the petrochem futures are kind of bouncing around right now. And I'm just trying to understand how you expect the spot market to play out and what's embedded in the guidance. Yes. Good morning, Truman, I'd begin by telling you that we called out here, we've seen a sequential decrease in our third quarter into our fourth quarter and we're expecting that trend to continue. In our first quarter, we're kind of expecting the basket to be flat to slightly up, and you'll see a bigger benefit as the year goes on. To your point, key feedstockâs like propylene, they have started to come down pretty meaningfully significantly. And eventually, it's going to find its way even more into the resins and the solvents that we buy. And that's starting to happen. We buy some of our raw materials on spot prices, so we can take advantage of that where it makes sense, and we have some on contract. I think what you also have to look at, though, is that as we look across the entire basket. Each commodity really has some dynamics associated with it. So while we're expecting down low singles to mid-singles for the basket, there's really a wide range across those different products that we buy. Some are better than that range and some are worse. And I think you're also seeing -- in addition to that, you're seeing input costs like energy and wages, which are very volatile. Those are also putting some pressure right now. So I think the takeaway would be you can expect us to continue working very closely with our suppliers to bring those costs in line with the industry demand levels, and that also reflects our position in the marketplace. Okay. Thank you. And then when you mentioned the lead demand indicators, could you just -- what are those? Could you run through some of those? And then you mentioned that you have a little bit less visibility into the back half of the year. I guess, how is today maybe a little bit different than prior periods outside of just general uncertainty in the economy? Well, I'll talk about the indicators that you mentioned, Truman. They're the ones that we've cited for many, many years on our Analyst Days and our calls. So you heard a couple of them here on the res repaint side, the Lyra Remodeling index, existing home sales on the new res obviously, it's permits and starts. Commercial, there's a couple of different ones. If you look on the industrial side, John, in his remarks cited the PMI numbers, which have not been trending very well at all. So it's those kind of external indicators married with obviously the real-time feedback we have from our customers and our -- it's one of the advantages of our direct distribution model. And on the second half, Truman, I would say that the view of the first quarter, first half versus the back half, I think it's -- you can attribute that to a very fluid and changing market. Interest rates are moving up. Housing starts are adjusting accordingly. Quite honestly, in times like this, the flux in the market, and this is my 38 years of experience talking here as well is that the contractors vary in their ability to anticipate what's happening. Some of them will look at their short-term book and believe that everything is okay. We're working with those contractors to help them understand some of the pressures that are coming down the pipe. So some of what we leverage our own controlled CRM that we have developed, the fact that we've got almost 5,000 store managers and nearly 4,000 sales reps that feed a great deal of our understanding of the market. At this time, there's a little bit of a disconnect in that because some of our customers are feeling perhaps more bullish than we think that they should feel. Others are tied to other areas such as new residential, and they understand what the pipeline looks like. So when we talk about the visibility that we have in the first half, it's tied more towards the bids and contracts that our customers have in hand. It gives us more confidence. And that's why, as we mentioned in my prepared remarks, as we get through the first half, we'll reevaluate. I want to be very clear, we won't be adjusting our earnings forecast after the first quarter. We expect to have a very good first quarter, but we're going to wait and see as we get through the second quarter, what the balance of the year looks like. Once we have that better visibility, we'll speak to our investors as to what to expect going forward. But I would also add is, as we've come through COVID and some of the shortages that we've had in the market, we've become much closer with our customers. It was one of the benefits of the challenges that we've had. And so we believe we'll come out of this with a better line of sight as that relationship has improved dramatically, and it was already strong. But I think that as we get through the second quarter, we'll have a better line of sight. Good morning. I guess on Performance Coatings Group, can you just give us a sense as to what you're embedding for volume expectations by the sub-segments, auto refinish all the way through? That would be super helpful. Well, on refinish, I'd say there's a high demand here, coupled with a shortage of body texts and parts contributed to shot backlogs. We're working through a backlog of demand ourselves as we're securing more and more raw materials. As you work through some of these challenges, Ghansham, as you know, when there's a shortage of raw materials, the bottleneck moves through the process. So as we do get, which is a team effort at Sherwin, we're squeezing more and more raw materials and availability, that's improving, and we're trying to get more and more of the product out as a result of that. But as you look at automotive refinish, we're really pleased with the gains that we're gaining -- that we've gained, and we expect that to continue. I'd say packaging had a terrific year. Year-to-date, we finished the year in the mid-teens. That was on top of a year last year in the high 20s. So tough comparisons. We're gaining a lot of share here. We're investing in capacity as fast as we've added capacity and add capacity, it's sold out. So the faster we can get that capacity up and running, the business will grow at an even faster rate. Our coil business. This is seven consecutive quarters of double-digit growth here. Insight here that you're asking for, I'd say our North America end markets seem to be softening a bit. APAC, soft demand. And real estate market is limiting our extrusion business there and EMEA some pretty substantial declines as major coders in EMEA have shut down lines as a result of the demand. Our general industrial business, another strong year. And again, here, there are terrific opportunities within these segments. The heavy equipment market is very strong, and we expect that to continue into 2023, particularly in the ag and construction. Appliance manufacturers are appearing to slow down production as inventories get reset. Transportation and building products, I would say, are slowly down a bit. The industrial wood -- our industrial wood business is one that is tied to housing in many ways. If you look at kitchen cabinets, flooring, furniture, as I mentioned, they had a tougher quarter and were down slightly for the year. We've been investing in this business because we believe in our strategy. We've made a couple of acquisitions and have been open with the investors I've met with to tell them exactly that when we see these opportunities. We're a 156-year-old company. We're investing in this accordingly. We're not trying to win a week or a month or a quarter. We're investing long term. That confidence in our teams in each one of these segments, terrific leadership at the group level, Karl Jorgenrud, and we've got a lot of confidence that this is going to be a key driver for our business coming out of the choppiness and that we'll grow share during these choppy times. So it's really what we expect in the market. And again, we don't report we influence. We're going to outperform the market in each of these segments, we believe. Terrific. And then as it relates to TAG and kind of going back to your prepared comments and your characterization of the world we have today. I mean, obviously, interest rates having spiked over the last year having an impact on the housing ecosystem, including you. What would change the calculus of that? Is it just as simple as it reversible interest rates? And I'm just trying to reconcile the fact that interest rates have pulled back pretty substantially since October. Yes, it's a good question. I think you should expect us, first I want to be very clear, not waiting for the market to lift all the boats. I mean we're going to go really aggressively here, Ghansham, I would say that -- let me be careful in the words that I choose, but I would say I wouldn't want to compete with our team. These people are really well focused on the opportunities that we have. Yes, it will be impacted by housing starts, resale. We've got a terrific business in our property maintenance. We've always talked about kind of the table preparing from a strategic standpoint or which whatever way the table will tilt. And here in this environment, as the rates work their way through, if it's in residential repaint, you're going to see us outperform in residential repaint. If it's in property maintenance where people are going into multifamily homes as opposed to building homes, we're the leader there. And the same point on property maintenance as new res. We've done exceptionally well on a national standpoint. We're really cranking in after the regionals. This is the opportunity we have. We have competitors that are backing off because of some of the pressure in some of these segments. And we're going to go -- we're going to be aggressive. I'll just leave it there. We're going to be very aggressive in the regional pieces as well. Ghansham, this is Al Mistysyn. The only thing I would add to that, to your point, interest rates bounced around. And just like we talked about, as interest rates rose, it takes time to filter through the market and specifically into paint. So if you think about paint, we're always at the end of the project. So even if starts flip today, you're talking three to four months out, assuming no supply chain challenges before we get to our part of that project. And those are the things that we'll keep monitoring and pushing on with our teams to make sure we're gaining an outsized portion of the share as it returns. One additional point, I'll go back to Heidi's comment about our over-indexing a bit in new residential. We've done very well here. And so as those points that Al just made as housing starts begin, while there will be a lag, we'll see the benefit of that in a considerable way. And when it's down, we'll feel it perhaps a little bit more. Why don't I start with that and Al, if I miss anything jump in here? I'd say that David, our view as it relates to pricing is always looking at total cost of the basket, not just raw materials, but everything from labor, transportation, containers, everything that goes into that. And right now, I would say, we've not announced any additional pricing. I think we've demonstrated the ability, desire and conviction to stay on top of that and the willingness to do that. So if, in fact, we find ourselves in that situation where we need additional pricing the first people that we'll hear about it will be our customers, and then we'll quickly advise the street of our actions. Yes. David, the only thing I would add just to put some color around 2023 on pricing in general. We talked about on our third quarter call that we had no additional pricing, we'd expect a mid-single-digit impact on our full year '23. Obviously, that would be a little bit higher in our first quarter. Our expectation is we're going to maintain the majority of our price like we've seen in the past. We think we've gotten past the margin contraction portion of that cycle. We're starting to see margin improvement sequentially and year-over-year, and we expect that to continue going into 2023. Very good. And Al, do you still expect production this year to be below volume sell-through? And so how much -- what's the dollar impact on earnings here? Yes. I don't know we're going to quantify the dollar impact. But because we had to build so much inventory in 2022 to get back to more historic levels, and we are going to see a negative impact. And you could think about, and I talked about this, we'd expect a 5% to 7% decline in production gallons specifically on architectural. We are definitely expecting to see that. And that will have a drag when we look at Consumer Brands Group because that's where our global supply chain is embedded. So you're not going to see as much margin dollar improvement just for that very fact all else being equal. Thanks for taking my question. Just curious, you mentioned in the slides some inventory destocking in the North America retail channel it seems like. Are you seeing any destocking outside of that channel, perhaps maybe some of your OEM customers? No. Most of our OEM customers operate on a very low min/max level. So they're leaning on us to be responsive for them. So while some would have inventory, I'd say that they lean on us and we support that as a means of helping them to be successful. Yes. And the only thing I would add to that, on the retail channel side, I think coming out of the third quarter, you heard some of our peers talk about destocking. We did not see that. So we were probably a quarter later anticipated some of that. And as a result, you saw consumer do a little bit better in the fourth quarter than we had planned. Got it. That's helpful. And then just in the past, you've touched on some pretty positive trends in the Pros Who paint business. Maybe an update there that also seen a slowdown as you move through the fourth quarter and into this year. Well, it's an important -- very important initiative for us. That's in our Consumer Brands Group. For those of you that may not be familiar with it. Todd Rea, our President there, is working closely with our teams to really capture a terrific opportunity. If you think about what we call the Pros Who Paints, it's someone that might be involved in either house flipping or remodeling and while we're very focused on the painting contractor through our store, there are customers who enjoy the wide breadth of assortment and availability of products that they get through a different format like a home center. We're really excited about getting after this market because they prefer that type of a setting and we've got great relationships with customers that are interested in that. So I would say that in Sherwin, we're not a complacent company. There's good momentum here. But along with our customers, we want to go faster. We think some in the market have been enjoying an unencumbered run at this business, and we enjoy disrupting that and helping our customers to be more successful and we're intent on doing that. Good momentum, a lot of opportunity ahead. Yes, good morning. As you move the Latin American business over to consumer, can you help us understand what the associated margin uplift might be to consumer from that repositioning? Yes, Kevin, it's really not a material change when you restate all of the factor -- all the income statement, it might give it a little bit of a lift on the TAG side because, as you well know, Latin America has been dilutive of TAG. But on the consumer side, where we're at today, versus where Latin America is. And I'll give Latin America shout-out. They've done a lot of hard lifting and rightsizing their business and are now back to focusing on growth where before it was about cost management and that type of thing. So now that team is externally focused and really going after market share growth. So I don't think you're going to see a material change on either segment because of this. But I think from a strategic standpoint, a focus standpoint and where the market trends are, it's the right decision at this time. Yes. Kevin, I know you didn't ask specifically about -- I know you asked about the margin piece of it, but I do want to expand that to include it does have a positive impact on our TAG business. The focus on North America. We've got, as Al mentioned, a terrific leader, Alberto Benavidez down in Latin America that leads a wonderful team, and there's a shift in what's happening down there more towards what best aligns with our Consumer Brands Group. So it is a terrific opportunity from a best practice standpoint to align those two businesses. We think it's going to help our TAG business focus, and we do think that it will allow our businesses to share information. We'll take information out of Latin America that will bring up to North America and vice versa as well. Okay. Thank you for that. And then secondly, I wanted to ask for your updated thoughts on Al kid resins. It sounded like that was a meaningful constraint in the fourth quarter. Is there a way to size that? And is the availability beginning to improve yet as we talk today in the first quarter? Yes. Kevin, I would tell you that the availability, I'm not a surprise that alkyd resin does remain an industry-wide challenge. I give our technical teams and commercial teams a lot of credit for working through some very thoughtful and, in some cases, upgraded substitutions during this challenge. And we've really isolated this down a very few and are seeing sequential improvements already into our production. So I think you could expect over the next few quarters that we're going to be in a much, much better position. And the only thing I'd add to that is, we haven't called it out. It's -- so it's not material to the consolidated results. And as you know, it's split kind of between consumer products, it's split in industrial within each of those segments, it's not material. So that's why we haven't called it out. Yes, just sensitive to those that are affected by it, it's very material. If you think of our sales teams or our customers. Al was exactly right on a consolidated basis. But there have been many of our people that have been forced to work through some pretty challenging times and customers that have been working with us on that. So the materiality on a consolidated basis may not be as impactful as what it is to some of those that are truly impacted by it. Thanks very much. I was looking at your midrange assumptions on Slide 8. And in it, you assume that prices are, call it, up 5%, which is about $1.1 billion. And if volumes are down 5% maybe the detriment is 550. And SG&A, up mid-single digits is about 300, FX is maybe another 100, but that would be offset by a raw material decrease of 4%. So with these assumptions, why shouldn't your EBITDA be up $400 million rather than down $150 million at the midpoint. What is it in here that's really pulling the returns down if prices are really going to be up5%? Yes, Jeff, I think what -- we went round and round in this about mid-single-digit range because you're talking at a mid-single-digit range. You've got a pretty wide margin. So I would say -- at the midpoint, we're thinking maybe a little bit lighter on the price impact and a little heavier than what you mentioned on the demand side and the volume side. So I think there's nuance in that, and this is why, to be honest with you, I struggled with laying this out that way because you can interpret it just as you have, if you go to the high end of each of those that are positive and the low end of each of those that are negative, I can get a significantly different results. So to clarify, that's why I'm saying, in the range in the midpoint, we do expect EBITDA margin expansion and EBITDA growth, it's just not going to be as significant as you're talking about. And then for a follow-up, I think you had aspired to a 45% gross margin in the fourth quarter. And maybe you came in closer to 43%. Was it that volumes weren't as strong as you expected? Or was there a different factor? No, I think you're exactly right. And you're dead on, excluding onetime and items and acquisitions, we're probably 43.1%. And it's really by the missing tag. It's our highest margin business. It came in below the bottom end of our range. And as John talked about, some of the other segments, PNM, DIY were double digit but below our range. And we also I hate to throw a weather out there, but the last -- that snowstorm around Christmas really felt like a lot of people took the whole rest of the year off. Now that being said, we are seeing those sales back in our first quarter in January and our first quarter -- start to the first quarter is where our outlook is current... Yes, the last couple of weeks, it really dampened down and contractors pretty much checked out throughout that. And to Al's point, as January started, you see them back in the store activities right back where we expected it to be. Yes. Just one quick question. When you look at the midpoint of your guidance, I think you all said that the first half will be better than second half. So any help in terms of -- is volumes kind of flattish in the first half or down a lot more in the second half? And how does that sort of split up in terms of the 8.30. How much more front-end loaded is it than the second half? Thank you. Yes, Jeff -- Mike, I would say from a volume standpoint, we're expecting and I'll start with architectural volume. We're expecting architectural volume and TAG specifically to be up low single digits in the first half and then moderate certainly in the back half. Because when we think about the cadence of new residential and how I have it built into our plan, we'd start seeing a material slowdown as you get midway through the second quarter. That would accelerate into our third quarter. And then even if it's a shallow slowdown and it starts coming back, like I talked earlier, starts start coming back. We're not going to see the impact of that until three or four months out. So that's why it's a bigger negative impact on our fourth -- our second half than our first half. And as we've talked about, as volume goes, our operating margin and operating leverage is driven mostly by that. We expect to see more price in our first half than our second half as we annualize the price increases throughout the year, we'll see those moderate. And then we also expect to see more of the acquisitions in performance coatings in our first half and the sales and EBITDA incremental improvements there. And then as the July 1 acquisitions annualized, that will be more muted. And then a little bit offset by the way raw materials rolled out. Jim talked about the 4%, low to mid-single-digit benefit it's a little heavier on our back half than our front half just because even the first quarter, we might be flat or up or down slightly. Thank you. If I could just ask, if you think about the 2 halves of the year, and it's well understood that you've got some visibility in 1 half and you don't in the back half. And it's also well understood now what the key macro drivers are and so forth. If you think about the back half of the year and the back half of the year winds up coming in worse than you anticipated in the different segments. What do you think the key risks are in those segments that we really need to be watchful of to sort of be on guard in case that back half wounds up actually being worse than what you anticipated to be? I think, Vincent, the thing that -- I would say it this way, the thing that we're watching specifically is within TAG and within new residential -- and the -- it's not an exact science when you look at the timing of a potential slowdown as John talked about, and the macro headlines of single-family starts slowing. You see some of the national homebuilders talking about the lower orders, but it's really as the homes get to completion is what impacts our sales the most and there's variability in that. So as we continue to work with our national homebuilders and get a clean line of sight of that and the impact that not only has on our new residential and TAG, but also kitchen cabinets, flooring and furniture on our Performance Coatings businesses, that's going to be the main driver of whether the second half is stronger or less strong than what our current outlook is. And can I just ask 1 quick follow-up would be in Consumer Brands and in Performance Coatings. In Consumer Brands, are there any shelf space issues that we should know about? And likewise, are there any share gains or losses in Performance Coatings? I think there's no impact on the shelf impact shelf restriction on consumer, but I think there's a huge amount of market share gain opportunities within our industrial businesses, and that's all of them. As John talked about, we do not have 100% market share in any of our businesses, segments or regions and that's the way we're going into 2023. We're marching aggressively. So there are terrific opportunities that we're going to be pursuing. And we often talk about the coiled spring as this business comes back and we grow share, grow customers and it returns, it's going to spring. There's been a lot of discussion here on the new housing market. Obviously, we've seen a slowdown there. We did see that permits are also down 40% year-on-year. I guess my question is there has been a greater correlation though with architectural gallons sold in existing home sales. And there's probably a lag between starts in existing home sales as well. So could you comment on what's your outlook for existing home sales and how that ties into your guidance? Do you see any risk that maybe the low end is not low enough if the existing market gets worse from here? Thanks. Arun, on the existing home sales, I'd remind you that drives a portion of our res repaint, but there's other factors as well that drive that repaint business. And I think, as John said, in his comments, that's an area we've been investing in more stores, more reps to go after res repaint. So I mean if you look at existing home sales, they've been down for 16 straight months but you've got other things that might offset that home price appreciation is still up year-over-year. You got the aging housing stock. You've got the baby boomers aging in place, all these things we've often spoken of. So while that will be a headwind, there's other things that will help drive that repaint. And along with the share gains that John is talking about, we think got a good outlook and high expectations for res repaint next year. Yes. Ron, the only thing I would add to that is, as you know, res repaint is our fastest-growing segment. It's our largest segment, and it's our largest opportunity for market share growth. And I think that's what the focus of our TAG team is on with the specific investments in dedicated new res repaint stores and dedicated res repaint reps. As part of what gives us the confidence as we compare this to the last slowdown, we came out of the last slowdown determined to grow that residential repaint business to help offset, we call it almost a resilient segment, having the growth that we have had and we continue to invest. I think I don't know what the number is out. What the number of stores that we have now versus the last slowdown were up, how many? 1,200 more stores now versus the last slowdown, probably a near similar number of reps focused on this area. And so it shouldn't be a surprise that we're growing the last 10 years over 11.5% and the conviction and determination that we have, I think, is an all-time high. And we expect, as we work through this challenging times to grow more share that we'll enjoy as the business -- through this as well as when the business comes back. So I would add to that, too, I think over the last 10 years. I think while the marketing dynamics certainly are similar to back 2008, 2009, I would say it's almost even better now. There's so much change in the market. I think as you mentioned, our incremental store count, we've been aggressively adding stores. Our competition, I would say, has been aggressively closing down stores. So with these changes, there's been some confusion in the marketplace that we believe is our opportunity. So we're adding a new store about on average every four days. And I think we'd all agree we're confident in our long-term strategy, but our near-term ability to execute. Okay. Thanks. And just another follow-up, I guess, was given that a lot of your growth, you're investing is mainly on the organic side. Are there inorganic opportunities as well that may present themselves in a downturn like this? What are some of the areas within the portfolio that you'd need to buttress if at all? I know you made the bolt-ons in some of the raw material and technology areas, but anything would it be more like in those areas? Or is it industrial? Or what are you looking at for potential M&A? Well, we've been investing in a number of transactions that we think are terrific. We've been investing primarily on our Performance Coatings side. We've invested in industrial businesses, general industrial in Germany, industrial wood business in Italy. We've got a number of flooring businesses that we've welcomed into the family. And our goal here is not -- we're not portfolio managers. We don't bring them in and run independent businesses. These are going to be contributors on a much brand or scale to the overall business. So technology that we acquire in some part of the world we're immediately looking at how we leverage that across the entire platform. So as you're watching and absorbing the acquisitions that we're making, I hope everyone understands, we're really not interested in buying small positions in different parts of the world. We're making these acquisitions, and we'll leverage them across the entire platform around the world. So these have been good investments, we think, and there's still a considerable amount of opportunity ahead to better leverage them going forward. Just one kind of cleanup question on pricing. So in the deck that you showed on Slide 8 where it showed consolidated pricing carryover and there was a range, low single digits to mid-single digits. I guess what drives the range there? Because it sounds like it's just a carryover from kind of where you ended 4Q. So I guess what would make it go to the low end versus the mid-single-digit side? I guess, how should we think about that? Yes, John, I think it's somewhat similar, I would think, as when we talk about a range on raw material costs, there's a lot of different market dynamics from demand and other things that might cause that range to move. The point I would [Technical Difficulty] TAG 5 different price increases over two years. We fully expect to maintain the majority of that price. So even a slight decrease, increase or movement within that range doesn't impact the overall fact that we're going to maintain the majority of that price as we've done in similar environments in the past, and I think that's similar across the industrial businesses and consumer because we are looking at the total input cost basket that's affecting what price increases we've gone out with and what continued investments we've been able to make as we bring our gross margin back towards that long-term rate of 45% to 48%. So just to be clear, we kept investing when we're taking margin contraction through the cycle and now that margins start improving again. We can continue those investments to drive growth, both through our retail partners, through our own stores and help our industrial partners drive growth as well. Yes. I'd add to pricing isn't just a quick 30-minute discussion with our customers. It's the result of adding value everyday that's allowing us to be effective with them. So when you think of the value that we're bringing. It goes well beyond the product, but you talked earlier about services, project health, digital convenience. So we're really confident we're going to be able to hold on to this. We're not just talking about price of kind of a stand-alone discussion, so confident we're going to be able to hold on to that. Got it. And then maybe just a follow-up. So your stores tend to have a higher service component to it than maybe some of the competitors out there, and that's helped you on the share front. But I guess our concern would be with labor inflation as big as it is and labor being a bigger component of your cost, I guess do you have enough levers that you can pull to offset that beyond price because your competitors may not actually have to raise price as much to deal with kind of wage inflation. So I guess, how should we think about that? Yes, John, it's about driving higher quality products that make our companion contractors more efficient, allows them to get more jobs done with the same number of painters and it drives their bottom line. And I think when you look at it in an inflationary environment, and we've talked about this in the past, you tend to see more -- and I'll use as res repainters move up to a higher quality product because they're going to pay more for that gallon of paint. The gallon of paint is small relative proportion to the overall cost of a project. So as we get those higher quality products in their hands and show the efficiencies they can get, it drives higher -- as you imagine, higher quality products, higher margins. And that's how our strategy is when we innovate new products, and I've said this many times before, you always innovate the high end of the good, better, best continuum and over time, that good gets replaced. So I think that's a big lever for us and a big driver of how we can continue to expand our margins. Great. Thank you. the DIY paint historically is not price elastic, but do you think that some of the demand weakness here is that prices just got too high? Well, I'd say that our residential repaint business is strong, and it's as even more in times to have a contractor apply to paint, John. I know I understand that, but I'm saying that in the market, we are having customers that are continuing to invest in their homes as prices have gone up and in the breadth of product that we offer, while there's a wide platform of price points, we continue, as I mentioned, to see stickiness in the higher quality products. So I don't know that it's -- we've reached a point of demand destruction. If that's your question. I think the consumers are very well aware of inflation in the market, and I think that they're making decisions right now. No question that building up your tank has been more expensive than it has been in the past. But I'll go back to the point that we made earlier, which is that it's a -- amongst all the opportunities to influence the environment, which is most important to most of us, where you live, relative -- still a relatively inexpensive but highly impactful investment in your home. John, the only thing I would add to that is -- and we saw this in our second quarter, and I think it segment our DIY customers between what we see in the retail channels versus what we see in our stores, certainly, with the inflation of energy and food, and we saw a bigger impact on demand in our retail channel versus our stores channel. So there may be that nuance that you're seeing. One piece I would add to that, too, in terms of just elasticity, I think there's also the dynamic with the consumer DIY segment to Al's point, where they're purchasing less frequency, you're going to have some that are more value conscious. But we have introduced and innovated so many different products that have brought trading up to be more attractive, whether it's [indiscernible] increased durability. And so that consumer that's paying every five to seven years has demonstrated a willingness to pay for that as well. Okay. And then, Heidi, I think you mentioned that coil was one of the stronger end markets. Isn't that appliances and sheet metal for construction? What's going on there that, that outperformed? John, you might have misunderstood my voice versus Heidi so it was my voice that talked to coil. We have a nice business in our coil business that is impacted by our appliance business. And as I mentioned in my remarks, we do see some settling, if you will, in the appliance business as there's kind of a reset to inventory level. So it has impacted our coil business. A question on the China and the aerosol restructuring. I guess it's a pretty significant amount of sales you maybe walking away from or rationalizing. I guess, are we past the point of having any ability to monetize that? I'm sorry, Josh, when you say we past the point of ability to monetize it. No. I think we have consistently taken a review of our portfolio of businesses, brands, customer programs. And I think we look at it both midterm on their ability to get significant market share growth and return on sales and cash flow. But we also take a longer-term view of it to say, if there are opportunities to monetize the business. We'll work to reorg to get it in position and pursue that option, among other options. You can run it for cash, you can run it as a growth business or you can monetize it like you're talking about. So each of those options are being evaluated and we'll update the Street as we get to that. The short-term reality though is that market, in particular, China, architectural is under heavy pressure, and we have to and we did take appropriate significant actions to adjust to that market conditions. Okay. Appreciate that. If I could ask 1 just to follow up on Res. I mean it's obviously down low to mid-single, put a small dent in the 30% plus you guys have absorbed in terms of increases. I guess is this where raw materials stabilize in your view? And I guess if you have a weaker view on volume in the second half, do you have any visibility to either longer-term contracts or anything else becoming a relief point for raw materials into the next year? Yes, Josh, I think you hit it, I mean, if demand continues to deteriorate, we would -- or more so than what we expect in the back half, you'd expect raw material costs to drop with that. And there's not long-term contracts or agreements that lock us into to not participate in those kinds of actions. Thanks. Two questions. One, thanks for the helpful CAGRs on new resi versus resi repaint. Could you remind us as to how much bigger the resi repaint businesses compared to new residential? Yes. It's -- Greg, it's today, 2:1 res repaint versus new residential. Back -- prior to '08 and '09, it was 1:1. So John talked about the tremendous low double-digit growth in both segments since 2010. It's just the new res repaint was starting from a higher base. Perfect. And then the second is more about understanding the gross margin progression. It sounds like 45% to 48% is still the right goal. I think, John, you talked about getting that in a couple of years in a normalized environment. So I guess my question is, if volume this year ended up being flat or slightly up as opposed to down, would we be back in that 45% to 48% range this year? Or is there something else going on that is impacting being on... No, I think that's a fair -- that's directionally fair. I think if the volume is better. And in particular, the volume is better in TAG because it's our highest gross margin segment. And yes, with the pricing that we would maintain the majority of monitoring raw materials, the continuous improvement mindset that we have across our manufacturing and distribution facilities all play into driving that margin to that 45% to 48%. But to your point, Greg, it's always about volume, and it's about volume through TAG that's going to help lift that gross margin. Fair enough. Would it be fair to use the fourth quarter as a proxy to get an idea of that operating leverage? In other words, it looks like volume was maybe 300 or 400 bps lower than you thought it was going to be and gross margin end up being 200 basis points lower? Or am I thinking about that the wrong way? Just following up on the comment, John, you made earlier about your home center partners or you're helping them as they requested for the Pros Who Paint. And I was just curious whether any of your home center partners within consumer are trying to do what you can do through your stores, like delivery of large volumes to the job sites on a digital access. Are you seeing any of them do that? And does that have any impact on your stores in the area? Yes, Steve, I want to be really clear here that we're supporting our customers and their efforts to apply and execute on the strategies that will help them grow in this business. I think what you're trying to get after is cannibalization between the home centers and our stores. And we've looked at this in great depth. There would be very little -- there might be a few accounts here. They are a small amount. But we would gladly put those on the table to expand into a virtually untapped market for us. And the painter that's in our stores every day has expectations that are likely best filled through a specialty paint store. Some of them find their way into home centers, and we want to support those that find their way in there. But I would say that the target here and the higher level of success is going to be attracting those customers into the home centers that prefer the home center experience, largely because of the breadth of the product lines. And so we're not bashful about it. There'll be a little bit of cannibalization, very little compared to the opportunity that collectively we can pursue with our partners. Okay. And I wanted to ask you how much visibility do you have to the backlog that your contractors have? And do you have a view on how much do they have, whether it's residential repaint versus commercial and property management? Are those meaningfully different right now? And was there a big change recently. We had some dialogue with some contractors where there was a significant change like in the last month. Yes, there's been some change. I referenced that earlier that the pipeline of bidding has tempered down a bit. The quality of those bids seems to be improving and the scope of the projects continue to actually grow. I'd also say -- so the answer is yes. We do work closely with our customers. And as I mentioned previously, we I think are working much closer with them than ever in my career, partially because of the experience that we've had over the last couple of years. And so I'd say there's a wide spectrum. If you look at the one end, the commercial painting contractor and the industrial painting contractor, they generally have a longer view of what's happening because of the scope of the project. On the commercial side, something might be coming out of the ground and that project may be in a couple of years in the making. Industrial side, when they're talking about the protection of assets, there's usually a plan that they're following. That would be on the far right side. And on the other side, a shorter line of sight would be the residential repaint side. And in between would be property maintenance and new residential where there are varying lengths of view, if you will. So we work with our customers, all of them to have a good understanding. There has been some shift that's reflected in our guidance that we've given. But again, I want to reiterate, I want to -- this is really important. I apologize for repeating it so often here. We're not sitting here on our back saying well bad things are happening to us. We're aggressively pursuing any one of these segments we can talk to, what we think the market is going to perform it and how much better we expect to perform in that market. So whilst even some of the bidding that might have tempered down, again, we're not sitting here with 100% market share. We're aggressively pursuing and we expect our competitors as they pull back, we're going to take advantage of those opportunities as well as the new products. You mentioned a couple of those, the services, the new stores, we're going to be very aggressive during these times. And we expect as we go through this, to grow share. And as we come out of it, that coil spring is going to pop. The other thing I would add is, I think everything that John just covered across segments, I would say that in general, our customers like we have become better planners. And together, we are creating not just that stickiness we always talk about, but becoming better business partners and business planners together. Thanks for taking my question. I just wanted to ask on the SG&A guidance range? And what are some of the factors that you're going to be looking at when you decide to pull the trigger on some of the growth initiatives versus pulling back some. Is just a function of how demand is tracking this year? And maybe when do you have to make that decision, just given the range is down low single digits to anywhere to up mid-single digits through the year? Yes, Garik, I think we look at it as we progress through the first half and get a better outlook coming into the second half. I would tell you that from a G&A standpoint, we are going to maintain our G&A tightly through the first half. I think you're going to see us -- I'll use the term pedaling clutch like one of our predecessors here have used where we'll spend merchandising, advertising, things of that nature that are not committed and their they are discretionary. We'll manage those to how demand outlook we feel like. And it's on the long-term growth investments that you can expect us to continue to push those through stores, reps. We just talked about the Pros Who Paint because we have confidence and we have a lot of strong outlooks for the long term when it comes to architectural demand. We talked about packaging, we talked about any number of market share opportunities we have across all our businesses. So the confidence we have in the long-term outlook makes you say that we're going to continue to invest in these long-term growth opportunities. These other noncustomer-facing type of spending, we're going to maintain very closely. Okay. Thanks. Follow-up question is just on the pace of new store openings for '23. Just given that it picked up quite a bit in the fourth quarter, should we expect it to revert to maybe kind of a more linear pacing or any color on how that looks? Garik, we've been trying to spread those out more evenly for 38 years that I've been with the company. For a lot of reasons that they get back loaded as the year unfolds. We've got a good line of sight on the number and locations. But I would say they're likely going to be -- I hope not as backloaded as last year, but they're going to lean in the back half of the year again in 2023. Thank you. That concludes our Q&A session. I will now hand the conference back to Jim Jaye for closing remarks. Please go ahead. Thank you, and thanks, everybody, for joining our call today. As we went through our comments, I believe you heard that we're very confident in our strategy going forward. I'm very confident in our people. It's a very deep and experienced team. But at the same time, given what we see today, our outlook, I think, is a very realistic one starting off this year. Even in that outlook, we're going to continue to gain share. We're going to continue investing in the business to grow. You heard Al say we're going to control the G&A very tightly. And I think John said it multiple times that we really expect to outperform the market just as we have in the past. So thank you for joining us today. As always, I'll be available along with Eric Swanson for follow-up calls. Have a great day. Thank you. Thank you. This concludes today's event. You may disconnect at this time, and have a wonderful day. Thank you for your participation.
|
EarningCall_1122
|
Greetings, and welcome to the Cazoo Fourth Quarter 2022 Preliminary Financial Results and Revised 2023 Plan. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Robert Berg, Director of Investor Relations and Corporate Finance. Thank you. Mr. Berg, please go ahead. Thank you. Good morning, everyone. Thank you for joining today's call and webcast to discuss our fourth quarter 2022 preliminary financial results and revised 2023 plan. You'll be able to find today's press release on our Investor Relations website at investor.cazoo.co.uk. We appreciate everyone joining us today. With me on the call is Alex Chesterman, Founder and Chief Executive Officer; Paul Woolf, Chief Financial Officer; and Paul Whitehead, Chief Operating Officer. Before we get started, I would like to remind you of the company's safe harbor language, which I'm sure you're all familiar with. Management may make forward-looking statements, including guidance and underlying assumptions. Forward-looking statements are based on expectations that involve risks and uncertainties that could cause actual results to differ materially. For further discussion of risks related to our business, please see the filings of Cazoo Group Limited with the SEC. Thanks, Rob. Good morning all. Thank you for joining us today. As you will hopefully have seen from today's press release, we've set out our high-level preliminary fourth quarter 2022 results, which we believe showed a strong end to last year, and a revised 2023 plan aims at rapidly further improving our unit economics and conserving cash. The purpose of today's call is primarily to give you the opportunity to ask any questions you may have. We're very early in our 2022 year-end close process, but have today disclosed that in Q4, despite the significant macroeconomic headwinds, we had another strong quarter of U.K. retail unit sales of around 17,750 units in the quarter, up over 100% year-on-year. And we've now sold well over 100,000 cars in entirely online in the U.K. in just 3 years since our launch, which is testament to the strength of our proposition and the continued adoption of online car buying. Our U.K. revenues in Q4 were approximately £315 million and almost £1.25 billion for the full year, only our third year of operations. We also saw our U.K. retail GPU increased to around £600 in Q4, showing continuous improvement every quarter during 2022. Our positive momentum has continued into 2023, and so far, in January, we've seen solid unit sales and record finance and ancillary attachment rates. Our balance sheet remains strong with over £250 million of cash and cash equivalents, plus over £75 million of self-funded vehicles at the end of Q4. During 2022, we demonstrated our ability to buy and sell cars at significant scale. However, in the current economic climate, we believe the right course of action for 2023 is to focus on further improving our unit economics, materially reducing our fixed cost base and preserving cash as we make continued progress towards our goal of reaching profitability without the need to raise further funding over the next 18 to 24 months. To enable these improvements, we're resetting our 2023 top line ambitions to 40,000 to 50,000 retail units, allowing us to focus on higher-margin, faster-moving vehicles, and to rationalize our operational footprint to increase cost efficiencies. Following this reset, we expect retail unit sales to return to growth in 2024 and beyond. This plan is in the process of being finalized and implemented, and we'll provide more detailed information at the time of our full year results in due course. In summary, whilst 2022 was a challenging year in many respects, our continued strong unit sales, notable improvement in unit economics during the year and market-leading proposition gives us strong confidence that we can both deliver on our 2023 plan and realize the attractive long-term opportunity for Cazoo. Great. Thanks for the update here. Maybe a question firstly on the fourth quarter end and 2023, your cash and equivalents was down roughly £60 million quarter-over-quarter. Could you help us bridge that gap between the different items, including contributions from EU, any divestiture proceeds and the core U.K. business. Just trying to bridge that, and then I have a question on 2023. Yes. Thanks, Rajat. And I'll let Paul Woolf pick up on any detail. But generally, Q4 was a combination, the cash burn of U.K. burn at the old rate of fixed costs, which obviously are materially lower as we go into 2023 following this rightsizing and restructuring plan and also a number of one-off costs related to the wind down of our operations in the EU, which we'll see a little bit more of in Q1. But beyond that, those -- there should be no further one-off costs relating to restructuring either of the EU or the U.K. Yes. And, Alex -- so just to pick up on that, I think that I mean that's right. And broadly, the majority of the cash was related to the U.K. trading business, but then with some positives and negatives in Europe, which more or less offset, but were slightly negative overall. Got it. Got it. That's helpful. And then maybe on 2023, it looks like you're suggesting roughly £150 million in cash burn. Could you give us a sense of the cadence of that? And relatedly, could you talk a little bit more about the cost efficiencies from the pullback in growth? Is it more geared towards GPU improvements or SG&A reduction? Or I'm sure it's like there's an element of SG&A, too, but the confidence would be helpful. And should we continue to expect EBITDA breakeven by the fourth quarter? Or has that also been accelerated with this new plan? And that will be all for now, and I'll get back in queue. So again, Iâll pick up at a high level and then pass to Paul to sort of expand on it. In terms of -- thereâs a combination of improvements in 2023, so yes, there is a materially improved GPU expectation as we progress throughout the year and also significant cost savings. We expect SG&A savings of about £100 million in 2023 versus the Q4 2022 run rate as a result of restructuring. And of course, there are one-off costs. When you look at that cash burn number that you talked about, there are one-off costs associated with the restructuring, which will largely be in Q1 of this year and may still a little bit into Q2. I just wanted your thoughts on GPU for next year. Does doing fewer units help you accelerate the GPU more quickly? And is there a number in mind for where you'd like GPU to be by the end of 2023? That's the first question. And I think the other question is actually have been asked -- oh yes, sorry, I want to ask you how big the restructuring charge was as well? So on GPU, yes, reduced volume does help improve GPU because it allows us to focus -- when we're not optimizing for volume, it allows us to focus on higher-value cars, higher-margin cars, faster-moving cars, faster stock turn, et cetera, so we can be more selective and focused on higher GPU. And we have aspirations to reach what we set out as our medium-term GPU target some time ago of £1,500. We have aspirations to get there by the end of this calendar year. The plan is still in progress. So it hasn't yet been finalized, but, Paul, you might want to talk to that. Yes. No, happily. So the -- I mean, as Alex said, it's not with -- there is a -- the -- we're still evaluating the property side of it. So from -- I mean, there's obviously a difference between the P&L and the cash flow. From a cash flow side, it's going to be -- it's some -- a significant portion of the restructuring charges will be funded by the fact that we were running at a lower inventory. And we have, as you've been consistently told, significant cash tied up in inventory. So we'll clarify all of the full results announcement. But it's not a significant cash out over 2023 because of this sort of free up some inventory. First what I'm trying to work out is if there's £150 million of cash burn next year and that's after the £75 million benefit you get from the subscription cars, inventory being sold? So that's implying underlying £225 million cash burn in the U.K. business. I'm just trying to work out that's all EBITDA mostly because as you say, you should be getting an inventory working capital benefit as well. The self-funded inventory doesnât come down from £75 million to 0. The £75 million is an entirely on. So we will always â weâll still have many, many thousands of cars, which are largely funded, but also have some self-funded. So you should expect that we will, throughout the year, continue to have £30 million or £40 million of cash tied up in our own inventory. Great. Well, thank you, everybody, for joining, and feel free to reach out to Rob if anybody wants to follow up directly. Thank you. Ladies and gentlemen, this does conclude today's event. You may disconnect your lines at this time or log off the webcast, and enjoy the rest of your day.
|
EarningCall_1123
|
Greetings and welcome to the Fiscal 2023 Second Quarter Earnings Call for Applied Industrial Technologies. My name is Malika, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. [Operator Instructions] Please note that this conference is being recorded. Okay. Thanks Malika, and good morning to everyone on the call. This morning, we issued our earnings release and supplemental investor deck detailing our second quarter results. Both of these documents are available in the Investor Relations section of applied.com. Before we begin, just a reminder, we'll discuss our business outlook and make forward-looking statements. All forward-looking statements are based on current expectations subject to certain risks and uncertainties, including those detailed in our SEC filings. Actual results may differ materially from those expressed in the forward-looking statements. The company undertakes no obligation to update publicly or revise any forward-looking statement. In addition, the conference call will use non-GAAP financial measures, which are subject to qualifications referenced in those documents. Thanks Ryan, and good morning, everyone. We appreciate you joining us. As usual, I'll begin with some perspective and highlights on the key drivers of our results, including an update on industry conditions as well as expectations going forward. Dave will follow with more detail on the quarter's financials and provide additional color on our outlook and guidance, which we've raised this morning. And then I'll close with some final thoughts. So overall, we had another solid quarter with favorable performance across really all our businesses. Year-over-year organic sales growth strengthened, exceeding 21% in both segments. Our teams are doing an exceptional job at managing cost and driving continuous improvement initiatives. We expanded EBITDA margins to a new quarterly record of slightly under 12%. Looking at it over an extended period, our EBITDA margins have expanded nearly 300 basis points over the past three years. At the same time, we continue to invest in talent, safety, technology, and our service solutions further enhancing our capabilities and operational strength for the future. Taken together our respective sales, EBITDA and EPS was 21%, 36%, and 41% over prior year levels. As a reminder, we're facing more difficult comparisons these days. So to see this level of sustained sales and earnings growth is noteworthy and a strong indication of our enhanced growth profile and earnings power. I want to thank our entire team for their ongoing effort and focus on optimizing and positioning Applied to achieve these results. This progress is particularly exciting as we reflect on our company's history, including celebrating our 100-year anniversary a couple of weeks ago with more than 6,000 associates, a very proud and gratifying moment for Applied and our talented teams around the world. Our rich history and culture will remain a guiding framework to our strategy and evolution going forward, along with our valued supplier and business partners who work every day to help us serve our customers and advance our leading technical capabilities throughout our industry. So a few key points and areas I want to emphasize to provide more detail on what's underpinning our performance and opportunity moving forward. As it relates to underlying demand, we saw positive momentum sustain across many areas of our business during the quarter. Sales growth held strong throughout the quarter and exceeded our expectations. Sequential sales rates were above normal seasonal patterns, including solid trends through or during December. While order rates are slowing to more normalized level in some areas and markets as expected, customer commentary remains fairly positive and we've yet to see any meaningful slowdown to date. We are mindful of the ongoing cross currents facing the broader economy, which likely will continue to impact industry-wide activity in the near-term. That said, we remain constructive on our position and growth prospects long-term with our first half performance reinforcing this view. Of no, we believe we're benefiting from a more diverse mix of end markets and growth tailwinds. This is partially tied to our multi-channel strategy and business evolution in recent years. As we've highlighted before, we are favorably positioned to capitalize on key secular growth trends, gaining momentum across the North American industrial sector, including greater infrastructure spending, reshoring and aging and scarce technical labor force and incremental growth opportunities resulting from government stimulus spending. Similar to last quarter, customers continue to work through elevated backlogs. They're also embracing a higher level of technical maintenance requirements and capital spending, focused on reinforcing supply chains and equipment within their production facilities. This is particularly meaningful considering an aged U.S. production infrastructure. Service, reliability and efficient access to leading suppliersâ premium brands and technologies are more critical than ever. Overall, this is supporting demand for our comprehensive maintenance and engineering solutions. We're also executing on a number of internal initiatives aimed at driving greater salesforce effectiveness. We're using more analytics and various sales process tools to identify and capture new business opportunities. Ongoing talent investments continue to supplement our sales momentum as well. In addition, we're seeing solid traction with our cross-selling initiatives from flow control products supporting process maintenance to emerging robotic technologies, addressing labor and safety initiatives at our customers' facilities. The full suite of our technical solutions we offer today is meaningful to our value proposition. Our teams across our multi-channels are increasingly collaborating and solving problems for our customers as they face labor constraints, reassess supply chain strategies and embrace required technology investments. More and more, our customers recognize us as a leading solutions provider, integral to their most valuable production assets and supply chain reliability. Many of these internal sales growth initiatives have been instrumental to our Service Center segment results where organic sales growth exceeded 20% for the third straight quarter. In addition, our local service centers continue to benefit from a productive U.S. manufacturing backdrop and related demand for break-fix MRO support. There also remain focused on managing ongoing inflationary pressures and working effectively through supplier price increases. Gradual increases in infrastructure spending are driving greater demand from our aggregate mining and machinery customers. We also believe growth opportunities are arising as customers continue to consolidate their spend with more capable distributors offering leading technical support and solutions. This is particularly relevant given our market focus around critical motion and powertrain products in demanding applications, including notable requirements around supplier brands and local service reliability. We did see some slowing in select end markets during the quarter, such as metals, milling and lumber and wood. However, booking levels remain relatively firm month to date in January as customers reset budgets and remain generally productive. While our Service Center segment is not immune to cycles and potential slower industrial production activity in coming quarters, we believe the segment is exposed to more secular and company specific tailwinds today than in prior cycles, potentially providing a greater level of sales support if a slower environment does manifest. Within our Engineered Solution segment, which includes our Fluid Power, Flow Control, and Automation offerings, organic sales growth accelerated 300 basis points from last quarter, increasing over 21% year-over-year, despite a meaningful prior year comp of 19% growth. Backlog strength is providing solid revenue coverage with no material signs of cancellations at this point, modest improvement in some areas of the supply chain is helping release shipments of various system assemblies previously pent-up by component shortages. In addition, underlying growth prospects remain favorable within our core fluid power, industrial and off-highway mobile verticals. Our technical and engineering capabilities are in greater demand from smaller Tier OEMs as they face rapid innovation and accelerate integration of advanced features into their equipment. We are also integral to our customer sustainability initiatives from enhancing the overall efficiency and life cycle of hydraulic systems and power units, to helping design and integrate new electrification features within fluid power systems. While we're in the early innings of the development of these opportunities, they are positively influencing our business funnel and represent an emerging area of potential growth for Applied longer term. In addition, demand and booking levels remain solid for our higher margin process flow control products and solutions. MRO activity and maintenance project spending on process infrastructure remains positive in core end markets such as chemicals, refining, petrochemical, utilities, and metals. We also continue to benefit from our customers decarbonization efforts and other required infrastructure investments, as end market transition around new energy requirements. Additionally, we are seeing sustained progress in cross-selling our flow control solutions through our service center network, as we connect customers to these leading process capabilities. Our strategic expansion into flow control back in 2018 is a great example of the evolution of our channel capabilities and end market mix that we believe is providing more resiliency to our growth and margin profile today. We continue to make further progress expanding our advanced automation platform as well. We saw solid organic sales growth in the quarter and underlying order momentum remains healthy. Customer interest and new business opportunities are being driven by labor constraints and evolving production considerations. These trends are expanding the need for our leading engineering capabilities across functions such as machine tending, palletizing, and quality control. We are making traction with our greenfield expansion initiatives and developing new approaches to best serve our embedded customer base and further enhance our market position, including through proprietary turnkey solutions and leading application expertise. In addition, we announced the acquisition of Automation Inc. in November, which represents the fifth automation acquisition over the past four years, with annual sales around $25 million the transaction further optimizes our automation footprint in the Midwest, as well as our strategy of providing leading next-generation solutions around machine vision, robotics, and motion control. We welcome Automation Inc. and look forward to leveraging their capabilities going forward. Overall, the momentum sustaining across our core operations and emerging solutions is encouraging. At the same time, our teams remain focused on driving strong returns as this growth continues to manifest through both consistent execution and continuous improvement actions. For those that have been around Applied for a while, you know we have a deeply ingrained culture of operational execution and cost accountability. This remains apparent as we continue to manage inflationary pressures and drive high team incremental margins despite ongoing LIFO headwinds. At the same time, we've significantly improved our return on capital profile over the past several years, hitting strong double-digit levels in recent quarters, highlighting the value creation potential embedded across our business and strategy. And lastly, we ended the quarter with a healthy balance sheet and net leverage at one times and over $1 billion in balance sheet capacity. Our M&A pipeline is active across our priority areas of Fluid Power, Flow Control, and Automation. We remain disciplined as always, and continue to evaluate a number of attractive M&A opportunities that could enhance our growth and competitive position going forward. Thanks Neil and good morning everyone. First, another reminder that our supplemental quarterly recap is available on our investor site for your additional reference. Turning now to details of our financial performance in the quarter. Consolidated sales increased 20.9% over the prior year quarter. Acquisitions contributed 50 basis points of growth, which was more than offset by a 70 basis point headwind from foreign currency translation. The number of selling days in the quarter was consistent year-over-year. Adding these factors, sales increased 21.1% on an organic basis. As it relates to pricing, we estimate product pricing was a mid single digit percent contributor to the year-over-year sales growth in the quarter. As a reminder, this assumption only reflects measurable top line contribution from price increases on SKUs sold in both year-over-year periods. Turning now to sales performance by segment. As highlighted on slide six and seven of the presentation, sales in our Service Center segment increased 21.1% year-over-year on organic basis when excluding the impact of foreign currency. Year-over-year sales growth strengthened across our large national accounts during the quarter. We also continued to see favorable growth from smaller local accounts. When looking at the sequential increase in segment growth, the biggest end market contributors were chemicals, pulp and paper, aggregates, rubber and plastics, and mining. We also saw solid fluid power aftermarket sales growth in the quarter, reflecting strong execution and service support from our leading fluid power MRO specialist network. Within our Engineered Solution segment, sales increased 22.5% over the prior year quarter, with acquisitions contributed 140 basis points of growth. This reflects two months of contribution from our Automation Inc. acquisition, which closed in early November. On an organic basis segment sales increased 21.1% year-over-year, and over 41% on a two-year stack basis. Segment sales growth continues to be supported by strong backlog levels across our Fluid Power division, sustained customer MRO and CapEx spending into process flow infrastructure and ongoing demand for our next-generation automation solutions. Extend the supplier lead times and inbound component delays continue to weigh on segment by sales growth during the quarter, though we did see some modest improvement in lead times and supplier deliveries, benefiting system completions and shipment activity during the quarter. Moving now to gross margin performance. As highlighted on page eight of the deck, gross margin of 29.1% decreased 28 basis points compared to the prior year level, up 29.4%. During the quarter, we recognize LIFO expense of $8.9 million compared to $4.7 million in the prior year quarter. This net LIFO headwind had an unfavorable 39 basis point year-over-year impact on gross margins during the quarter and reflects supplier product inflation and ongoing inventory expansion year-to-date. We also faced a difficult comparison from favorable mix in performance, which boosted gross margins in the prior year quarter. On a sequential basis, gross margin performance increased over 20 basis points during the quarter and was slightly ahead of our expectations. Overall, we continue to manage broader inflationary dynamics well, reflecting broad-based channel execution, pricing actions, and ongoing margin countermeasures. As it relates to our operating costs, selling, distribution and administrative expenses increased 9% on an organic constant currency basis compared to prior levels. SD&A expense was 18.4% of sales during the quarter, down from 20.5% during the prior year quarter, which is a new record low. Despite ongoing inflationary headwinds, including higher employer related expenses, our teams are doing a great job of controlling costs in the current environment as we leverage our operational excellence initiatives, shared services model, and technology investments. Combined with the robust sales growth we saw in the quarter we saw in the quarter, EBITDA increased 36% over prior levels, while EBITDA margins expanded 128 basis points over the prior year to 11.8%. This includes an unfavorable 39 basis point year-over-year impact due to LIFO. We've continued to see strong operating leverage resulting in incremental margins in the high-teens despite the ongoing LIFO headwind year-over-year. Combined with reduced interest expense, reported earnings of $2.05 per share increased 41% from prior year earnings per share levels. I am pleased to highlight that this represents the second consecutive quarter of greater than 40% growth in EPS and the eighth consecutive quarter of adjusted EPS growth exceeding at least 25%. Moving to our cash flow performance. Cash generated from operating activities during the second quarter was $62.9 million, while free cash flow totaled $55.6 million. Compared to the prior year, free cash flow nearly doubled, reflecting higher earnings and stabilizing working capital investment. Looking ahead, we expect easing working capital trends into the second half of our fiscal year, including some benefit from the conversion of work and process inventories tied to our Engineered Solution segment, as well as continued benefits from our working capital initiatives. From a balance sheet perspective, we ended December with approximately $166 million of cash on hand and net leverage at 1.0 times EBITDA, which is below the prior level of 1.6 times adjusted EBITDA. Our leverage remains below our normalized range of 2.0 to 2.5 times, partially reflecting the significant EBITDA growth we have experienced in recent years, as well as ongoing debt reduction. We also remain disciplined with our M&A approach focus on targets and valuations, supporting our return requirements and strategic priorities. As it relates to recent areas of capital deployment, we announced in our press release today that we increased our quarterly dividend for the 14th time in 12 years. In addition, as Neil highlighted, we're excited by the acquisition of Automation Inc. in early November, which further enhances our automation portfolio. Our strong balance sheet, industry position and historical M&A focus are valuable attributes for our strategic acquisitions as they look to align their business and associates with the most capable and supportive organizations to best drive future growth and success. Overall, we're in a great position to continue to drive our strategic priorities going forward, including remaining proactive across our organic expansion initiatives, as well as executing ongoing accretive M&A. Turning now to our outlook. As indicated in today's press release and detailed on page 10 of our presentation, we are raising full year fiscal 2023 guidance to reflect the strong second quarter performance and an improved outlook for the second half of the year. We now project EPS in the range of $8.10 to $8.50 per share based on sales growth of 13% to 15% and EBITDA margins of 11.5% to 11.7%. Previous year guide assumes EPS of $6.90 to $7.55 per share, sales growth of 5% to 9%, and EBITDA margins of 10.9% to 11.2%. We are encouraged by our year-to-date performance and see ongoing opportunities supporting our growth and earnings potential in the back half of fiscal 2023. That said, our sales outlook continues to take into consideration prior economic uncertainty, as well as ongoing inflationary and supply chain pressures. We expect ongoing moderation in order rates and more modest pricing contribution in the second half of the year. We will also face more difficult sales growth comparisons in coming months, including most notably during our fiscal fourth quarter. Our updated guidance incorporates these various factors. In addition, based on month-to-date sales trends in January and our near-term outlook, we currently project fiscal third quarter organic sales to grow by low to mid-teen percentage over the prior year quarter. Please note that prior year sales comparisons are more difficult in February and March relative to January. We're also assuming some moderation in underlying billings following strong backlog conversion and back order shipments in recent months, combined with easing demand tied to the uncertain macro environment. We expect gross margins to be relatively unchanged from fiscal 2023 second quarter levels of around 29%. In addition, we assume incremental margins in the mid-teens based on our low to mid-teens sales growth increase assumptions for the quarter, combined with considerations around our annual focus merit increase, effective January 1st, ongoing inflationary pressures and reduced operating leverage as sales growth eases. Thanks Dave. So to wrap up, I am extremely proud of the Applied team and our performance through the first half of fiscal 2023. The underlying industrial backdrop remains promising long-term across North America, and we are benefiting from our industry position, the ongoing buildout of our advanced solutions and operational focus. We believe various secular and structural tailwinds are providing support to the broader demand environment. This includes an incremental focus on refreshing and expanding industrial production infrastructure and capacity across North America, and greater demand for advanced engineered solutions, particularly as customers manage through labor constraints and accelerate actions to reduce energy consumption. Our strategy and growth initiatives are strongly aligned with these trends and the requirements our customers are facing. Consistent with our commentary from last quarter, the uncertain economic backdrop is reducing transparency into the cadence of underlying orders and growth in the interim. As expected in our updated guidance, we continue to take a cautious approach to our outlook and anticipate a moderating growth environment in coming quarters. That said, we believe any near-term slowdown could be transitional and shortened nature given positive tailwinds underpinning the industrial sector and a greater focus on supply chain reliability in the wake of meaningful shocks faced in recent years. In addition, we enter the second half of fiscal 2023 with our balance sheet and liquidity in a solid position and the opportunity to drive stronger cash generation reflecting our improved margin profile and normalizing working capital requirements. This will support ongoing strategic growth opportunities and shareholder returns going forward. And lastly, following our first half performance, we've made meaningful initial progress toward our intermediate financial targets of $5 billion in revenue and 12% EBITDA margins. These targets provide clear milestones to achieve significant value creation for all of Applied and our key stakeholders long-term. First question for me, I'm curious if you could just contextualize what your macro outlook assumes for the back half, and I think last quarter you mentioned that the outlook assumes a 500 basis point contraction in IP year-over-year in your fiscal back half. And is that still your expectation, or just how is that -- how has that evolved? So, Ken, I think one way we're looking at it, if we take it at the midpoint, we would assume low single digit to flattish year-over-year IP in the third quarter, and then low single digit to perhaps a mid single digit contraction in the fourth quarter. And if we think about, or we look at perhaps the core manufacturing or capital goods portion of those markets, ex inflation, it's probably closer to the low single digit to mid single digit growth in Q3 and then perhaps flattish to a low single digit year-over-year contraction in the fourth quarter. So, we still believe the consumer oriented industries are facing more of this potential contraction than some of our core industrial markets. That's helpful. From my follow-up, I -- you talked a little bit about pricing, and obviously it's been a positive contributor here, similar to the prior quarter. Any way you can just kind of help us understand the moving buckets within the organic growth outlook, you still expecting pricing to mirror 2022 at this point? And then, any other way to talk about the benefits of better mix versus volumes? Yeah. So, I can start and then probably Dave will come in. As I think about pricing, we would still see increases coming from suppliers. If we compare perhaps to a year ago, they're lower in count and frequency, but we still expect annual lifts or increases coming from suppliers into this time. As we also think about the backdrop of things not easing in an inflationary environment, things around the labor, the supply chain and what has been and continues to be a good demand environment that we don't think those abate. So, we think there's going to be pricing contribution to the overall business and to the top line results as we work through the rest of the fiscal 2023, albeit perhaps at a lower level than we had in the last quarter. And early, as we talked last call, still assume we're going to see that tail off some modest incremental pricing, as Neil has indicated in response to some of those factors, but kind of more of a kind of lower, obviously, tail as we move off here got to be below mid single digits as we get into Q3 and lower single digits as we get into Q4, talking about the comp issue. And then you referenced the mix side of it, we're still encouraged that as we bring more advanced solutions into the business, we have the opportunity for positive mix contributions around our products and solutions, some of the end markets that we're participating in. So, those should set up favorably as well. And we've said in the remarks, right, we will believe for Q3, in the second half kind of gross margins in a similar range. Understood. Maybe if I could just squeeze one more in here. You talked about the benefit of infrastructure spending and federal stimulus being a stronger secular tailwind versus prior cycles. Is there any way that you can help us size what the exposure is for AIT in those end markets today? And maybe what kind of benefit are you assuming, if any, in the new guide? So, also, we would say it's inclusive into what we think about into the second half. With that said, I think some of it's just getting started into that side. So that will probably be for us more color in fiscal 2024, because I think it will still take some time to ramp. But if we think about our exposure to kind of some of these mid cycle, later cycle industries, the heavier industries, directly and indirectly, we're probably between 30% to 50% in those industries, machinery and metals and aggregate and equipment and such that are going to benefit from this infrastructure buildout, and also the technology sector that will participate in that as well, be it 5G and data warehouse and storage and others. So, we think the underpinnings of that occur more late this fiscal year and really into the back half of the calendar year. Thank you. Our next question is from the line of Chris Dankert with Loop Capital. Please go ahead. Your line is now open. Hey, morning. I guess congrats first on the near-term impressive results and on the 100-year anniversary to the whole team there. I guess kind of jumping in here, core organic growth in both business really accelerated versus the first quarter. I mean, that wasn't in our expectation, I don't think in your words either. You touched on some pieces, but can you just kind of maybe sharpen up what -- the real driver of the outperformance in 2Q was on the kind of the core organic basis? Well, I think there are a few things you take it across. And we think about on our Service Center side, break-fix demand activity stayed strong throughout the quarter. That was positive. We're still seeing benefit coming from the cross-sell and the collaboration of those more advanced solutions is helping in that front. We think our industry position, service liability, the inventory that we have in place for some of those critical break-fix times and -- plus our local presence, all help that Service Center side of the business performed very well. Within Fluid Power, we saw nice execution on projects coming in. We've talked about having a productive backlog in Fluid Power. So, the team were able to execute on a portion of that backlog as suppliers improved some availability of products or perhaps the availability of smaller componentry that was holding up a shipment going out. The Automation team benefited from that and so organic growth into the 24% in that period, which was positive. And then, we're seeing continued strength around Flow Control. And it's typically a later cycle business. And so, we think that sets up well for the process flow control business and ourselves as we think about going into the second half. Gotcha. So, it really is a lot of pieces all pulling together. That's great color. Thank you. And just kind of a follow-up here. Inventory was up again sequentially, but days are still kind of well below the long-term average. Maybe how should we think about inventory positioning today and maybe working capital into the back half of the year here? Sure. I'd expect working capital as we talked about in the script to be a bit of a tailwind as we move across Q3, but more pronounced in Q4. So, we did see some stabilization. To your point, we did see further increase, once again, really driven by those project focused businesses and that strong backlog position that we enjoy there. Did see some stabilization though, I said, as we move through November and December in terms of inventory levels, would anticipate kind of that being flattish as we move across Q3 as we continue to work through some of that project backlog and see some of those supplier constraints start to ease further. And then, we'd be targeting a reduction in inventory as we move in Q4. So, a tailwind when you think about the cash generation. Understood. And if I could just sneak one last one in here. Given the rise interest rates and just kind of what we're seeing in very low leverage from you guys today, I mean has the target leverage range change from kind of that 1.5 to three times just given what interest rates are doing, or is it still that's kind of the long-term target for debt? We talked about longer term in a more normalized environment, 2% to 2.5% being the target, putting the balance sheet to work, working at accretive M&A that we've been so successful in driving value with. We are sensitive to the interest rate environment and the implications and leverage, continue to be improved in terms of the M&A and kind of really stay focused on the priorities. So, we'll be cognizant of that. But on the longer term over cycle is still a two to 2.5 times target in terms of that leverage ratio as we move forward. Thank you. Good morning everyone. To dig in a little bit more here on the guidance, just so I understand, is it a fair statement to say that your assumption for the economic backdrop has shifted a few months to the right based on your new starting point that you've seen here in the first half of the fiscal year? Or has there been in fact a change in your view on the depth and/or duration of the downturn? I can start. David, I would say it's -- it could be a shift to the right. We know what we can see from a visibility standpoint. And so, we touched on January and a solid start. We know the comps get a little more challenging in February and March in that side. And so, our view is we feel like we have very good line of sight to Q3 with that sales up to the mid-teens and expectations around margins and thus, those mid-teen incrementals. So, we see that. We just can ignore what could potentially be some of these cross currents and when they develop. We know our Service Center segment in Q4 has a tougher comparable. I think last year, it was up plus 21% in the side and even around the Engineered Solutions segment, it was good last quarter as well. So, we just want to be mindful as we inform or lay out the guidance. That's very rational. You made a comment in the release that said the business is more resilient in past -- than in past cycles due to your channel strategy. Could you elaborate on what you mean by that? I think it's a lot of the buildout of our capabilities, not only service centers and bearing and power transmission and the importance of those products, but what we're doing in Engineered Solutions around fluid power, the addition of process flow control and now the start with automation. With its run rate now at $175 million to $180 million, that's adding to our value proposition and offering that's very important to customers, plus our participation and presence in maintenance supplies and consumables on that front. So, as we buildout those capabilities, very helpful because I contend the customers are looking to consolidate their spend with fewer, more capable suppliers to partner with someone that can help them deal with their labor constraints and challenges and their operational desires for much greater uptime as they continue to serve their industry demand. And as we've said kind of regardless of what depth kind of comes at us in terms of a market slowdown, really feel like because of that more comprehensive offering, the ability to continue to drive kind of market outperformance with cross-sell, we have the ability certainly to soften that impact as we work through the next cycle as it comes. And regardless, we still know how to be operators and like I said, gauge the business accordingly as we've demonstrated through each of the downturns. Okay. Thank you for that. I guess I'll stick with the theme of three questions, if it's okay with you guys. Could you talk about the average order size of an average discrete automation solution, maybe a little bit about the sales cycle there? I assume these are capital items for customers. Just anything you can share with us regarding the -- what that type of sale looks like in terms of magnitude and the sort of the length of time it takes to gear up, something like that? Yeah. So, I don't know that I have the average order size, but let me come at it a couple of ways. I'd say; one, we are doing more to have productized solutions that can make this sales process go very quickly. And so, if a customer wants to deal with labor constraints and has machine tending, and they want to have fewer operators to each fabrication equipment, they can leverage collaborative robots and perhaps have one operator per four pieces of equipment. And so that's been an area that's been helpful. We're doing more in palletizing and help distribution oriented companies or to help the volume of outflows that people have dealt with challenges perhaps around warehouse labor. We're also active in envision for safety type products. And so, move from manual inspection on those. So, great enhancements and improvement, but also on consumer packaged goods, where you cannot have a labeling or product defect, especially if it's going to some key retailers, that packaging has to be pristine. And you just can't afford or do it effectively from a manual vision standpoint. So, those systems are very helpful. So that's helping the sales process go quickly. I'd say, Dave, on the other side, then we have sales engineers and application engineers that are connecting with customers, especially on our -- now our legacy service center side where we know their production equipment so well in solving a discrete automation problem or challenge. And so, we'll start focused and perhaps small of how mobile or mobile and collaborative robots can help our vision or motion control type products or maybe connectivity in the plant, and we're solving small projects. And I would say not all of them are going to the level that these are extensive capital projects that they're bringing along, but they're getting approved, but they opened the door for other projects within that plant. And based on the ownership equation of those companies into their other facilities, as they look to replicate that success or impact that we could have. So, we're encouraged by the business activity and the presence. It's not extremely long cycle massive investments that customers have to undertake to positively impact their performance with automation. Thank you. At this moment, I'm showing we have no further question. I will now turn the call over to Mr. Schrimsher for any closing remarks. Please go ahead. Thank you, Malika. And I just want to thank everyone for joining us today, and we look forward to talking with you throughout this quarter. Thank you. Ladies and gentlemen, that does conclude today's call. We thank you for your participation and disconnect your line. Have a good day.
|
EarningCall_1124
|
At this time, I would like to turn the call over to Mr. Chris Stevo, Senior Vice President and Chief Investor Relations Officer. Please go ahead, sir. Good morning. Welcome to Pfizerâs fourth quarter earnings call. Iâm joined today by Dr. Albert Bourla, our Chairman and CEO; Dave Denton, our CFO; Dr. Mikael Dolsten, President of Worldwide Research and Development and Medical. Joining for the Q&A session, we also have Angela Hwang, Chief Commercial Officer and President, Global Biopharmaceuticals Business; Aamir Malik, our Chief Business Innovation Officer; Dr. William Pao, our Chief Development Officer; and Doug Lankler, our General Counsel. Before we begin the call, I wanted to remind you of some of some logistical items. Materials for this call and other earnings related materials are on the Investor Relations section of pfizer.com. You see our forward-looking statements disclaimer on slide 3. Additional information regarding these statements and our non-GAAP financial measures is available in 10-K and 10-Q under Risk Factors and Forward-Looking Information and factors that may affect future results. Forward-looking statements on the call are subject to substantial risks and uncertainties, speak only as of the callâs original date, and we undertake no obligation to update or revise any of the statements. Thank you, Chris. Hello, everyone, and thank you for joining us today. During this morningâs call, I will touch on some of our highlights from 2022, and share some thoughts regarding Pfizerâs exciting near and long-term growth plans. 2022 was an outstanding year for Pfizer on multiple fronts. We exceeded $100 billion in revenues for the first time in our 174-year history. We maintained our industry-leading clinical success rates and further improved our cycle times, which already were among the industryâs best. We were named to 10 different âbest employerâ lists, including those published by Forbes, LinkedIn, Glassdoor and others. And most important, more than 1.3 billion patients around the world were treated with our medicines and vaccines. A truly humbling achievement. Our key growth drivers for the full year 2022 included: global sales of Paxlovid, strong growth for Comirnaty in developed markets, the launch of Prevnar 20 for the adult population in the U.S., the continued strong growth of Eliquis globally, the strength of our Vyndaqel family globally, and the addition of newly acquired products Nurtec ODT/Vydura and Oxbryta. Looking ahead, we foresee strong operational revenue growth of 7% to 9% in 2023, excluding revenues from our COVID-19 products and the impact of foreign exchange. We expect our potential new launches, newly acquired products and inline products will all contribute to this growth. These projections include our forecasts for several important potential product launches, including our RSV vaccine for older adults, potential Prevnar 20 pediatric indication, and products and candidates that came to us through recent business development activities, including etrasimod for ulcerative colitis, Nurtec and zavegepant for migraine, and Oxbryta for sickle cell disease. Weâre in the midst of an 18-month period during which we expect to have up to an unprecedented 19 new products or indications in the market. 15 of these 19 are from our internal pipeline, with the remaining 4 coming to Pfizer, as just explained, via the recent business development deals. Recognizing the importance of these potential launches, as well as those expected in 2024, to both Pfizer and the patients who rely on our innovations, we are increasing the support we are putting behind them by investing an incremental $1.3 billion in SI&A expenses in 2023. Dave will provide more details on these investments during the presentation. One example of a product that is already benefitting from this additional support is Cibinqo, which recently has seen an improving growth trajectory that we expect to continue through the course of 2023. In the fourth quarter of 2022, Cibinqoâs new-to-brand prescriptions grew 84% sequentially, the fastest growth rate in the class. We have started 2023 with 55% commercial formulary access, and we expect that access to continue to improve during the year, especially with the upcoming expected expansion of the U.S. indication to include adolescents, 12 to 18 year-olds, if approved. We also introduced a new direct-to-consumer campaign in November, which has increased patient awareness of Cibinqo and led to more patients asking their doctors about it. We look forward to the expected U.S. launches of etrasimod in ulcerative colitis and ritlecitinib in alopecia areata, if approved, as well as the expected launch of Abrilada, our biosimilar to Humira, to further expand our franchise in immunology this year. However, we recognize that investors are not only interested to hear this yearâs guidance, but also to understand the long-term growth prospects of the Company. Particular questions are focused on our plans to offset the expected $17 billion impact of the LOEs between 2025 and 2030, and our long-term projections for our COVID-19 products. We will try to address both, starting with this slide regarding our business, excluding COVID. As you can see in this chart, we expect the 15 of the 19 potential launches that are coming from our internal pipeline to generate 2030 revenues that will more than offset the expected LOE losses forecast for 2025 to 2030. The potential $20 billion in this chart is a risk-adjusted number. I would also point out that some of the potential launches are expected to be bigger contributors to our growth than others. And if all 15 were to achieve their full potential, this figure could go even higher. In addition, we believe we have the ability, if successful, to add at least $25 billion of risk-adjusted revenues to our 2030 topline expectations through business-development activity. As we have said previously, we believe the deals we have already done for Arena, Biohaven, Global Blood Therapeutics and ReViral have the potential to get us more than 40% of the way there with approximately $10.5 billion in expected 2030 revenues. I am very pleased to see that the analystsâ consensus expectations for the same revenues have already reached $9.5 billion, closing materially the gap that previously existed between internal and external expectations. Four of these products have already launched or are expected to launch, subject to regulatory approval, in 2023. We also have more than enough capital to invest in the additional opportunities needed to meet or exceed this target. And, of course, we have many more potential vaccines and medicines in our pipeline, with numerous launches expected in the 2024 to 2030 timeframe, if successful in clinical trials and approved. Some of the most promising assets include: our oral GLP-1 candidate for diabetes and obesity, all of them are under this dotted box, XB; potential combo vaccines for flu, COVID-19 and RSV; our potential vaccines for Lyme disease and shingles; multiple new oncology product candidates, including ARV-471 and our CDK4 inhibitor for endocrine receptor-positive breast cancer; our gene therapy candidates for hemophilia A, hemophilia B and Duchenne muscular dystrophy; our pan-hemophilia A&B antibody treatment; and many more. If approved, we expect each of these to be key incremental contributors to our growth aspirations through 2025 and beyond. Even without any of these additional potential products, we expect our 2025 to 2030 revenue CAGR to be approximately 6%. And if some of them are successful, the CAGR could exceed 10%. Now, let me turn my attention to our COVID-19 portfolio. At the JP Morgan Conference earlier this month, I spoke about expecting 2023 to be a transition year, representing a low point in our COVID-related revenues. Let me provide a little bit more color on that. I will start with Comirnaty in the U.S. as an example. In 2022, 31% of the population, or 104 million Americans, received on average 1.4 doses of COVID-19 vaccines for a total of 144 million doses. Comirnatyâs share was 64%, or 92 of these 144 million doses, as you can see in the first column. In 2023, we expect about 24% of the population, or 79 million people, to receive vaccine doses for COVID during this year. This drop is due to expected fewer primary vaccinations and reduced compliance with recommendations. We expect they will receive about 1.3 doses per person on average in 2023. The drop is because fewer people are expected to receive their primary doses and, for the most part, only those who are older or at higher risk are expected to continue receiving more than one booster per year. This should result in about 102 million total vaccine doses administered in 2023. We believe Pfizer will maintain at least its 64% market share and therefore expect about 65 million doses of the Pfizer-BioNTech vaccine to be administered in 2023. In 2024, we expect the utilization rates and market share figures to stabilize and come in roughly the same as in 2023. Then starting in 2025, and continuing in 2026 and beyond, we expect to see an increase in COVID-19 vaccination rates, assuming the successful development and approval of a COVID/flu combination product. A successful introduction of a COVID/flu combo could over time bring the percentage of Americans receiving the COVID-19 vaccine closer to the portion of people getting flu shots, which is currently about 50%. Outside the U.S., we expect these general trends to be similar with some variations from country to country. So, what does this mean for revenues? We expect 2023 to be a transition year in the U.S. In 2022, we sold at pandemic prices more doses than were eventually used. This resulted in a government inventory build that we expect to be absorbed some time in 2023, probably the second half. Around that time, we expect to start selling Comirnaty through commercial channels at commercial prices. We expect that in years 2024 and beyond, the doses sold and doses used in a year will more closely align together and the commercial price to remain relatively stable with only inflation-like price increases. Now, let me briefly urn through Paxlovid. In 2022, we estimate that 110 million COVID-19 symptomatic infections were reported in the world, excluding China. Approximately 12% of them were treated with approximately 14 million oral therapy courses and Paxlovid had the lionâs share of them with approximately 90% market share. Average was 86%, but in the second half of the year exceeded the 90%. Keep in mind that this reflects a full year of reported infections, but only a partial year of Paxlovid availability due to supply constraints in the first quarter of 2022. In 2023 and beyond, we expect infections to increase slightly at 2% annually, due to waning immune protection of the population resulting from reduced vaccination rates. Similarly, we expect treatment rates to increase as awareness, education and additional oral entries will grow the oral antiviral market. Finally, we expect Paxlovid to maintain very high share despite additional competitive entries, given its strong benefit-risk profile and brand recognition. So, what does this mean for revenue? As with Comirnaty, we expect 2023 to be a transition year for Paxlovid as well. In 2022, we sold at Pandemic prices more treatment courses than were eventually used. This resulted in a government inventory build that we expect to be absorbed some time in 2023, probably second half. Around that time, we expect to start selling Paxlovid through the commercial channels at commercial prices. We expect in years 2024 and beyond that the courses sold and used will align closely together within every year. There has been a great deal of speculation regarding the new but uncertain market opportunity for Paxlovid in China, so let me share what we are seeing. We have an agreement with one company to import and distribute Paxlovid in China, local company, and we have a manufacturing agreement with another local Chinese company for local manufacturing. Pfizer shipped only tens of thousands of courses to China in fiscal year 2022. From December, which is the first month of our non-U.S. fiscal year, through March, we expect to ship millions of courses to meet local demand. We expect we will be able to sell effectively under government reimbursement through end of March. And despite Chinaâs recent decision not to include Paxlovid on the countryâs National Drug Reimbursement List, we expect to offer the product on the private market after April 1st unless, of course, a listing opportunity opens up before then. Lastly, I want to point out that while we are expecting increased utilization in all regions of the world as infections increase, we are not including any major new non-U.S. or non-China contracts in our 2023 forecasts. Let me close with a few thoughts regarding our scientific engine. R&D continues to be the lifeblood that fuels us as a company, which is why we plan to increase our R&D spend by at least 8.7% in 2023 to $12.4 billion and $13.4 billion range. In addition to the increased investments, we are taking steps not only to further improve our industry-leading success rates and cycle times, but also to increase overall return on investment and R&D productivity. As you have seen in the last year, we continuously prioritize our pipeline to focus on the assets that represent potential breakthroughs and have the potential for generating higher returns, putting more capital behind larger opportunities like GLP-1, flu, elranatamab, and others. We are at an inflection point to act from a position of strength with our best-in-class R&D productivity, a robust pipeline of innovative assets and one of the highest R&D budgets in the industry. With that, I will turn it over to Dave to provide details on our fourth-quarter performance and our outlook for 2023. After Dave, Mikael will provide an update on our R&D pipeline. Take it over, Dave. Thank you, Albert, and good morning, everyone. Albert has already taken you through many of the key drivers of our full-year performance, so I will focus my opening remarks on some key highlights from the fourth quarter. Revenues grew 13% operationally, primarily driven by Comirnatyâs strong growth in developed markets following the slowdown in deliveries that we discussed in the third quarter ahead of the rollout of the bivalent booster. We also saw very strong performances from Paxlovid outside the U.S. and the ongoing launch of Prevnar 20 for adults within the U.S. Excluding direct sales and alliance revenues related to our COVID-19 products, Pfizerâs revenues grew 5% operationally in the quarter, and if recently acquired products from Biohaven and GBT are also excluded, revenues were up approximately 3% in Q4. Reported diluted EPS this quarter grew by 48% to $0.87, while adjusted diluted earnings per share of $1.14 grew 69% on an operational basis in the quarter. Both EPS figures include a $0.32 benefit from lower acquired IPR&D expenses compared to last yearâs fourth quarter. Once again in the quarter, foreign exchange movements significantly impacted our results, reducing fourth quarter revenues by approximately $2.5 billion, or 11%, and adjusted diluted earnings per share by $0.19, or 24%, compared to LY. On a full-year basis, foreign exchange negatively impacted revenues by $5.5 billion, or 7%, and adjusted diluted earnings per share by $0.36, or 9%. Turning now to 2023 and the financial outlook for the Company. Let me first point out that our approach to guidance in 2023 is fundamentally different than prior years. Given the expected transition to commercial markets for our COVID franchise, and away from an Advanced Purchase Agreement environment, our guidance reflects our best estimates for revenues and profits for these products for the full year, not just what has been contractually secured. On a total company basis, we expect revenues of between $67 billion to $71 billion, reflecting an operational decline of 31% at the midpoint. Importantly, we expect that revenues from our business excluding COVID will grow between 7% and 9% on an operational basis in 2023. That growth is projected to be split between contributions from our new product launches, our recently acquired products, as well as our in-line portfolio. The total company revenue declines are entirely driven by our COVID products, which are expected to go from their peak in 2022 to their low point in 2023 before potentially returning to growth in 2024 and beyond. While patient demand for our COVID products is expected to remain strong throughout 2023, much of that demand is expected to be fulfilled by products that were delivered to governments in 2022 and recorded as revenues last year. I want to point out that our total company revenue guidance range is wider than what is implied by the 7% to 9% operational growth rate range for the business excluding COVID. The wider guidance range reflects the potential volatility that we see in our COVID product revenues, given that they can be significantly impacted by factors outside of our control, such as the infection rates and the severity of the virus, as well as the timing for transitioning to a traditional commercial model here in the U.S. Now, you can see on this slide our cost and expense guidance for 2023. As I mentioned in my remarks at our investor event in December, both SI&A and R&D expenses are expected to be significantly higher in 2023 versus 2022, despite the fact that our overall revenues are coming down. Higher investments in SI&A are significantly focused on the successful launches of the large number of potential new products that Albert highlighted, as well as recently acquired assets. Additionally, the expected commercial launch of both Comirnaty and Paxlovid in the U.S. will require additional investments as we transition away from the government market. These investments are squarely focused on supporting the Companyâs 2025 to 2030 growth aspirations. We also intend to invest significantly into our research efforts this year, with multiple exciting and potentially high-value programs receiving additional funding, including our oral GLP-1 programs, elranatamab, and respiratory combination vaccines. All of this spending to support our commercial and research activities, we believe, will not only yield an attractive return, but will also contribute toward setting us on a path to achieve our long-term growth goals. Iâll point out that when you exclude revenues and expenses related to COVID products, our expected operating margin profile this year is largely consistent with the prior year. This reflects incremental investments in SI&A related to launch products and R&D, as well as lower acquired IPR&D. In 2023, we are investing in both R&D and SI&A in advance of revenue contributions from new products. Looking longer-term, we expect this spending will be maintained, with the P&L growing into this cost base as new product revenues begin to be fully realized, with margins improving as a result. Given that 2023 is both a year of investment and transition, I thought it would be helpful to outline many of our key assumptions built into our guidance. I donât intend to walk you through all the elements here, but both slides 19 and 20 outline many of the details. In summary, these assumptions include: strong revenue growth of 7 to 9% in our business excluding COVID products; additional investments in SI&A and R&D to support Pfizerâs near- and longer-term growth plans; continued patient demand for our COVID-related products worldwide, with vaccination rates declining slightly and utilization of treatments slightly increasing; rephasing of the European Commission Comirnaty contract over multiple years versus full delivery in 2023; and, finally, U.S. commercialization of the COVID products in the second half of 2023. In summary, as we enter a new year, our business is extremely strong, with many in-line, acquired and expected launch products capable of driving strong growth with an attractive pipeline of potential products coming in the future. We believe 2023 will be an important year for Pfizer, and that is why we are deploying our resources into quality execution in order to fully realize the growth opportunities we see within our portfolio and pipeline, which have the potential to impact our growth outlook through 2030 and beyond. Today, I want to set the stage for an anticipated catalyst-rich 18 months. As Albert mentioned, we are in a position of unprecedented strength in our history and Iâm excited to share a high-level overview of an evolved strategy for Pfizer R&D to focus our resources on transformative programs which could be most impactful for patients, drive improved return on R&D investment and create the most value. We will leverage and continue to innovate our powerhouse capabilities in medicine design, and continue to innovate light-speed drug development to further improve our industry-leading success rates and cycle times. We have rethought our approach to rare disease and will move from having a standalone research unit to aligning key programs with other therapeutic areas. We plan to externally advance rare disease programs that do not fit into a core therapeutic area of focus. At the same time, we plan to tap into the expanding external innovation ecosystem by actively pursuing biotech innovation and emerging innovation that fits strategically and accessing external assets that are differentiated. Taken together we believe these actions will help position us to lead the industry in reaching more patients with the most impactful near-term blockbuster breakthroughs while driving forward the next wave of innovations. Iâm pleased to share some examples with you today. We are pursuing potentially transformative efficacy in our inflammation & immunology franchise, with the potential launches of etrasimod in ulcerative colitis and ritlecitinib in alopecia areata, which both have the potential to be blockbusters, and a planned Phase 3 study start of anti-interferon Beta in dermatomyositis and other idiopathic inflammatory myopathies. Our next wave of innovation includes two monoclonal antibody candidates for atopic dermatitis which exemplify our multispecific platform and in-house biomedicine design expertise. Two assets currently in Phase 1 clinical trials each target three cytokines in a single therapeutic, so we refer to them as trispecifics. On the right are Phase 1 pharmacokinetic profiles of the average plasma concentration. For both molecules, the profiles suggest that once-a-month, or even less frequent, subcutaneous dosing may be supported. There is potential for improved efficacy with more potent interleukin 4 and interleukin 13 neutralization plus an expanded breadth of efficacy by blocking Thymic Stromal Lymphopoietin to potentially cover more endotypes, or by blocking interleukin 33 (sic) [interleukin 33] to potentially enhance itch reduction. The Phase 1 studies continue. We aim to bolster our 30-year experience in hematology with a strong pipeline that complements our in-line portfolio and collectively has blockbuster potential. I will talk more about elranatamab and GBT-601 in a moment, so will highlight here that we expect multiple data readouts for TTI-622 in hematological malignancies, two Phase 3 readouts for inclacumab in sickle cell disease in the second half of 2024 and a Phase 3 readout for marstacimab in patients with hemophilia A or B in the second quarter of 2023. Marstacimab has FDA Fast Track designation for both, hemophilia A and B with inhibitors. If successful, we project submitting for the non-inhibitor indication in both A and B hemophilia in the third quarter of 2023. We recently announced positive top-line results from a Phase 3 study of our hemophilia B gene therapy candidate and expect a pivotal readout for our hemophilia A gene therapy in the first half of 2024. We recently presented strong updated Phase 2 data on elranatamab, our investigational B-cell maturation antigen, or BCMA, CD3-targeted bispecific antibody, for relapsed or refractory multiple myeloma in heavily pre-treated patients who had received at least three classes of prior therapies. This candidate, which has the potential to be a leader in the BCMA bi-specific class, demonstrated a high objective response rate of 61% in patients with no prior BCMA-targeted treatment, early and deep responses, and a manageable safety profile. Given factors currently limiting the availability of novel therapies in the triple-class exposed setting, elranatamab has the potential to reach a broader and greater number of patients as an off-the-shelf option with reduced dosing frequency that is administered subcutaneously, offering more convenience than intravenous administration. With FDA Breakthrough Therapy Designation granted last year, elranatamab could potentially be approved this year. As there is blockbuster potential and patient value beyond the triple-class refractory population, our clinical strategy aims to move to earlier lines of therapy and combination approaches with the potential, if successful, for multiple approvals to expand eligibility and duration of therapy. Now, to our next generation oral, once-daily, hemoglobin S polymerization inhibitor candidate thatâs in a unique class and has the potential to expand the prophylactic treatment of people with sickle cell disease. Standard-of-care treatment rates have typically been low due to side effects, poor efficacy, or both. While Oxbryta made substantial progress in preventing hemoglobin polymerization, or sickling, GBT-601 is a potentially best-in-class candidate which may improve both hemolysis and frequency of vaso-occlusive crises. The most recent data from our Phase 1 multiple ascending dose study showed improvements in hematocrit and hemoglobin levels over time, mean hemoglobin occupancy of more than 32% for the 100 milligram maintenance dose and more than 41% for the 150 milligram maintenance dose, and improvements in red blood cell health with the higher maintenance doses. The maintenance doses were well tolerated. We believe these results may be transformative for patients, with a potential to achieve 35% to 45% hemoglobin occupancy, which is considered optimal for both hemoglobin oxygen affinity and preventing sickling, and approaches levels seen with gene therapies. This asset is also being studied in an ongoing Phase 2 study with a seamless Phase 2/3 design. We plan to start the Phase 3 part in the second half of 2023. Next, we aim to expand our leadership in breast cancer with a pipeline of complementary next-wave candidates. Our CDK4 inhibitor targets improving on CDK4/6 inhibition standard of care by maximizing CDK4 coverage. We are studying it in Phase 1 in hormone receptor positive/HER2 negative metastatic breast cancer as a single agent and in combination with endocrine therapy. The majority of hormone receptor positive breast cancers express low CDK6, while CDK4 is likely to be a major cell cycle driver. We have seen that CDK4/6 inhibition can lead to neutropenia that requires more frequent blood test monitoring, mostly driven by CDK6 inhibition, and that complete CDK4 inhibition by CDK4/6 inhibitors is challenging due to dose-limiting hematological adverse events. In the Phase 1 combination study, the confirmed objective response rate in combination with fulvestrant or letrozole reached nearly 30% and the clinical benefit rate was approximately 50% in 21 patients with measurable disease. The median progression-free survival was more than 24 weeks in 26 patients including 5 without measurable disease. All participants were heavily pre-treated with a median of four lines of prior treatment. All patients received prior CDK4/6 inhibitor treatment and 67% received prior fulvestrant. The asset was well tolerated with CDK4 drug showing only 15% Grade 3 neutropenia and no Grade 4. Here, we show a scan of a patient who achieved partial response and was on treatment for 47 weeks. She had received six lines of prior treatment, including CDK4/6 inhibition and fulvestrant. We are currently engaged in dose optimization, enrolling CDK4/6-naïve cohorts, and planning to start a randomized study in second-line treatment of estrogen receptor positive/HER2 negative metastatic breast cancer this year. Additional data readouts from our next wave of breast cancer candidates are anticipated in the first half of 2023. In addition to the assets I spoke about today, we anticipate multiple milestones over the next 18 months. We expect a pivotal IBRANCE readout in hormone receptor positive/HER2 positive metastatic breast cancer, a pivotal study start for ARV-471 and a Phase 2 readout for our KAT6 inhibitor. We have achieved incredible advancement in our vaccines portfolio, including candidates that harness our leadership in mRNA, with an unprecedented number of milestones expected. In addition to the expected launches shown here, we expect a Phase 3 data readout from our modRNA flu candidate vaccine, and a potential respiratory combination vaccine study start. A Phase 1/2 study of our shingles candidate, the first mRNA-based shingles vaccine program, began last week. In inflammation & immunology as well as internal medicine, key catalysts include potential launches of potential blockbusters, a planned pivotal study start with anti-interferon Beta and data readouts in metabolic disease. Weâre also making good progress in our anti-infectives portfolio, including anticipating full approval for Paxlovid, and planned study starts for both our second-generation COVID-19 antiviral candidate, which may have no or limited drug-drug interactions, and our RSV antiviral candidate. In closing, we are very optimistic about the many transformative catalysts emerging from the pipeline. Pfizer scientists are working with urgency and commitment to help the most patients as quickly as we can. Thank you, Mikael. Chelsea, why donât you poll for questions, please? Weâll take as many questions as time permits and Investor Relations will be available after the call to answer any detailed questions that weâre not able to address on the call itself. So first question I have for you is due expect your COVID/flu combo to be on an mRNA platform? And then, I wanted to ask you on this RSV vaccine, thereâs a few players in the space. And just wondering if you think anybody could potentially get a preferential recommendation from ACIP or is that really hard to achieve? And the last question is on your trispecific monoclonal antibodies. Is atopic dermatitis still a key focus for you? And if so, are you moving the focus to this monoclonal antibody, or are you still focused on etrasimod for atopic dermatitis and also you had an oral PD -- sorry, a topical PDE4 that was in development? Thank you. Thank you, Louise. Clearly, for the ACIP, will depend on the data and itâs difficult now to say if preferential could be achieved or not. But for both questions, COVID/flu is mRNA, RSV is not, Mikael, and then also what about the trispecific antibodies? So, as Albert spoke about Cibinqoâs expansion, we think thereâs room for many opportunities in atopic dermatitis. We wanted to highlight this as a really novel pioneering approach to go beyond the current antibodies in atopic dermatitis with potentially many other allergic diseases. But there is room for several products in our pipeline in both oral and topical segment, as you mentioned. So, this is an area, I think, we will excel in. Well, I think it actually offers an opportunity when you have the breadth to have a pipeline with different platforms. We think that the COVID/flu, which contains six components, and we have made a real good progress in enrolling the study in which start to share data in the near future has, by itself, of course, a Fast Track forward pending data. But for the use of a potential triple vaccine, rather than adding up more and more mRNA with the current technology that we have seen can lead to ritlecitinib limitation and less tolerability, we think this flexibility to add on a protein may give you the perfect balance between efficacy and tolerability. Thank you, Mikael. And also to -- as you know, we are mastering multiple technologies in vaccine. So, we are using fit for purpose here. Every time we feel that the technology is appropriate for the problem weâre trying to solve, we apply this technology. Flu and COVID, they are -- speed is of essence because there are variants that are coming. So mRNA is ideal position to address this challenge. With RSV, the virus is not changing that often. So, a protein approach that has a brilliant tolerability profile, almost like -- when we saw the data, the responses of the vaccine arm compared to the placebo arm were very difficult to separate, with very, very high efficacy in our case. I think itâs the best way to move forward. Thatâs the benefit having multiple approaches and multiple technologies. Next question, please. Maybe two-part for me. I was just wondering if you can provide any more details on European vaccine -- the European vaccine contracts that were extended. Just wondering if you were able to secure a higher average price, given some of the headlines in the press earlier this week. And then, latest thinking on Paxlovid commercial pricing in the U.S. as well, was wondering if you could weigh in on that. And then the second question relates to economics with BioNTech on a combo vaccine. Just wondering how that will work in the event that you do go forward with a combined COVID and seasonal flu messenger RNA vaccine. Thank you. Iâll take the last one and then Angela will answer the European vaccine and the Paxlovid. As you know, the flu vaccine that we are developing, BioNTech also have an economic position into it. And of course, the COVID vaccine, it is a vaccine that we are sharing with them. So, we are not ready to make any comments regarding the economics about the potential COVID and flu vaccine. Angela, what about the European situation and Paxlovid pricing? So, for Comirnaty in Europe, as you know, this was a multiyear contract that we entered into with the Commission and the member states. And so I think the pricing there is what it is for the contract. And weâre in discussions with the European Commission regarding â23 and what the deliveries will look like. Specifically for Pax, I think that was your next question, that is going commercial only later in this year. So, we are now preparing what those pricing scenarios could look like, and weâll share more at the right time. Thank you, Angela. And also to repeat, I think David has mentioned it already that in our guidance for this year, we factor only a portion of the European contract. So, we spread the volumes into multiple years, although no agreement has been reached yet. Next question, please. So just to drill down a little bit on Paxlovid. It looks like a IQVIA numbers are implying about 9.3 million versus say the 12 million that you mentioned for 2022. So, I was wondering if you think about the split going forward ex U.S., could it be somewhat similar? Do you think itâll be more skewed, be more even to the U.S. and ex U.S.? And then my second question is, it also could imply that about half of your 20 million contracts were used in 2022. So, how do you think about -- could it be very minimal revenue as you draw down that Paxlovid and will that go into a stockpile? Thanks. Well, letâs start with the U.S. Paxlovid. So, in 2022, when we launched Paxlovid, we -- the first quarter of Paxlovid, the first quarter post launch, we did not really have sufficient supply because we were still ramping up. So, the total number of doses that were used in the U.S. for Paxlovid is actually less than the demand. So, thatâs why you see -- we used about 8.6 million, 8.9 million doses in the U.S. when actually demand was much more than that. Then you asked a question about IQVIA, the difference. As you know, IQVIA doesnât capture all the channels, so youâre not going to see an exact match. But I think that in general for 2023, the number of doses that you will see for the U.S. and for ex U.S. is just going to be a function of the contracts that were made, the deliveries that we have to make in each of the countries and also the timing of the commercialization. And it just looks different in every single country. Thank you, Angela. And also to emphasize that the 12 million, calculation is a global number, not a U.S. number. Itâs a global number. So, I believe the 9 million of IQVIA is approximately in the U.S. And -- but I donât know if they have also estimations for outside the U.S. So, next question, please. Iâm sorry for the -- itâs a global number, excluding China, well that I mentioned. Next question, please. Just have two. The first one is on COVID. When you look at the 2023 demand and beyond really for both products, I guess, Iâm trying to better understand the volume side of the equation. Are you guys baking in the emergence of, say, a new variant or maybe a change in behavior towards boosters? Thatâs the first question. The second one is, from a BD perspective, Albert, you have a lot of cash to deploy. If your COVID assumptions donât quite play out, does that inform the number of deals or the size of deals? I guess, Iâm trying to get a view about where BD fits in your strategic priorities. Thank you. Of course. First, what is the assumption about the disease because thatâs a fundamental assumption behind all these projections that we are doing. It is that the disease will continue in the foreseeable future, manifesting clinically the same way that it has the last 6 to 9 months. So there will be mutations and there will be infections over there. And -- but the vaccination rates will be coming down because of lack of compliance but will stabilize to a certain degree of people, but they believe in vaccinations and they feel they are at high risk and they want to make their vaccines. At the same time, the infections were slightly going up because when you have waning immune protection for the population, then you will see more infections are actually more severe infections. So, these are the assumptions that we are using. We are not using assumptions that all the variants will have -- will escape in the protection of the vaccine. But we are using the assumptions that people will be getting 1.3 in the beginning and then going down 1.1, 1.2 doses per year as a normal booster. What was the second question? On the BD, yes, clearly, business development is, by far, one of our biggest priorities, something that I personally take care of and something that we have a very big team screening all the opportunities. I would like to ask Aamir, who is responsible for that area, to make some comments about our priorities. So, Geoff, specifically to your question, you heard Albert described, we set this aspiration goal of $25 billion in 2030 from BD. Weâre over 40% of the way there with approximately $10.5 billion of that number through the deals that weâve done. And we feel very confident that weâve got the financial flexibility on the balance sheet and the firepower to complete what we need to, to achieve that goal. And weâre going to continue to be disciplined about how we pursue that. Thank you. I have a couple of questions. On page 4 of the release, Pfizer reiterated that non-COVID revenue growth in 2023 will be 7% to 9% and anticipates it will be split between launch, acquired and in-line products. That implies about $3.5 billion in incremental revenue growth. But in 2022, Prevnar alone grew $1 billion, and Eliquis and Vyndaqel together added another $1 billion. So with the launch in acquired products growing well, what does this guidance imply for the base business in 2023? It seems like a substantial slowdown is implied in the base business in the current year. Second question, has Pfizer learned anything from the Zeposia performance to date that would either increase or decrease its confidence in etrasimod? Thank you very much. I would say, Dave, do you want to say how is allocated the growth between in-line, new products and acquired products? Yes, a really good question. I think if you look at each one -- each of those 3 buckets, we see growth from acquired products, we see acquired from new products and importantly, we see growth in our in-line portfolio as well. We do not anticipate nor do we see a slowdown in that perspective. I think weâre really excited about etrasimod as a new entry you see. Itâs a market that has been heavily dominated by biologics and then followed by of these JAKs after the biologics. But really, in the earlier treatment positions, there really hasnât been much innovation, and thatâs where we see etrasimod fitting in. I think the safety profile of etrasimod and its efficacy allows it to be used very well as an agent prior to the use of biologics. And thatâs where we see the ability to tap into a new segment and to grow. Yes. I would just say weâre excited about the best-in-class profile with the study that we did, had a treat-through design. We hope and anticipate that weâll have no black-box warning. We donât anticipate any required for titration, the once-oral dosing, 100% of our patients were in complete remission after a year and that weâre in complete remission after one year with steroid-free. And we also have quick lymphocyte recovery after discontinuation. So, we feel all of these features potentially make etrasimod a best-in-class profile. Sure. Thatâs exactly the point. Best-in-class in an area that it is poorly served right now with current solutions, so we see a lot of opportunity. Letâs go to the next question, please. I guess, first question on COVID and to sort of piggyback on what Geoff was asking. Some of your slides and comments, youâre clearly expecting a sort of stable vaccine utilization rate, when in the last 12 months weâve seen this number decline on a backdrop of a virus that is evolving to less clinically severe variants. And so, what underpins your confidence in these longer-term assumptions? And then also in terms of your COVID â23 guidance, you mentioned youâd guided to a sufficient range of variations in infection rates, et cetera. I was just wondering how much an allowance youâve made for the potential timing or reduction in contractual orders that is the current situation with the Brussels negotiation? And then, maybe just a quick one on the pipeline DMD, this feels noticeably in the background versus other assets at the similar stage. Just, could you update us on your level of enthusiasm and commitment to this program, especially in light of the potential competitor approval in May of this year? Thanks so much. We continue to be enthusiastic about gene therapy in DMD. I think we have actually published the strongest data on the two drugs with efficacy as well as a lot of biomarkers from our Phase 1 across a much broader age group than anyone else. And I canât comment when possibly someone else will get it registered. But, we expect data readouts within possibly less than a year. And we think that this could be a very important drug. And we will have randomized data, which is not the case for any other application currently to have at that size and scope. As regards the assumptions of our COVID protection vaccines, for example, we are dropping the numbers. So for example, 31% of people receiving a vaccine, that was the actual in â22. We are going to â24. Then you are reaching a level of really people that they are really committed to the idea of getting vaccinations and they are looked by physicians that donât really believe in the vaccination, the value of vaccinations. We are also dropping the number of doses there. So, weâll go to 1.3. And then eventually, as the years progress, the number of doses that people will receive is small. Keep in mind that to get numbers like 1.2, you need a very, very small percent of population 2 doses, so that you can achieve something like that. Maybe 5% of the population to get a second dose, and then you will go to these numbers, as you will see, if you include also primary doses and children. So, we believe the assumptions are very reasonable with the expectations that COVID will remain as it is right now, so nothing more severe and nothing that will make it less disappearing and we take into consideration that the compliance with the recommendation of the health authorities also because of the fact, will be less. Clearly, pivotal moment will be the introduction of combination vaccines because the convenience of something like that and the fact that people are presenting themselves to receive flu vaccines, given that a combo vaccine would be in the same injection and will cost zero co-pay, likely will become the choice of many to get this full coverage. So, we have quite confidence on these assumptions. And of course, there are only assumptions. We need to wait and see. The other thing, it is -- on the Europe, you asked a few questions. I know that there are rumors, but I donât think that it is appropriate for us to make any comments while we are in negotiation with our partners in Commission and with the member states. So, we only said that we factor on part of the deliveries in this year instead of all the deliveries because we are in the middle of negotiations, but we canât make other comments. Next question, please. Hi, guys. Good morning. Itâs Trung Huynh from Credit Suisse. I have a quick clarification on COVID and then my question. So just on the clarification in those long-term COVID vaccine and Pax slides. Do you expect any U.S. government sales in â24 and â26? It just looks like commercial sales on your slides. So, does that mean Medicaid, Medicare populations are bought at a commercial price? And can you comment on the margin change for the vaccine and Pax as you step up to that commercial price? And secondly, just following on from the base business question from Steve, we saw lower revenues ex U.S. for some important base business drugs. So, Eliquis was down 19% ex U.S., IBRANCE minus 22% ex U.S., Prevnar, there was also a decline there. Youâve noted some product-product related issues. But are you seeing anything more broadly in the U.S., which is making it for a more difficult environment? And going forward, should we expect more normal levels ex U.S. for these products? A quick one because thatâs easy, we do not expect â24 and â25 and beyond to have governmental sales in the U.S. In fact, we think that not even this year, other than some small deliveries that we have still pending with the U.S. government from the -- before, we will not see any U.S. purchases. Thatâs our assumption right now that we will move into a commercial model that will cover all channels as with all other vaccines and products. Margin changes, we havenât said anything yet about Paxlovid. So, I canât comment, if you can calculate. We set there is price, you can calculate the net and then you can make your assumptions on margins. We donât give margins on specific products. Now, a little bit on the lower revenues -- about the revenues ex U.S. Angela, do you want to make any comment on that? Sure. As you said, there were some specific reasons for why we saw what we saw for Eliquis, IBRANCE, PCV. I mean, Eliquis specifically was the loss of exclusivity and our patent challenges that led to some generic increase at risk in both the U.K. and Netherlands. I mean, IBRANCE is a mature product. And so, it goes through sort of the reimbursement and the sort of the pricing regulation that it typically goes through in Europe. And I think PCV in general, what weâre seeing is that, at least on the kid side, not on the adult side, but on the kid side, vaccinations are still -- are not back up to where they are where it was prior to the pandemic. So, I think in all three cases, there were very specific reasons for what you saw. And we donât anticipate anything extraordinary or different in 2023. I think itâs sort of business as usual. Thank you. I think one of the challenges for analysts modeling Pfizer is to try to understand what the flow-through to profitability is from Paxlovid and Comirnaty. So, Iâm hoping directionally, you can tell us how that looks going forward once you get past this transitional year of â23. So, in â24 and beyond, is the profitability of that combined franchise likely to be higher, less or the same as what it was in 2021 and 2022? And then, a second question is on SG&A. How much of that increase was driven by inflation in 2023? And just any quick comments on your European austerity measures on pricing. Yes. So on -- maybe on the COVID franchise, obviously, we donât give profitability for each product. But you can imagine, as we stated before, on the vaccine, we split our gross margin with BioNTech. So therefore, that would obviously carry a lower profitability mix compared to a typical product. And Paxlovid is probably the opposite in the sense that we share that -- the economics of that fully. So, thatâs probably a bit on the larger -- higher margin side in general. You can predict that, for example, in the first years, â21, â22 had very high R&D expenses also. We maintain our R&D expense to COVID. Very big part of our expenses in â23 is for COVID because we are investing. But you expect over time, those unless if we bring new products that will not be as high as. On the contrary, prices are going up, but margins could improve but also SI&A, promotion expenses are going up, right? So, without wanting to give direction from what it used to be â21, â22, we expect going forward to be higher, the margins. But all of these equations will be in play. Next question, please. Maybe one question, if I can ask. So regarding the expenses for COVID business, Dave, you mentioned that you will be essentially relaunching these products with the commercial scale and everything. So is there -- so how much cost, given that your COVID business is declining significantly this year? Are you modeling any kind of cost cuts in that business or should more -- or dollar basis are still the same? And is there any synergies you can achieve, especially for vaccine with your existing Prevnar business because the channels are similar or not? And last part is, do you think you can do more share buybacks, given the stock price at this point? Thank you. Let me take the first two quickly. Of course, as you saw, the business is going down because of COVID, the average is growing. Expenses are going up because we are promoting new launches, including COVID. So right now, moving into Comirnaty in commercial and Paxlovid with commercial channels, now we treat them like normal promotional products, very sensitive in promotions at the beginning of their launch. So, we are going very hard with promotions, TV, field forces and all the other educational measures that we are taking when we do this type of launch. So there is -- clearly this speaks. What about, David, are we going to buy back? I think as we look at capital allocation at this point in time, we actually see a lot of opportunities to invest back into our business, both from a research perspective and importantly, getting behind our launches to make sure that weâre doing all that we can to ensure that our growth trajectory in â25 and â30 and those goals and aspirations become reality. So, I think our best and highest use of capital right now is investing in our business, both internally as well as from a BD perspective. I would say never say never to an incremental share repurchase, but thatâs not high on the priority list at this point. And Mohit also, you asked also about the synergies. Clearly, there are a lot of synergies right now both. In the Paxlovid -- Paxlovid is covered by a lot of physicians, and we have very, very strong primary care field force and we have very strong also vaccines field force that is covering all these physicians that we have, either vaccinate or prescribing Paxlovid. So, clearly, a lot of synergies in retail and in the medical profession also. Letâs go to the next call, please. Just building on some of the OpEx discussion here. I just want to make sure Iâm understanding the OpEx dynamic is properly over time. So, I guess, should we think about 2023 as more of a onetime step-up in OpEx and then much slower growth in â24 and beyond? Or should we be thinking about this a couple of year process as you really get the pipeline and new products ramped, and then itâs maybe more second half of the decade before we think even about margin -- bigger margin expansion or is that OpEx slowing? I just want to make sure Iâm understanding those dynamics properly. And then the second one was on the COVID/flu combination. I guess, is your expectation that the tolerability of that will be similar to what we see with Comirnaty, or is there some trade-off of we could see maybe slightly higher kind of side effects for the six components you mentioned but thatâs offset by the convenience? Iâm just trying to make sure I understand what your expectations are for that program. Thanks so much. Yes. We think that the tolerability will be well on par with vaccines used in the target population and be perceived as tolerable and convenient. As you described, the combination will attract the high volume of flu people to also be able in shot to renew the COVID coverage, particularly with more and more variants coming. So weâre very positive and think weâre right in the balance of those and opportunity there. Thank you. And, of course, Dave will say, but right now, this is the profile that we are targeting. And we think itâs easy to do it with two viruses, so to load enough so that we have very good efficacy and good tolerability profile. We believe it will be more challenging, but of course, needs to be seen. And thatâs why we believe that our RSV -- protein and having such a good tolerability profile offers better combination of a triplet than triplet all with mRNA. Dave, also there was this question that I think you touched upon it earlier in your script about how we see going forward, the expenses of SI&A. Yes. So importantly, 2023, weâre seeing a step-up in SI&A and itâs really, again, investments around the launches and the products that have been acquired, which we think are really important to really drive growth in the back half of the decade. So, weâre already focused on that. We do think â23 is probably the big year of step-up from expenses. And then post â23, those expenses will grow more moderately after that. Yes. Thanks very much. Thanks for all of the additional details that youâre providing. So, it seems like the 2023 guidance is conservative, which is encouraging. But looking to Paxlovid longer term on slide 11, I guess Iâm surprised that the percentage of symptomatic patients that you expect to be treated with an oral therapy would almost double from 12% to 22% between â22 and â26, even though the pandemic is being viewed as being over. So, Iâm hoping that you could talk a little bit about those assumptions and what the denominator is. So, when you say symptomatic patients, is that high-risk/elderly that youâre calculating the 12% on going to â22, et cetera? And then, in terms of the Paxlovid share, it was approaching 91% at the year-end of â22, according to this slide but only declining to 80% in â26 when there are several companies, both large and small, ranging from Gilead to smaller companies that are planning to develop agents to compete aggressively and that could have implications for both, volume and pricing longer term. So wanted to understand that. David, very good questions. Let me try to explain a little bit. First of all, itâs not 12% going to 22%. Itâs really 17% going to 22%, right? The 12% which is in â22,it is a partial year, so it didnât include the full year. The real demand, it is, letâs say, â23 full year, it is 17%. And itâs going up because of two factors: one, it is a small increase in infections. And as I explained, the assumption is that COVID will not disappear, will be there. But vaccine rates, vaccinations are going down. So that will create -- will wane the protection -- the protection of the population. And that will manifest with a small increase, which you factor, 2% based on our modeling, a small increase of both the infections and eventually also the severity. So, thatâs one. So, the second is that the more introductions of new entries rightly will not happen before â25 -- â24, â25 in the U.S. at least. Will depend if EUA will still be available, which will depend if we will be in a state of emergency or not for EUA. But if we will not be in a state of emergency, which could be like a scenario, there will be no EUAs, we donât see, in â24, any introduction, actually we see in â25 the introductions. The introductions though, also, as always, are increasing the overall cost. So, fact, itâs what also is driving. We are dropping markets share but we are increasing the volume. The last is are we dropping the market share aggressively enough or are we, letâs say, very optimistic in dropping. The assumption here it is that we are the only one, we have right now for years presence in the market with a label that is extremely strong with 86% clinical efficacy against hospitalization and against deaths -- high action against deaths. So, itâs very difficult for anyone to reproduce this data right now, The studies will run forever likely and will be very large. So, very, very difficult to reproduce something like that. So as a result, given that for years, we will be among -- we will be basically the lion market share, plus the excellent profile, the loyalty that will be developed. All of that are telling us that it is very reasonable with -- to maintain very high market share, you can see that in first-in-class and itâs in every treatment, from cancer to that compared to the second and third, itâs easy to maintain 60%, 70% of the relevant conditions. Now that we have all these advantages, we think maintaining at 70%, 75%, I think, is reasonable. Of course, weâll have to see. Next question, please. Two questions, one on Paxlovid cross-currents there between China in terms of the million doses that you described for your first fiscal quarter and a potential transition into a private market in China, and then, U.S. where a similar transition will occur to the commercial. Can you help at all frame what you think the relative contributions could look like in â23 and how that could progress? And then in particular for the COVID franchise products, can you share any early color on the discussions or engagement that youâre having with payers? What kind of dynamics? Any color there would be helpful, particularly in the broader context of a global pharmaceutical opportunity with many different therapeutics that will be on their list of budget items, obesity, Alzheimerâs, et cetera. So, any color on the discussions with payers would be helpful. So I think for Paxlovid, again, the time period, the way to think about it is in two time periods from now until April, which is a reimbursed market, which gives us access to both public as well as private channels, and then after April, private channels only. As you heard, we have included in sour guidance what we believe we can do in the first three months of this year. But given the fact that the back half of the year, we will -- itâs going to be highly uncertain. It will be a very dynamic market. Weâll continue to make sure that we have supply, but weâll have to just wait and see what happens there. On the side of U.S., similarly, we will be transitioning this year. We will have a year where some of the revenue will be made through the completion of contracts that we made with the U.S. government in 2022. And then part of the year, the revenues will come from the commercialization of Paxlovid. So, youâre going to see that play through -- both of those dynamics play through. And then I think you had one more question. Yes. So itâs still early days, especially in the U.S., right, because thatâs only happening middle of the year. But what I can say is that we have had some early discussions already with agencies and reimbursement agencies outside of the U.S. who have given us, I guess, earlier feedback. And even if you take a country like the U.K., we actually had very favorable feedback on the pricing that we provided, and they agreed with the cost effectiveness of our Paxlovid. So I think weâll -- obviously, thatâs good feedback, and weâll be taking those learnings and those value arguments to multiple countries around the world. Thanks for taking the questions. And David, thank you for all the transparency on the underlying assumptions. I guess, two for me. First off, just in terms of the upcoming, I guess, messaging around the end of the public health emergency. Can you talk about the potential impact you see on your EUAs, access as well, specifically thinking about Paxlovid populations in this period before we switch to a commercial market where youâre still -- the government is still, I guess, working through the inventory they have in hand? And then, going to the COVID/flu combination, just trying to better understand some of your assumptions here. Because I guess when we think about that â26 40% adoption number, -- itâs some -- I guess, either the incremental bump from â24, 15% or the 40% absolute, just kind of what that implies about how you think the underlying flu market will change. I guess, that complies 30% to 80% share within two years, but just wanted to understand kind of the underlying drivers there and how you think about that market evolving. Thank you. Maybe I try myself quickly because weâre running out of time. If there is an end of emergency, we donât think that will have any impact on current in U.S., will have an impact on issuing new in U.S. I donât think that anything changes in the way that -- emergency or not, whether the inventories will be managed or the access that patients will have in any of these treatments. Now, as regards of COVID/flu, if the introduction of combination for products would change the flu market, I think, yes -- well, would say itâs a major flu market was always a single market until now. And suddenly, there is a chance that other respiratory cases like COVID or RSV will come. So I think that would change. But now, the step-up, it is clear we expect that around 24%, 25%, it is a population in the U.S., that believes needs protection and is diligent enough -- not believes, more belief, but they are diligent enough to follow the recommendation and go and get their annual booster for COVID. When they will present themselves -- excuse me, when the flu people will present themselves and they will be asked that question, if you want flu single or flu with a combo, and they will be given the information that will protect them in a single injection at the same time, zero co-pay, for COVID as well, we believe itâs reasonable to expect that the 25% stable will become 30%, so weâll add another 5% of the population. And that over time, that will move closer to the 50%, we project 40 over there. So, those are the assumptions that weâre using. Next question, please. A couple of questions on vaccines please. Firstly, on RSV, can you confirm youâre on track to provide that second season of data ahead of approval and reimbursement discussions in May-June for the older adult vaccine? And can you confirm whether youâve now filed your maternal RSV vaccine with the regulator? If not, are you waiting for the approval in the older adult setting first? And then just on the flu/COVID combo, if we assume you have positive flu Phase 3 data in the second half of the year, positive Phase 1 combo data in the first half, would you expect to move the combo into Phase 3, or is that the possibility you will not need a full Phase 3 combo study to proceed to filing an approval? Thanks. Yes. I mean, we always follow multi-seasonal vaccines and weâll share the second season data as soon as itâs available. Of course, there are many ways this can play out with combination vaccines and which could lead to more regular vaccination rather than protracted. And on -- you also asked about the, letâs say, the flu/COVID combo here. So if we need a full Phase 3, if we have both flu and COVID? We expect that you need a Phase 3 that is based on immunogenicity and safety and not a large trial based on events. So, we think we can complete that fast. And if anyone can do it first, itâs we. So, thatâs very high on our list currently pending data to move with light speed in. Yes. I think it will impact ACIP recommendation in vaccines. Once you have ACIP recommendation or not, youâre getting automatic actions with all formularies without co-pay. So, that, I think it will be the key what ACIP will say. And letâs go to the next question, please. On Paxlovid, following commercial approval and the withdrawal of the EUA, will pharmacist prescribing remain intact? And then a couple for Mikael. Could you just explain the reasons for the out-licensing of the TL1A inhibitor to Roivant? I apologize if I missed it. And then second, in relation to your multispecific antibodies, your trispecifics, this has been tried previously, I think AbbVie and J&J previously tried in RA, and I think in psoriasis with TNF IL-17s but they ran into an issue with binding affinity and they didnât have efficacy. Do you think youâve managed to solve the issue here? Andrew, the first one is simple, I donât know if the pharmacist will. Itâs very unlikely, I think. But I donât know, we donât have it in our assumptions right now. And letâs go to Mikael. Iâll start with, Andrew, great question. You touched my heart today. We have cracked it. These antibodies that I shared today have, first of all, pharmacokinetics like an excellent single antibody but 3-in-1 product and have very high potency, which you asked about, actually exceeding the marketed product substantially. So, we think itâs really something that we will move very quickly as we learn more of it. And you asked about TL1A. We think we have a very good partnership with Roivant that helps us to do more things within our pipeline. And youâve heard Aamir Malik earlier alluded to that we have commercialization rights ex U.S., Japan. We have about half of the value of this product. And we have a follow-on bispecific TL1A p40 thatâs active mechanism of STELARA. So, we think we have such a richness in this space and really enjoy to build the ecosystem with others and maximize what we bring to patients. The only quick thing I will add, Andrew, is if you look at how prolific our R&D engine has been, the total funding demand from all of the R&D programs that were generated would significantly exceed what we guided to as our R&D spending in â22 and â23. So, in that context, we are going to be very thoughtful about how we prioritize. We have a robust process for that. And consequently, from time to time, youâre going to see programs like the TL1A that have very clear scientific merit, but we think weâre sharing the cost, the risk and capabilities with the partner is the best way to create value. And thatâs what we did in that situation. And weâve had a long history of doing that in a number of other situations as well. Thank you for squeezing me in. And Iâm not going to ask a COVID question because I think they were all asked. So, just looking at business development, when you hit Biohaven, what were some of the characteristics of the deal that you want to bring forward in kind of your go-forward approach for BD? How should we think about potential holes in your pipeline that you could fill with external deals? Thank you. Sure. The Biohaven deal for us represented an excellent opportunity to leverage our capabilities. And specifically, where were capabilities in terms of our global commercial footprint, that Biohaven as a company alone could not maximize but where application of those capabilities could take Nurtec and the follow-on product to places and reach us for patients that they couldnât have gotten to alone. And also the way in which we structured that transaction, began with an ex U.S. partnership, which we then expanded to take on the full global CGRP franchise and also excluded some assets that were less relevant to us strategically that created a newco. And I think what you can take away from that is that weâre going to continue to look for things that are scientific breakthroughs where we can add capabilities and weâre also going to be creative and disciplined about how we structure our deals. And we think thatâs going to serve us well as we complete our ambition against our $25 billion goal. Thank you, Aamir. So, thank you, operator. In summary, let me close by saying, first of all, I feel extremely proud for the team at Pfizer that was able to deliver -- break all records in 2022, the highest-ever revenue, the highest-ever profits, the highest, more importantly ever number of patients, that we protected or treated with our medicines. The best-ever reputation for our company, the most productive wave of R&D with 18 -- 19 products launching in the next 18 months, the best R&D machine in terms of multiple measures, all of that were able to achieve in 2022. Clearly though, I believe that the best years of Pfizer are ahead because we are building on a significant capital position that we know how to deploy to create growth. We are building on an R&D engine that it is more productive than ever in the history of this company, a manufacturing engine that it is the envy of the industry, commercial envy -- commercial engine that it is around again and again and again as the best commercial engine in the industry. And, of course, a mindset in Pfizer that is characterized but nothing is impossible. We can make everything possible. So with that in mind, I think that we are moving ahead, hopefully, to an even more successful 2023. Thank you very much for your attention, your interest in us and your support as shareholders. Thank you. Thank you, ladies and gentlemen. This does conclude Pfizerâs fourth quarter 2022 earnings conference call. We appreciate your participation, and you may disconnect your line at any time.
|
EarningCall_1125
|
Welcome to Wintrust Financial Corporationâs Fourth Quarter and Full Year 2022 Earnings Conference Call. A review of the results will be made by Edward Wehmer, Founder and Chief Executive Officer; Tim Crane, President; David Dykstra, Vice Chairman and Chief Operating Officer; and Richard Murphy, Vice Chairman and Chief Lending Officer. As part of their review, the presenters may make reference to both the earnings press release and the earnings release presentation. Following their presentations, there will be a formal question-and-answer session. During the course of todayâs call, Wintrust management may make statements that constitute projections, expectations, beliefs or similar forward-looking statements. Actual results could differ materially from the results anticipated or projected in any such forward-looking statements. The companyâs forward-looking assumptions could cause the actual results to differ materially from the information discussed during this call are detailed in our earnings press release and in the companyâs most recent Form 10-K and any subsequent filings with the SEC. Also, our remarks may reference certain non-GAAP financial measures. Our earnings press release and earnings release presentation include a reconciliation of each non-GAAP financial measure to the nearest comparable GAAP financial measure. As a reminder, this conference call is being recorded. Thank you very much. Welcome, everybody, to our fourth quarter year-to-date 2022 earnings call. With me always are David Dykstra, our Chief Operation Officer; Dave Stoehr, where are you, Dave, our CFO; Tim Crane, the President; Rich Murphy, our Head of Credit Guru; and Kate Boege, our General Counsel. Now the same format as we have been doing in the past, I am going to give some general comments regarding results for both the quarter and the year in total, turn it over to Tim Crane for more detail on the balance sheet and then to David Dykstra is going to discuss the income statement in detail. Rich Murphy is going to talk about credit and back to me for some summary comments about the future. We will have some time for questions. We finished the year very well. Itâs a great year for us. Beach ball jumped up. Itâs selling its way up, earnings for the year of $509 million, almost $510 million, up almost 10% from the previous year. Grew earnings per share of fourth quarter $144 million, $145 million, compared to $142 million, $143 million in the third quarter and about $99 million in the fourth quarter of 2021, earnings per share $2.23 for the quarter, $8.02 for the year, compared to $7.58 for the previous year. And our pre-tax pre-provision income, it was a record for us, I think, $2.43 versus $2.06 for the year of 780 versus 579. And the prospects for growth were good for this to continue our way up as the margin finished at 3.73%, 3.17% for the year, up from 3.35% in the third quarter or 38 basis points and 59 basis points year-to-date to 3.17%. And then we expect to approach 4% coming this next quarter. Tim will talk about all that. Return on the assets around 1% for the year, 1.10% for the quarter, current equity of 12.72% up 41 basis points for the year. Tangible book value rose to $61 a share, compared to $59.64 fourth quarter 2021. Again it was a very good year for us. If you look at the balance sheet to some extent, assets grow nicely for the year. The loan growth about $1 billion with about almost $700 million over average, so we will be able to work that going forward. The margin, as Tim will discuss -- Tim and Dave will discuss trying to hedge it a little bit to maintain our downside risk. It makes sense as rates go up. Their next move will be down at some point and we are adjusting the balance sheet for that. Tim will talk about that. Credit side, credits are remarkably good. Rich Murphy will talk about that, but we will point out that if you look at the real numbers, the quarter was actually down for the quarter, because of about $17 million of fiscal Life loans that got hung up in waiting for the money to come back. Only the fiscal portfolio you have to understand it all that money thatâs out there that we show is past due, has been confirmed is going to be returned. So credit was actually better than it was before and we feel very good about that. Thatâs good. Thanks, Ed. Iâd like to highlight a few balance sheet items. I will offer a comment on several items likely to be of interest, including the continued impact of rising rates on the margin expectations. The approximately $1 billion of growth for the fourth quarter was 11% loan growth on an annualized basis, which continues to be spread nicely across all major loan categories. As noted in the release, period-end loan balances were $630 million higher than the quarter average, which will help our first quarter 2023 results. Going forward, while we remain encouraged by stable loan pipelines, we believe there is some evidence of a modest slowdown in market loan demand, loan growth in the mid-to-high single digits on an annualized basis remains a reasonable expectation given the current economic uncertainty. Rich will speak to loans in more detail in just a few minutes, but a couple of notes on the provision and on our allowance. Of the $48 million in provision, approximately two-thirds is related to a modest deterioration in the CECL macroeconomic factors and only one-third is related to our growth and portfolio changes that occurred during the quarter. To be clear, we are not signaling a change in our credit performance. With respect to our allowance of 91 basis points of total loans, itâs important to note that excluding our historically low loss niche loans, primarily the premium finance loans, our allowance is 142 basis points of total core loans. You can see that on table 12 of the press release where we provide some detail. Deposit growth for the quarter was approximately $105 million. The continued rise in rates is clearly making deposit gathering more challenging. The cost of deposits are rising and nominal changes in deposit mix are occurring. Interest-bearing deposit costs of 130 basis points for the fourth quarter were up 66 basis points. We anticipate continued increases in both the Fed funds rate and the rates associated with the bankâs loan and deposit activity. Increases in loan yields, however, at this point in the cycle continue to exceed the change in deposit costs given our asset sensitive position. Our deposit betas and the increase in deposit costs to-date are in line with our expectations. Currently, the beta on our interest-bearing deposits is approximately 25%. We anticipate an interest-bearing deposit beta of approximately 40% to 45% over the full cycle of interest rate changes. Our securities book was up $1.5 billion in the quarter as we believe yields are becoming more attractive and represent the opportunity for reasonable longer-term returns. At year-end, liquidity remained strong with approximately $2.5 billion of cash on the balance sheet. As discussed last quarter, our securities book is split almost equally between available-for-sale and held-to-maturity, while the AFS valuation swings during the year were significant. As Ed pointed out, the bankâs tangible book value was up for both the fourth quarter and the year to $61 a share. Those of you who follow us know that the tangible book value per share is an important metric for us. It has increased every year since going public in 1996. With respect to rate sensitivity in the margin, although our GAAP position is trending down, we remain asset sensitive and well-positioned to continue to benefit from rising interest rates. We believe each 25 basis point increase in the Fed funds rate at this point in the cycle will result in approximately $30 million in pre-tax net interest income on an annualized basis and an improvement in the margin of 5 basis points to 8 basis points. Note, this is down slightly from our prior positioning. To be more specific on the margin, as Ed mentioned, it was 3.73% in the fourth quarter, an improvement of 38 basis points. With rates rising, we continue to achieve, and in some cases, exceed the margin improvement discussed or projected on our prior calls. At this point, depending on the impact of competition for deposits and the pace of additional Fed increases, we believe our margin will approach 4% at some point during the first quarter and has not yet peaked. Conversely, while we clearly benefit from rising rates, as discussed on our last call, the bank entered into several interest rate collars in the third quarter of 2022. Further, early in this quarter, first quarter of 2023, the bank entered into additional derivative contracts with the intent of reducing the variability of the margin in a lower interest rate environment. Our approach has been to leg into these contracts and we anticipate that additional activity on this front is likely. You can see table eight in the press release for more information on our GAAP position. As you know, we also view our mortgage business as a natural hedge as it has proven to perform well in lower rate environments when margins tend to be pressured. For the fourth quarter, capital ratios were stable to up slightly and remain appropriate given our risk profile and with the higher net interest margin and currently forecasted loan growth, the companyâs earnings are projected to result in organic improvement to our capital levels in the coming quarters. Great. Thanks, Tim. As usual, I will cover some of the noteworthy income statement categories, starting with net interest income. Tim and Ed referenced some of these numbers, but we will just go through it in detail. For the fourth quarter of 2022, net interest income totaled $456.8 million. That was an increase of $55.4 million as compared to the third quarter of $22 million and an increase of $160.8 million as compared to the fourth quarter of last year. The $55.4 million increase in net interest income as compared to the prior quarter was due to an increase in the net interest margin and loan growth. As a 38-basis-point improvement in the margin brought it to 3.73% in the fourth quarter, a beneficial increase of 84 basis points on the yield on earning assets and a 22-basis-point increase in the net free funds contribution, combined with the negative impact of a 68 basis point increase on the rate paid on liabilities resulted in that improved net interest margin. The increase in yield on earning assets in the fourth quarter as compared to the prior quarter was primarily due to an 87-basis-point improvement on loan yields and higher liquidity management asset yields as the company earned higher short-term yields on its interest-bearing deposits held at banks and its investment securities portfolio. The increase in the rate paid on interest-bearing liabilities in the fourth quarter as compared to the prior quarter was driven by a 66-basis-point increase in the rates paid on the interest-bearing deposits. Tim already went through the deposit beta, so I will let you refer to his comments on that. Turning to the provision for credit losses, Wintrust recorded a provision for credit losses of $47.6 million in the fourth quarter, compared to a provision of $6.4 million in the prior quarter and a $9.3 million provision expense recorded in the year ago quarter. The higher provision expense in the fourth quarter was primarily a result of less favorable macroeconomic environment conditions including wider projected credit spreads and less favorable commercial real estate price index data included in the economic forecast that we use. Stronger loan growth also contributed to provision expense for the quarter. Rich will talk about credit in more detail, but I should know that the current quarterâs net charge-offs, the mix of classified loans and the delinquency data all remained relatively stable or better and really pretty good. So those factors really did not have a significant impact on the level of the fourth quarterâs provision for credit losses expense. And as Tim said, this is not the larger expense level, itâs not a signaling of any specific issues, itâs really a function of the macroeconomic forecast that we use in our CECL models. Turning to other non-interest income and non-interest expense. In the non-interest income section, our wealth management revenue was down $2.4 million from the prior quarter and was at the level of $30.7 million for the quarter, decline in revenues for this quarter were primarily related to less fees associated with our tax deferred like kind exchange business, which had been very strong in the prior quarters and slowed just a bit in the fourth quarter. Consistent with overall industry trends and the impact of relatively higher home mortgage rates, our mortgage banking operation experienced a revenue decline of $9.8 million from the third quarter due to lower loan origination volumes and lower production margins during the quarter. We expect mortgage origination volumes to continue to be low in the first quarter due to the rate environment and the seasonal purchasing trends, but itâs still an important part of our business, and we expect it to pick up some volume in the spring buying season starts in the second quarter. The company recorded net losses on investment securities of approximately $6.7 million during the fourth quarter, compared to a $3.1 million net loss in the prior quarter as market conditions and equity valuations continue to affect a portion of our securities portfolio. Other non-interest income totaled $19.3 million in the fourth quarter, which was up $3.5 million from the amount recorded in the prior quarter. The contributing reason for the increase in this category is that the company recorded approximately $1.1 million of higher BOLI income, which was primarily related to higher earnings on BOLI investments that support certain deferred compensation plan benefits. And so I should note that, that $1.1 million increase in the BOLI income has a similar offsetting increase in compensation expense during the quarter. So they have sort of net -- as far as net income goes, but there is an increase in both those categories for the quarter. Additionally, the prior quarter had a negative valuation adjustment of approximately $2 million on our early buyout loans -- certain early buyout loans, whereas the prior quarter had a $2 million negative valuation on the early buyout loans, whereas the current quarter had an insignificant adjustment. Turning to non-interest expenses. Non-interest expenses totaled $307.8 million in the fourth quarter and we are up a little over $11 million when compared to the prior quarter total of $296.5 million. The primary reason for the increase was due to higher compensation related expenses and a variety of other less significant contributing factors. Salaries and employee benefits expense increased by approximately $4.2 million in the fourth quarter as compared to the prior quarter of the year. Relative to the prior quarter, the increase of $2.8 million of higher salaries expenses and $2.3 million of higher employee benefits expense were the primary causes. As to the higher salaries expenses, so itâs caused by $1.8 million of increased deferred compensation costs. As I mentioned, partially related to the underlying BOLI investments where we recorded the income on the other non-interest income part of the income statement and on the employee benefits side, those are almost exclusively related to higher health insurance claims during the quarter, so elevated in the fourth quarter generally as people try to use up some of their health benefits before the deductibles recept. Also although a smaller change from the quarter, commissions and incentive compensation was slightly lower as mortgage banking commissions were reduced, although we did have some higher bonus and long-term incentive compensation accruals for the quarter related to the higher earnings level, but then that was a reduction in that category. Advertising and marketing expenses decreased by $2.3 million in the fourth quarter compared to the prior quarter. As we have discussed on previous calls, this category of expenses tends to be lower in the fourth and first quarters of the year due to less marketing and sponsorship expenditures related to various major and minor league baseball sponsorships and less summertime sponsorship events that we obviously donât do in the winter time. Professional fees increased by approximately $1.7 million in the fourth quarter. These fluctuations were primarily related to some consulting services that we utilized in conjunction with the implementation of various new financial and customer related processing systems. Other miscellaneous expense increased by $4.8 million during the quarter, which included a $1.1 million additional charitable contributions and a variety of other normal operational fluctuations, none of which I think are worth noting for this call. Our efficiency ratio declined to 55% for the fourth quarter from 58% in the third quarter as our expenses did not increase at a rate commensurate with the increase in revenue. Thanks, Dave. As noted earlier, credit performance for the fourth quarter was very solid from a number of perspectives. As detailed on slide eight of the deck, loan growth for the quarter was $1 billion or 11% annualized, an outstanding result. And similar to the past few quarters, we continue to see loan growth across the portfolio. Specifically, commercial real estate grew by $373 million. Commercial loans bolstered by a strong quarter and leasing grew by $290 million. Commercial premium finance had another solid quarter, up $136 million and residential real estate loans were up $137 million. Year-over-year, we saw total loan growth of $5 billion or 15% net of PPP loans, a very productive 2022. As noted on our prior earnings calls, we continue to see very solid momentum in our core C&I and CRE portfolios. Pipelines have been very strong throughout the year and we saw that materialize into increased outstandings over the past several quarters. In addition, ongoing disruptions within the competitive banking landscape continue to work to our benefit. Also, commercial premium finance had a very strong 2022 with increased outstandings of close to $1 billion year-over-year. We anticipate this momentum will continue into 2023. While we are optimistic about loan growth for this year, we would anticipate that the pace of growth may trend closer to the middle of our guidance of mid-to-high single digits for a number of reasons. While Wintrust Life Finance grew by $1.1 billion during 2022, the rapid increases in rates during the past year have affected that pace of growth. This portfolio grew $86 million in the fourth quarter versus $396 million in the third quarter. We would anticipate the slower rate of growth will continue in this higher rate environment. Also increases in commercial line utilization, excluding leases and mortgage warehouse lines as detailed on slide 17 have flattened during the fourth quarter, possibly reflecting a more cautious business sentiment. As a result, while we continue to be diligent about the possibility of a business recession, we believe our diversified portfolio and position within the competitive landscape will allow us to grow within our guidance of mid-to-high single digits and maintain our credit discipline. From a credit quality perspective as detailed on slide 16, we continue to see strong credit performance across the portfolio. This can be seen in a number of ways. Non-performing loans remained stable at 26 basis points or $101 million, compared to $98 million in the third quarter. And as Ed noted earlier, of this total, $17 million was related to Wintrust Life loans, which went 90 days past maturity. Roughly half of these loans have since been paid off, the balance of which are fully secured and we would anticipate full repayment from the carrier shortly. Overall, NPLs continue to be at very low levels, and we are still confident about the solid metrics in the portfolio. Charge-offs for the quarter were $5.1 million or 5 basis points, up slightly from the previous quarter. Charge-offs for 2022 totaled $20.3 million or 5 basis points. Finally, as detailed on slide 16, we saw stable levels in our special mention and substandard loans with no meaningful signs of additional economic stress at the customer level. Thanks, Murph. Year end is always a good time to review, not just the fourth quarter and the year-to-date, but whether we view the entire body work over a longer period of time versus our stated goals that the company has had. Letâs go back 10 years. Now if you go back 30 years results versus peers will be about the same. Increasing tangible book value, we think is extremely important. One of the goals we always look at, as Tim noted earlier, we have increased it every year since we went public eight-year CAGR of 8% is pretty good. Even last year, it had been kind of tough, but we still were up above -- we were positive. Earnings growth 16% at 10-year CAGR, asset growth 12%, dividends paid 22%, stock price only 9%, go figure. During 10 years under review, we saw a bit of everything, high rates, low rates, pandemics, you name it. Interest has thrived during all of these. Itâs a testament to our business model. We employ in the people who work at Wintrust. When rates were low, our mortgage company helped pick up the slack and net interest margin compression -- of the net interest margin compression that occurred. Lower rates what we more increase our positive gap where the risen mortgages has died down. I say this because I am often asked, well, you are a mortgage bank. No, we are not. Itâs just is part of what we do. This is an orchestra here now at a combo. This is a big orchestra. We all sort different parts at times, they all kick in. Times say, they donât kick in. Mortgage is an extremely important thing of important offering that we have, but it -- itâs not doing well now, but it will do well as rates come back down. Now about our -- the margin up, we are embarking on, as Tim mentioned, locking in this increased margin for a longer period of time. All the above is going to accomplish by maintaining our exceptional credit statistics. High metro concentrations kill [ph] has also served us well both in deposit and the asset side, extremely well diversified and thereâs something that always works when something isnât working. Where growth come take what the market gives us, acquisitions organic growth or have both worked very well for us. Based all the above and many more points, one has to wonder why we consistently trade at a discount to our peers. I have to put that in there, I am sorry. As the future you can spend more of the same. Our margin should continue to increase as the remainder of asset portfolio reprices and liability costs increased at a lesser rate. Marginal force is in our future. We will be locking at a higher margin. As we mentioned in todayâs comments, is already underway. Loan pipeline is still strong, but a bit lower than historically, as Murph pointed out, and we keep our guidance the same, but are focusing on the lower side of that. Credit stats are solid, but we are prepared for additional humeral attack by the folks at Moodyâs, which we had on this quarter. I was just thinking still being evaluated in all aspects of our business. Pricing is still an issue, especially given our stock price. Now as the acquisition of Rothschild American business on track for a first quarter or second quarter closing. In short, we like where we stand. With all that, I think, you can sure our best efforts going forward. We will be consistently good. We are all the major owners of this. Our networks are tied up in this company. Not going to do anything stupid. In fact, we hope to thrive no matter what the economic cycle is and where we are at in it to ensure our best efforts in this. [Operator Instructions] Thank you. Our first question comes from the line of Jon Arfstrom of RBC Capital Markets. Your question please. You guys -- the numbers look good here, the one that surprised me a little bit was the provision and it seems like youâve touched on it and alluded to it, but what do you want the message for us to be going forward? It feels like itâs going to pull back. It feels like it pulls back with a little bit slower loan growth as well, but you guys view this as more of a onetime step up and we go back to a normal pace or how should we think about that? Well, I think, Jon, the CECL, as you know, is sort of a life of long concept. And if we have loan growth, the provision will go up. But if the economic scenario stayed exactly the same, you would have no additional provision in the next quarter per se for that. So it really depends if the economists obviously changed our forecast frequently. But if that forecast gets better next quarter, you could expect the provision to come down, I think, gets worse, it would probably stay elevated. So itâs really a function of where the economy is going. But as Tim and Rich and Ed and I have all said, thereâs nothing specific here that we are pointing to that we think is a current problem in the portfolio. This is just how commercial real estate price index forecast and how credit spreads and GDP on all those forecasts got moderately worse in the forecast that we -- economic forecast we use. So it really is a function of the CECL modeling and not a function of us seeing a deterioration in our credit. So if you can tell me where that crystal ball is next quarter as far as economic forecasts, you could know which way our provision is probably going to go. The -- yeah, yeah, yeah. The other question I have was on the margin. I think I understand what you guys are saying, but if the Fed, it feels like you are trying to predict -- protect downside, but does the Fed bumps a couple more times and then hold it for a while. What could happen to your margin? Are you guys were talking about a 4% level, but then, Ed, you kind of alluded to floating a little bit higher above 4%. What do you think about the margin outlook in that kind of a scenario where the Fed is not cutting? Well, they are raising where it should be, as Tim said, $30 million on an annual basis per quarter. Eventually, the -- we have been lagging on the private, we have been lagging on the deposits. Much is going to catch up to that overall beta. But we still have a lot of assets that are repricing right now, if you think about premium finance business, every prices over the course of the year, the other assets do the same. We are monitoring this very carefully as we leg into these derivatives to help maintain the margin. So itâs hard to say where itâs going to be, it depend on some of derivatives, we give up some upside to protect the downside. But I think that depending on how rates go, margin will continue to go up. If we can predict something in the 3.75% to 4% range long-term, depending on where rates are, that would be a good thing, but itâs going to take a lot more derivatives to do that and we are not really good at market timing. So we will -- when that happens, the mortgages will kick in and life will be good in that regard. So we kind of had some internal hedges, too. But Tim, do you want to talk about that? Yeah, Ed. I think, Jon, in general, we would expect the margin to sort of top out after the Fed stops raising rates. And so whether thatâs a quarter or two or whether we moderate that with some thoughtful decisions around the derivatives, thatâs kind of what we are thinking. Yeah. This is Dave. I think what we have said here is that we expect the margin to approach for and if the Fed raises some more, it may pop a little over for, but itâs -- but then we think given existing competitive pressures and the existing yield curve that if they stop raising that we can kind of hold it there if all else being stable, because as Ed said, we have a lot of asset beta left too, everyone talks about the deposit betas. But if you look at our life insurance premium finance portfolio, as you know, that those reset once a year. And if you go back a year, they are based generally off of a 12-month LIBOR or 12-month treasury rate and those rates were 58 basis points a year ago, if you look at the page 25 of our earnings release. Those rates are up over 400 basis points. So thereâs a lot of repricing that happens there. The property and casualty premium finance loans are fixed rate loans and so they reprice over the course of the year. So thatâs a third of our portfolio that has pretty good deposit -- our asset beta changes left that we think will substantially offset the deposit betas. So we feel like we can kind of hold the margin if they go higher and then plateau. Good. Good. You guys bucking the trend here on the deposit side showing deposit growth, a lot of the banks continue to have outflows. What are your expectations on the deposit flows? And then also mix shift hasnât changed too much as you alluded to, do you see much mix shifting coming in the next couple of quarters? Yeah. David, itâs Tim. The deposit activity has been lumpy and both in and out I would add, weâve been pretty disciplined with our pricing and cautious about getting ahead of the market. We are responding to promotional activity to retain our clients, and frankly, weâve got some higher deposit costs built into our projections. We think we operate in good markets with a lot of deposit potential. We have typically outperformed our peers in terms of growth. Even though we are one or two in deposit share in many of our markets, we still only have 6%, 7%, 8% overall growth in Chicago and Milwaukee. So our multi-charter brand and approach we think will help us and we think we are holding our own. Iâd add sort of an interesting fact here during the last quarter or two quarters, rather, we have helped clients purchase almost $1 billion worth of short-term treasuries that previously had been held at deposits at the bank. And as the gap between deposit pricing and treasury starts to narrow again, we expect we will get an opportunity at some of that money. But we donât -- I mean, we will protect the mix as best we can. Clearly, people are moving out of DDA in some cases for the rates in money markets or savings or CD products. So I think itâs possible that will continue. But I can tell you, we are intensely focused on adding deposits and relationships and we still think weâve got terrific market opportunities. So we are going to hold our own and stay at it. Good. Thanks, Tim. And then my follow-up here relates to the amount of cash you have versus deposits, a lot of your peers donât have much cash and they have really had to increase FHLB borrowings and use of higher cost CDs. Your cash, as I see it, is down to just under 6% of deposits, you are up over 10% at September 30th. Do you monitor that, is that something that you have a target you want to keep above a certain cash level just in case you do get some deposit runoff and you donât have to chase yields? Yeah. I think we are sort of comfortable where the cash is now. If you remember last quarter, at the end of the third quarter, we had a $1 billion extra sitting in cash, because we had done some borrowings at the Federal Home Loan Bank that we indicated we would invest at the beginning of the quarter. We did that. So I think, if you look at it, we were in the high 3s and then we went to the high 2s, if you adjust for that $1 billion that we invested currently after the end of the third quarter and now we are around $2 billion. We like that position. We sort of focus on a loan-to-deposit ratio of 85% to 90%. We are slightly over that fulfillment rate we are comparable with. And then we were lagging on investing in that securities portfolio in the past. We just thought investing in the 1% range was not that prudent and so we were patient and then we have invested now that rates are higher. And we think that part of the remixing of the balance sheet to protect against down rates is to invest in some of the longer term securities mile for a portion of the balance sheet. So I think we like where we are at right now as far as the mix of cash, securities and loans, and as we grow, that mix will probably stay about the same. Yeah. Liquidity has always been very important to us and you can expect our deposit costs to go up, but we have a lot of room there, given the 40% beta we talked about. We are not there yet. At the same time, the asset should move and the real trick is going to be protecting the margin when this peaks out in black swan hits and itâs going to drop like a rock, no matter what the environment is and you have to be prepared for that, too. So we are busy, we are constantly looking at it and liquidity is extremely important to us. Donât forget, Continental Bank went under, because of liquidity, not because of credit. It was the largest bank failure at the time and well liquidity is still important to us. We monitor it very, very carefully. How are you doing? Dave, the 4% margin roughly that you are talking about, I guess, what does that map to in terms of loan yields, right? You have got the premium finance book that keeps this kind of kind of backward lag, but is it somewhere like the mid-6 -- it feels like itâs kind of somewhere in the mid-6s, is this kind of where you are going to -- your loan yields are going to go? Itâs probably mid-6s to approaching 7 right now, I would say. But if rates keep going up and the mix of the business changes, I mean, thatâs a variable, but thatâs -- we donât give guidance -- give specific guidance, but thatâs the right zip code. Okay. And then there was a comment in the press release that just talked about additional improvements in efficiency, maybe you could throw a little bit more color around that. You are obviously in a good spot exiting the year in the mid-50s. But how would you think about that ratio playing out, appreciating that mortgages in recessionary levels? Thanks. Yeah. So mortgage -- lower mortgages, obviously, helped the efficiency ratio. But the expense side of the equation, we will have some additional expenses in 2023. The FDIC rates are up. Compensation cost will go up a little bit as we push through salary raises and the like later in this quarter. But I think with the inflation and the FDIC and those sorts of things, generally, you are probably slightly above mid single-digit growth in expenses and if you add on the acquisition we are planning, itâs probably high single-digit expense growth for the entire year. First quarter, it probably doesnât grow too much on the expense side, we donât think, but then as we add in the acquisition that -- when that closes, that will add to it and then salaries will kick in margin. The margin is going to increase substantially, and we think that mid-50 efficiency ratio we have probably drifts down closer to 50 and we will try to even do better than that. But the increase in the revenue will more than offset the expenses as we look at now to continue to drive that efficiency ratio lower. We continue to look at cutting costs also in different areas. Mortgage area being one. We -- if you look at the net overhead ratio, which I like to look at, it was a lot higher this quarter, but if you take out that security loss, you are closer to 1.5. We have to grow also and we have to invest in growing the bank, which is part of the increase in expenses. Hopefully, that growth will get our net overhead ratio back below 1.5. Hard to do with how mortgage is kicking in, but between the acquisition of our Rothschild and additional asset growth, we would like to get that number down below 1.5. I know the healthy efficiency ratio also, but if -- I never concentrated the efficiency ratio now itâs doing well all the way efficiencies good, because the margins up. But the net overhead ratio we need to continue to get below 1.5, and we are working very hard to do that. Just one more. Dave, on the covered calls, obviously, that number has been bouncing around. But how active are you going to be there, and I guess, maybe help us with what makes it go on either side? Well, the covered calls, as you know, we do those, again, to protect against a down rate environment. It adds a return on those securities. And if you are doing them on mortgage backs, if rates fall, the securities pay off fairly quickly. And so you get that extra revenue and our analysis has been over a long period of time that you are better off by writing the calls and getting that revenue and even have to reinvest, itâs usually a better trade. But as I talked about a little bit earlier when we were talking about the liquidity position, we invested $1 billion of that liquidity into securities in the fourth quarter and wrote some calls against that. And you can see on our balance sheet, those were called and we invest them, so at a decent rate here in the first quarter. So it depends on volatility, and it depends on where rates where the yield curve is at. But itâs a little bit outsized from normal given the size of the investment purchases that we had. But my guess is that in a normal environment that number is somewhere in the $2 million to $10 million range and it really drives a lot off of volatility. So itâs hard to tell until you get to the point where you invest the securities, what the yield curve shape is and what the market volatility is. But somewhere in that range would seem reasonable to me. Hi. Good morning. Maybe first off, Dave, thanks for reminding me the repricing opportunities of the loan portfolio in 2023, I think, itâs something I overlooked. So I appreciate that. And maybe for a question circling back, I think, it was Jonâs question on protecting the margin, and Ed, you kind of threw out 3.75% to 4%. I just want to make sure, is that the floor of this strategy you think can produce and if rates go down 100 basis points or all the way back to zero, I just think thatâs an important kind of comment there and I want to make sure I understand what you were saying there. Yeah. Just to give you, Terry, a little bit more detail. I mean we have entered into a combination of collars and some received fixed swaps with terms out three year to five years, and obviously, the impact of those instruments depends on the interest rate scenario. So, we are trying to take some steps to improve margin and lower, lower interest rate environment, but it depends on the scenario, how much impact thereâs going to be. The other thing, though, is itâs just not these instruments. If you look at table eight, you can see that in various scenarios, both up and down, we have sort of reduced the variability of the net interest income and so we are mindful of trying to operate independent of the interest rate environment at a higher level. Yeah. So, and Terry, Iâd add in there. I mean that would sort of be the goal, but we are not going to do all of the derivatives all at one time. We are going to leg into this diversity as far as the length of these derivative contracts, as far as how much fixed rate loans we put on the books, at what strike price these swaps or collars have. They all matter. I always tell people, our crystal ball isnât perfect, and if you go back 18 months, I think, maybe the outlook for increases in rates was 25 basis points. So the economists that put out these forecasts arenât perfect either. So we are trying to protect the margin and so we are going to leg into it. So depending on what the curve is and where we can buy the swaps going forward as we leg into it from diversifying the risk perspective, we would like to be able to lock in into the upper 3% to 4%, but it really sort of is dependent upon how fast rates move and where that longer end of the curve settles out in. So itâs a lofty goal. We are not saying we have locked that in yet. But thatâs what we would like to do if the market sort of allows us to do that over time with these derivatives. I mean⦠Yeah. I was going to say we feel great. I mean these are sort of unprecedented interest rate margins for us right now. We have not been at 4% in our history and so -- and we prepared for it, we have managed for it and we are enjoying that and we just would like to attempt to maintain it going forward through balance sheet positioning and derivatives, but itâs going to -- we are going to like into it. Keep that beach ball up in the air. I understand. And then maybe a follow-up -- just as a follow-up, could you maybe just expand upon, I think, you hinted earlier just market dislocation disruption, you are benefiting from that, where specifically you are seeing that maybe some hiring efforts and within that budget -- expense budget for 2023, do you kind of factor in some hiring from the disruption? Thank you. The answer is yes. We are continuing to benefit from disruption from competitors we have talked about on prior calls. Obviously, when relationship managers feel like they canât take care of their clients, we look like a good home. We will continue to pursue those opportunities as they arise, but itâs not a large team or a number you are going to see pop on the financials in a single dose. ⦠market disruption even from existing players that have disruption internally. So thatâs been part of our DNA since the beginning of Wintrust. Oh! Thanks, guys. Most of the questions around the margin have been answered, but it reminds me of Ed on that just says, it canât go broke by taking profits and it makes sense, you are going to willing to take a little off the upside table to protect the downside. So in essence, you are kind of manufacturing to some degree a revenue line, but when you think about revenue relative to expenses, letâs say, there is that kind of the downside scenario economically or Black Swan event. Is there anything in the net or the non-interest expense that you can cut abruptly or anything to that extent that you kind of match out the two? Well, on the non-interest expense side, we are kind of a growth company, so we donât plan to cut. But as Ed said, the big factor there is and we saw this in the past when rates dropped precipitously with the Black Swan event is that the mortgages kick in dramatically. We had a couple of quarters before rates went up, where we had record net income quarters and itâs because the mortgage business kicked in. So itâs really shifting the mix of the business from spread the business if that would happen dramatically to non-interest income business, which would be the mortgage side. So thatâs the biggest factor, I would say and itâs a business strategy. We think we need to be in the mortgage business, because we are not going to send our customers to some other financial institutions for mortgage. And if we think we are going to do it, we will do it with scale and then we will do it, because we always want to be asset sensitive and we have said this on other calls, the degree of asset sensitivity changes. But you always want to be asset sensitive, because if you do have inflation, then your expenses are going to go up and then how do you cover that increase in expenses and for a bank like us, itâs getting more in the margin. So you should always say asset sensitive to be able to cover the inflationary cost and thatâs the case in the mortgage business itâs a natural business hedge and so thatâs how we look at it. Got you. Okay. Thatâs helpful on the strategy. And then some of your say larger competitors have national deals are involved just other M&A activities themselves, which gives me -- gives you guys the opportunity to take this clients and share of the market space. Is there anything you are targeting specifically in terms of loan growth with that regard? I get that you guys are all encompassing bank, you do a lot of people, but knowing that your competitors are kind of involved with integration themselves outside of the Chicago land area. Is there anything that you guys are approaching for 2023 in terms of the strategy to be offensive? We always see opportunities. Larger banks always have various things that they are getting involved with, whether they are pulling out of a particular asset class or changes in some of their staffing or and those really, we have been the steady provider in all these different asset classes that we are in. So the line we use around here is that we donât jerk the wheel that we try to be very consistent in the way we underwrite, the way we price, the way we go to market. And as a result, we saw this back half of this year where certain banks were trying to change the way their balance sheets looked and we were able to take advantage of those. So our job is just to be very consistent, very steady and itâs just over the 30-plus years that Wintrust has been in existence. Thatâs really our -- been our model. It take what is available in the marketplace, then usually thatâs as a result of the bigger banks doing things like you referred to. For example, one of the large banks, they got the largest bank in Chicago, stated they are going to do safe deposit boxes. Thatâs an opportunity for us, because people still like safe deposit box, we got them, they donât cost much to run, we are now offering -- we are going to be offering free safe deposit advice for a period of time. We get new people in. Those things are like they mean a lot of people. Itâs a panic for them to change banks. But the big banks seem to step on it themselves and allow us the opportunity to work through that stuff and we have great products, as indicated by the Greenwich awards and the with some of the⦠J.D. Power award we won last three won, three of those, I guess, the last five -- four years or five years and people like what they hear. We are the mouth of suites [ph]. So we think that the play they keep opening the door for us, we are going to take advantage of it. Good. Good. I had a question on mortgage. I was curious, what was the production margin in the fourth quarter and has that bottomed in your view and outlook? Yeah. The production margin was hovering down closer to 1% in the fourth quarter. We expect in the first quarter here it 15% is sort of a reasonable range, which is clearly lower than normal. But you also have to understand the production is very low right now. As we showed in the slide deck, the originations for sale were just a little over $400 million, so actually, the majority of our revenue in the mortgage business now as the servicing income of roughly $11 million. So first quarter, we expect to be slow again, although applications are still coming in. Thereâs still purchase activity out there and a little bit of refinance activity, but over 80% of our -- of that $400 million is really purchase volume. But itâs competitive out there as people are just trying to get the volumes in, so itâs squeezing the production margins. So very small, but it has become such a small piece of the revenue stream given these higher rates and seasonality in the last couple of quarters. I think we are about as low as we are going to go as far as the production revenue. I think we will continue to at least have what we have now and as I said on my comments, I think, as we get into the second quarter and the buying season picks up and people get a little bit more used to the new level of mortgage rates and digest them, I think, we will start to see pickup in the second and the third quarters. Yeah. Yeah. I agree. I agree. Okay. And then on the deposit strategy, I saw a lot of deposits came out of saving came -- deposit growth came from savings in CDs. I was curious if you could provide details on your CD strategy as far as what prices you booked demand in the fourth quarter, and as far as terms, six months, three months, et cetera? Yeah. Rates are trending up particularly promotional rates toward 4%. Most clients are still not willing to go along. So you are seeing terms from nine months through, call it, two years, but most of it kind of around a year. And the alternative is there are, obviously, promotional money market and savings rates that are also available for people that donât want to lock into a term product. Yeah. And the other thing I think Iâd point you to is on table two of our earnings release, we do show the CD rates by maturity. So you can kind of see how they roll off. Most of them right now are plus or minus 2% on average and so, but the promotional rates are⦠Okay. And then for 2023, how confident are you in your ability to generate operating deposits and DDAs for this year? Do you think you are expecting very low growth from those categories and those interest-bearing accounts? Well, no, we are working awfully hard to continue to add clients and as we bring new clients on, they bring deposits that include their operating business. We have talked on prior calls about how nicely our treasury management business is performing, and so again, itâs lumpy as thereâs kind of large inflows and outflows, but we plan to continue to add clients and deposits. Thanks. Good morning. Most question, little housekeeping items. The -- on the expense side, I think, you alluded to a mid single-digit expectation for the full year. I think you are about 4% for 2022, which is pretty good in the inflationary environment. But what was the expectation again for 2023? Well, I was saying probably mid-to-high single digits to the middle of that range sort of just normally with an acquisition that probably gets to the high single digits for the full year. First quarter will probably be less, because the acquisition -- pending acquisition. If itâs in there, it will be the end of the first quarter or early second quarter, but so it wonât have much impact. And some of the increases are later in the year, as we talked in our comments, second quarter and the third quarter tend to be higher for certain expense categories, particularly sponsorships and marketing. And then salary cost, we do salary increase effective February 1st, so that will impact a little bit in the first quarter, but more so the second quarter. So, probably not a lot of growth in the first quarter, but as the year goes on for all those other reasons, probably mid-to-high single digits. But again we would expect that with the leverage and the growth in the balance sheet and the higher margin that will more than offset that expense growth. Right. I guess we could back into your comments on the efficiency ratio, still seeing improvement despite a reasonably higher expense run rate. So just to catch up on the margin again, did you have a December average for the month? Yeah. We donât really havenât disclosed that and we donât want to get in the position of doing that. I think what you can see is in the past. We told you we would be around 3.70% for the fourth quarter and we were, and I think, we are pretty confident in our guidance for the full quarter of the first quarter. So I think we will leave it at that. Okay. Fair enough. And then just the last one, on the tax rate, any expectation that thatâs going to change anywhere off of 27% -- 27%, 27.5%. Is that a reasonable assumption for 2023? Yeah. 26.5% to 27% is a reasonable assumption. It bounced around a little bit because of what we noted in the press release with a $2 million expense in the third quarter and $1.7 million of that reversing in the fourth quarter related to some minimum taxes with our Canadian stuff. But you take those out in 26.5% to 27% seems like a reasonable rate. Yeah. Thanks everybody for listening in. We -- our mask out here, yes, of course, and the rock rolls down the hill at the end of the year and we have to push it back up this year. We got everybody who got their shoulders in this will be a big rock, but we are going to make it. So if you have any other questions, please contact any of the speakers today and we will talk to you again pretty soon. So thank you.
|
EarningCall_1126
|
Ladies and gentlemen, thank you for standing by. My name is Lisa, and I'll be your conference operator today. At this time, I would like to welcome everyone to the CSX Corporation Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions] Before beginning, the Company would like to remind you that the forward-looking disclosures have been provided on slide 2, and non-GAAP disclosures are on slide 3. I would now like to turn the call over to CSX President and CEO, Joe Hinrichs. You may begin your call. Hello, everyone, and thank you for joining our conference call. I'm here with Kevin Boone, Jamie Boychuk, and Sean Pelkey, and we are excited to update you on our quarter results and share our initial views on the upcoming year. I first want to thank all our CSX employees for dedication as they work diligently on behalf of our customers through all the challenges and uncertainties that we faced in 2022. Because of their efforts, our network has continued to run safely and our financial performance has been very strong. We have accomplished a lot over the last four months since I joined the Company. This inventory my visits to our railroads out in the field, visit to our customers, our investors and our many partners in the government, we finalized agreements with our labor unions. We reached a positive solution for the Gulf Coast with our colleagues at Amtrak. And we started to make updates to the nuts and bolts policies on attendance and make a big difference for our employees' quality of life. I am particularly proud to report that our service metrics continue to show real improvement into the fourth quarter after starting a clear upward trend in the early fall. And we are very pleased this progress continued throughout this month. As we anticipated, our hiring successes have allowed us to deliver better customer service that will allow us to capture more business with more volume over time. Looking forward, we are focused on building on our momentum, leveraging our industry-leading operating model and growing this railroad. As we go through the details and answer your questions, I believe that you will get a great sense of the energy and optimism that we all share across the organization of the opportunities ahead for CSX. Now, let's turn to our presentation to review the highlights for the fourth quarter and the full year. CSX generated over $3.7 billion in revenue, up 9% from the previous year on 1.5 million carloads in the quarter. Revenues benefited from higher fuel surcharges, strong core pricing, and higher storage and other revenue. Operating income increased 7% year-over-year to $1.46 billion and our operating ratio was 60.9%. As we've reminded you before, our Quality Carriers trucking business adds roughly 250 basis points to our OR. Earnings per share increased 17% to $0.49. Quickly looking at the full year 2022, our revenues of nearly $15 billion were up almost 20% compared to 2021. Our full year operating income of $6 billion increased 8%. Excluding the gains from the 2021 real estate transaction with the Commonwealth of Virginia, our operating income grew in line with our guidance for double-digit growth. Operating ratio was 59.5% for 2022. Finally, earnings per share increased 16% in 2022 to $1.95. Merchandise revenue increased 7% in the quarter, as a 9% increase in revenue per unit more than offset a 2% decline in volume. For the full year, merchandise revenue increased 9% on 1% lower volume. 2022 merchandise growth was driven by higher fuel surcharge combined with an increasing pricing environment as inflation accelerated through the year. Looking forward to 2023, we have significant network momentum as we began the year, and we expect to leverage industry-leading service into growth opportunities with our customers. This is reflected in our recent customer surveys where we have seen a significant improvement in overall customer satisfaction scores. We see opportunity for solid volume growth in merchandise for the year, led by continued strength in automotive, our growing export plastics business and share gains as customers respond to our improving service. This growth is likely to be partially offset by weaker housing-related and domestic chemical shipments as we start the year. On slide 8, you can see fourth quarter coal revenue increase 20% on 9% higher volume and a 9% increase in revenue per unit. Full year revenue increased 36% on 1% lower volume and a 38% increase in revenue per unit. In 2023, we expect export coal volumes to grow in both, met and the thermal markets. So, we do expect benchmark indexes to decline from the elevated averages of 2022. We're optimistic about the potential positive demand impact of China's reopening. While on the supply side, we have a new 4 million ton met coal mine coming online this year. We also anticipate volume opportunity as we lap 2022 issues, including reduced production at some CSX-served mines and capacity limitations at the Curtis Bay and Mobile export terminals. We expect domestic volumes to be low -- be driven by low thermal stockpiles that remain below historical averages. Healthy inventory levels will allow utilities to better respond to natural gas volatility and more readily dispatch capacity to reduce stress on the U.S. power grid. U.S. steel production, which drives domestic coal consumption to benefit from a recovery in the automotive industry as well as higher infrastructure demand. Now turning to slide 9. Fourth quarter intermodal revenue increased 4% as a 9% increase in revenue per unit more than offset a 5% decline in volumes. For the full year, revenue increased 13% on flat volumes due to a 14% increase in revenue per unit. International intermodal markets continue to be negatively impacted by slowing activity, which looks likely to continue into the first half of 2023. Imports have declined and warehouses have seen elevated inventory levels. To help counter this, we are pursuing several initiatives to bring new solutions to our customers to help them reach new and existing markets. With our domestic intermodal business, we see opportunities even as the trucking market has softened. The team is focused on accelerating truck-to-rail conversions, and now with equipment constraints largely behind us, the team has more opportunity to pursue these initiatives. We are seeing existing customers and those that are new to intermodal adopt strategies to drive more of their transportation spend to rail. The team is doing a great job of identifying these opportunities and building the relationships to drive this growth. Finally, moving to slide 10. Let's discuss CSX's role in reducing our customers' emissions. As we pursue truck-to-rail conversions across the markets we serve, we are actively promoting rail's environmental advantages to our customers. We are increasingly looking for ways to reduce their own emissions. These are board level initiatives for our customers and the opportunity to choose rail over trucks provides real, measurable savings across the entire supply chain. In 2022, CSX customers avoided emitting 10 million tons of carbon dioxide by choosing to ship with CSX versus truck. To continue providing an emissions advantages for our customers, we need to keep innovating. We are not only piloting new technologies that should provide fuel savings like zero to zero, but we are exploring emerging technologies that can be implemented in the future and keep CSX at the forefront of delivering best-in-class efficiencies. Providing visibility to our customers is also a priority. I'm excited about the additional insights we will provide to customers to help them identify and convert incremental freight to rail by utilizing our updated carbon calculator platform that will launch in the first quarter. Lastly, we are proud of the recognition CSX has received for our sustainability efforts, with several of our awards listed on this slide. It is a priority for us to remain an industry leader in environmental stewardship, and we look forward to sharing more details on the several projects we have underway throughout the year. Safety remains our top priority at CSX and has been the foundation for our service restoration. As shown on this slide, our personal injury frequency index was flat from the third quarter and unchanged for the full year. The FRA train accident rate increased from the third quarter but improved versus the prior year. Most importantly, for the second year in a row, we ended the year without a life-changing event. These results were delivered with onboarding over 2,000 new conductors during the year and underscores the safety culture that runs deep within our ONE CSX workforce. Now hires learned the importance of operating safely in the classroom, but the most impactful lessons occur day in and day out on locomotives and in terminals working with more experienced employees. These daily interactions are reflected in our recent safety performance and emphasize the commitment to our operating safely at CSX. I would like to recognize the over 6,200 employees within CSX's engineering department, which set a record for the lowest number of train accidents in the department history. This is a true accomplishment, given the nature of their ballast-level work. In the year ahead, we will continue to instill the safety culture within our new hires, maintain that culture among our experienced employees and focus on the training and discipline we need to reduce human factor incidents. Moving to the next slide. You can see the success that our entire team has had in driving meaningful service improvement with a clear trend emerging around the middle of the third quarter as staffing levels at many of our locations reached key thresholds. Even with the temporary hit from the weather towards the end of the year, average velocity was up 11% sequentially in the fourth quarter, dwell was down 13%, and trip plan compliance improved by several percentage points for both intermodal and carload. This progress has not stopped as we crossed into 2023 with our service metrics continuing to trend towards pre-pandemic high water levels of late 2019 and early 2020. Our team is focused on improving network fluidity and delivering a consistent, reliable service that will encourage our customers to shift business onto our network, and the data shows that we are well on our way. Now turning to hiring. A robust training pipeline in over 350 conductor promotions over the fourth quarter allow the team to achieve our long-stated goal of 7,000 active T&E employees. Getting our resources to this level has driven the service momentum Joe discussed a few minutes ago. We will continue to support improved service into 2023. Going forward, we expect to stabilize active T&E headcount with targeted hiring continuing for key locations and to offset attrition. Looking at fourth quarter financial results, revenue increased 9% and operating income increased 7% to $1.5 billion as top line gain outpaced several expense headwinds that I will discuss in more detail on the next slide. Interest and other expense was $6 million favorable compared to the prior year and income tax expense increased by $15 million. The effective tax rate in the quarter was 21.9% as a result of favorable adjustments to deferred state taxes. Our expected tax rate going forward continues to be 24.5%. Fourth quarter net earnings increased 9% to $1 billion, while EPS grew 17%. Full year 2022 results were highlighted by top line growth of 19%. Operating income was up 8%, which includes a 4-point impact from the Virginia real estate transaction, resulting in 12% growth when adjusting for these gains. Let's now turn to the next slide and take a closer look at fourth quarter expense. Total fourth quarter expense increased $210 million compared to the prior year, driven primarily by higher fuel costs and inflation. Fuel expense was the most significant driver of $129 million due to higher prices. Labor and fringe expense increased $23 million as the impacts of additional headcount and wage inflation were partially offset by lower incentive compensation. PS&O increased $54 million, primarily due to higher operating support and terminal costs, which will remain somewhat elevated near term as operations continue to improve. PS&O inflation is also running around 5% and the quarter included about $10 million of expense from obsolete inventory and technology write-offs. Depreciation increased by $33 million in the quarter, which includes an ongoing quarterly impact of about $20 million related to the completion of a periodic equipment study. As a result of this study and a higher net asset base, full year depreciation expense will be up approximately $100 million in 2023. Equipment and rents was relatively flat versus the prior year and gains on property dispositions increased $31 million. While we are always looking for opportunities to leverage excess real estate, we'll likely have a few small gains. We aren't expecting any significant sales activity in 2023 at this point. Overall, congestion-related expenses were slightly above $30 million in the fourth quarter, and part of that cost was incurred during winter storms at the end of the period. Despite elevated inflation and increased headcount, we expect to deliver strong cost efficiency throughout 2023, as better fluidity reduces terminal costs, overtime pay and other expenses. Now turning to cash flow on slide 18. Full year free cash flow of $3.7 billion decreased $100 million but was approximately $100 million above prior year results adjusting for the Virginia transaction. Operating cash flow increased over $500 million on higher earnings, more than offsetting approximately $350 million of additional capital spend from our continued focus on both, investing for the long-term reliability of our network, as well as identifying and executing high-return strategic projects. After fully funding capital needs, we returned nearly $5.6 billion to shareholders in 2022, including over $4.7 billion of share repurchases and $850 million in dividends. We exited the year with a strong balance sheet and liquidity position, including $2.1 billion of cash and short-term investments. Looking forward, we remain committed to a balanced and opportunistic approach to returning excess cash to shareholders. Thank you, Sean. Before we discuss our outlook, I want to briefly touch on a couple of key ideas that we think about the ONE CSX concept and how it fits together with the fundamentals of scale railroading [ph] at the core of this company. This past year has seen a lot of commentary from many different parties about what scale railroading is and how it's supposed to work. For us, it really is quite simple operating philosophy based on the 5 principles that you see across the top of slide 20. The key, just as it is with the railroad network, is to keep everything in balance, optimize your assets and ensure you show respect for your employees; be disciplined in cost control; and maintain your client to good service. If you can't service your customers well and reliably, all the cost control in the world won't deliver a healthy growing business. CSX has been tremendously successful over the last several years as the Company has undergone its transformation. In my view, we've done particularly well across the first three of these scale railroading principles. The opportunity for us now is to focus on getting to even better balance with those last two. We will redouble our efforts in serving our customers and ensuring that our employees, the people who are delivering that service to our customers, feel valued, appreciated and included. To address this and bring out the best of this operating model can deliver, we are building a ONE CSX culture that prioritizes our relationships and leverages our common goals. Whether you are an employee, a customer or a shareholder, you want a strong and thriving CSX. A healthy culture leverages that alignment to do better together. Under each heading, you will see a couple of the ways we have brought these principles to life over the last year. At the bottom, we give examples of what we aim to do. As an example, for customer service, we have added the T&E resources we have needed to increase capacity, and we have built resilient momentum as our service measures have improved. Now looking forward, it is critical that we ensure that our service metrics reflect our customer experience and that we are measuring and evaluating ourselves in the right way. We also know that we have to improve the way that we interface with our customers and make it easier to do business with us if we are going to win market share from trucks. Every week, we get together as a leadership team. We are challenging ourselves to find new ways to address these issues and take advantage of the great energy that we are creating here at CSX. We have tremendous talent here. And with these principles at our road map, we have a clear, collective goal. Now, let's conclude with a review of our outlook for '23 as shown on slide 21. First, as our service levels keep improving, we expect to achieve overall volume growth for the year, which will outpace real GDP growth, driven largely by strong contributions from merchandise and coal, as Kevin discussed. That said, we do believe that international intermodal volume is likely to be soft, particularly over the first half of the year, as imports have slowed and retailer inventory levels have recovered. Next, the pricing environment remains favorable for us. Our customers have experienced substantial inflation and understand that we face our own cost pressures, including the effects of the recent labor agreements. This transparency has helped us as we renew our pricing agreements, which will support our top line performance. That said, there are a couple of important things to note for 2023. First, we do expect revenues from intermodal storage to decline through the year as supply chain conditions improve. We currently believe it is reasonable to expect we will see a reduction of approximately $300 million in intermodal storage revenue compared to last year, which would imply a quarterly average close to levels seen in early 2021. Second, international met coal benchmarks have recovered from their lows of last fall, but remained volatile. High quality Australia met coal averaged roughly $355 in 2022 and sits at $315 today. It is likely that the average this year will be lower year-over-year, which will impact our coal RPU and our total revenue. Now regarding profitability, we will face cost pressures in 2023, but we know that we can get better operationally. Where it is possible and where it makes sense, we will make every effort to realize efficiency gains and reduce some of the extra costs that we have been carrying to manage through the congestion and resource constraints of that post-pandemic period. In the end, our margin performance will largely depend on our success in driving more volume through our network and realizing potential operating leverage. Finally, we estimate that our capital expenditures will increase to approximately $2.3 billion, driven by a full year of spending for Pan Am, additional equipment for Quality Carriers truck to rail conversion opportunities, investing in strategic high-return growth projects and the effects of inflation. Now, before we close, I want to emphasize what an exciting time it is for all of us to be a part of the ONE CSX team. We have a common goal to profitably grow this railroad, and you are seeing the real progress that we are making toward that goal as we put people and resources into place. I am personally very optimistic about the opportunities ahead, and I look forward to updating you on the achievements throughout the year. Thanks, operator. Hi, everyone. I wanted to ask about yields kind of on a consolidated basis for this year. Obviously, the supplemental revenue and fuel will be somewhat of a headwind. I guess, standing here today, would it be fair to say kind of yield be flattish on a net basis? And Sean, I guess, if revenue is kind of flat, can you just remind us of kind of the costs that are in the system that you think can be reversed to maybe offset some of the cost inflation? Thank you. Amit, this is Sean. Yes. So, in terms of the yields, I think Joe sort of laid out our expectation on the coal side, perhaps a little bit lower just looking at the comparison versus some of the record levels last year, fuel potentially a little bit of a headwind on a yield basis as well. We'll have a little bit of positive mix, at least in the first half here with the pressures on intermodal, specifically relative to the growth that we expect in merchandising coal. So, that's the yield story. And then, in terms of the costs, I think there's a number of different categories. Certainly, with the intermodal terminals becoming more fluid as some of that traffic moves its way out of the system and start spinning again. We should see some costs come down and the terminals are in very good shape right now. We should see reduction in freight car rents as our cycle times improve and they have already, things like overtime and ancillary costs related to the crews getting hung up last year with delays in service and then locomotive maintenance as we're able to spend the assets faster here. So, those are a few categories where I would say we ought to expect some improvement this year. Sean, any numbers around that, though? I mean, in terms of -- I know you've talked about $40 million a quarter, but any sort of quantification around some of those efficiencies -- inefficiencies? No specific number, no. I mean, we're going to have inflation headwinds, right? I think, probably in the 4% to 5% range. And our goal is going to be to offset as much of that as we can, both through taking out some of those extra costs that we carried last year as well as continuing to find efficiency gains across the business. There are a lot of moving pieces this year in the outlook. So, I was just curious if you could give us any directional color on the year-over-year change you're anticipating for both revenue and operating income? And maybe you could comment on what that trend line could look like throughout the year, if things are going to get better or worse? Would just love some additional thoughts. Yes. Justin, we're not going to get specific in terms of the guidance itself. When you look at first half, second half, the volume comps on coal are a little bit tougher in the second half than in the first half. In terms of intermodal, Kevin talked a little bit about some of the headwinds we're seeing on the international side here in the first half of the year. Those are really sort of the big drivers on the volume side. And then, in terms of other revenue, that coming down about $300 million for the year, obviously, second half of 2022 was higher than first half of 2022. So we'll be facing sort of a bigger headwind there. And in terms of overall operating income, I think we've laid out some of the factors, right? I think we feel great about our ability to recapture some of the share that we missed in 2022, given where the service product is, given that we've got the headcount that we need and we've got the assets that we need, which is why we're going to grow above GDP. We're going to see gains in merchandise and in coal. We've got a strong price environment. We've got the cost opportunities that I've talked about. And on the flip side of that, we have a few headwinds between the supplemental revenue, the other revenue piece, higher depreciation and probably lower real estate gains. So, those are the factors. But that being said, I think the fact that we are expecting growth. And as we add that growth to the system, we're going to add it at strong incremental margins. So, I guess, maybe piggybacking off that answer there, Joe. And I know you've only been there a couple of quarters now, but we've heard for a year plus that the real limitation here was headcount, resources and more importantly, service levels that you're delivering. I mean we're seeing that come through the data, I think, pretty strongly in the fourth quarter and as we start out here in January. So, can you talk to how you're going to convert that. And Kevin and Jamie, maybe how closely are your teams working together to ensure that you're growing in the right places? Because I think in the past, we've seen growth that can come in the wrong places and lead to even more op challenges for the other carriers. Yes. Thanks, Brandon. I think -- this is Joe. First off, thanks for recognizing the pretty significant service improvements and operating performance that we're seeing continuing into January. Our team works great together. So for what it's worth, and clearly, Jamie and Kevin, their offices are next to each other, and they're talking all day long. I'll let them talk more about that. But you referenced the fact that there's been some conversation for quite some time that our challenges were manpower levels and then how that affected the fluidity of the network, we're seeing, as you just referenced, the performance that comes from game of manpower levels where we want them to be and running this network the way it was run prior to the pandemic, which is a very strong operating team. So, the conversion opportunity is to demonstrate some repeatability and predictability around our performance and to show our customers that we now only have -- we have the capacity in place and we have the performance to demonstrate that you should come back to us. And I'm feeling optimistic about that. And the conversations we're having with customers, they're recognizing the improvements that we've shown for the last several months. And they're also confident in our ability to continue that, especially now that we have the manpower levels where we want them to be. So, if you look at it, we're still not meeting all the demand thatâs out there for carloads and our business -- for our business. And as we go through the year, we'll look for every opportunity to do that. I'll let Kevin talk more about some of the opportunities in the markets themselves. And then I'll let Jamie talk about the operations. Thanks. Yes. Brandon, you did mention obviously, the remarkable improvement in our service that we've seen, and it's a real change, and there's a lot of excitement around this organization about it and what we can do going forward. Joe has brought both, Jamie and I and his teams together to talk about some of the key markets. And there's been a lot of interesting ideas that have come out of that where we can really leverage what we can do service-wise and what we can do creatively to create those opportunities for us. And those things are the fun part of what we do every day, and we're doing a lot less of that and a lot less of customer service and a lot more coming up with new ideas and having those discussions with our customers about growing. I'll tell you, I've had a chance to meet with a lot of customers over the last month or two. And every time, probably 90% of those conversations, we walk out with a lot more opportunities to pursue. Sometimes it means that we have to think differently. We have to introduce customers to what the intermodal product is or what we're capable of. And what we're capable of today is much different, obviously, than what we were capable of a year ago. And so, the team is getting together the whole sales and marketing organization. Jamie is going to spend time with them. I was going to spend time with them next week and it's off to the races. It's up to us to find those opportunities and really pursue them. But I'll hand it over to Jamie to talk about the upside. I think really, the only thing I can add to that is there's a lot of capacity out there. So what Kevin and I talk about is where is that capacity, what can we do with that capacity, and how do we get out there and sell it. My team is out in the field, ensuring that they are talking with customers more than they ever have because they have time to do that. Previously, we were trying to find a crew to run a train here or there or wherever else. Now they have the time to sit back and deal with any of those customer demands that might be out there that helps Kevin and his team grow. Some of those discussions we have are what does the customer really looking for? Is it the right metrics that we're looking at that the customers are looking for and that first mile, last mile improvement that the team has been able to put together is really record-breaking for us. If I look back at the last 6 years, we haven't -- '22, unfortunately, wasn't the best year for us, but exiting '22 with our customer service and in '23 are some of the world record numbers we just haven't seen. So, our job is to keep producing those numbers and making sure Kevin and the team has what they need to get out there and sell and commit to the customers that -- what you see out there is what you're going to continue to see. So some great collaboration between our two groups. So I guess, thinking about the outlook and the optimism around growing merchandise and coal and good incremental margins with that coming on sort of compared, contrasted against some of these what are perceived to be very high-margin sort of revenue headwinds that you have, whether it be the accessorials coming down $300 million or the coal -- export coal yields coming down. When you think about those two relative to each other and the potential for cost out, I guess, any help in terms of how to think about operating ratio or the outcome of that whether it be maybe first half versus second half or across the whole year would be helpful. Just I think that perception of high margin on those headwind pieces is something that we're struggling with a little bit. Yes, Chris. So, on the -- obviously, the coal yields, there's no cost associated with that on the accessorials. There are costs associated with congestion in the terminals as well as needing to rent out space at container yards to move those containers around. So, that's part of the, call it, $150 million or so of additional costs that we carried over the course of this year. So, some of that will adjust down. And then, as we grow the business, our confidence is in the fact that we can grow it at very strong incrementals. And so, you put those together, and I think the question around what happens to the OR really depends on how much growth can we convert. We talked last year about the fact that there was demand out there that we weren't able to meet because we didn't have the crews that we needed in the right places. We've got those crews now. So, there's a real opportunity in front of us. So, maybe I'll try it this way. How much volume growth do you think you need to be able to grow earnings this year? And then, it sounds like there's going to be some OR pressure this year. You've got some headwinds. I think that's understood. I guess, Joe, I guess, I want to understand, what's your commitment to longer-term OR improvement kind of beyond 2023, just thinking out the next several years. Yes. Scott, on your question about how much growth, I don't think we're in a position to answer that one right now that you kind of run it through the model, but I think we've given you enough of the factors. And I think the fact that we sort of pointed to coal and merchandise as areas where we think we can sort of meaningfully outperform whatever the economic indicators that are out there is a reflection of the fact that we feel good about where we are from a capacity and service standpoint and the ability to sell into that market. But, we're not going to give you a specific number there. This is Joe. On the OR question, Scott, I think there's a couple of points here. I'm very confident that our team will continue to deliver on the denominator side, operating improvements and continue to show strong operating results. On the numerator side of the equation, you're right in the sense that there have been -- there were some things that were strong tailwinds last year, the fuel surcharge, intermodal storage, the coal price, et cetera, and we'll see how much of that repeats in 2023. But that certainly helped the numerator side of OR last year and maybe some of those things won't be quite as strong in 2023. But having said that, on the numerator side, the volume growth opportunity that we can now go after with the confidence that we have in our operating model and our performance and knowing that for our customers who are feeling cost pressures and feeling inflation pressures and potentially even feeling effects of a slowing economy are going to be looking for cost reduction opportunities. And so, we feel very, very strongly that this year and beyond, continue to demonstrate the capacity that we have in our performance, the growth opportunity will be there for us as we earn the right to do that and get that business. And our customers will be wanting to do more business with us. In addition, of course, we have the environmental advantage of ESGs and emissions when it comes to rail. So, all that being said is we're not going to put a target out there for OR. We're very proud of our performance. I mean, last year, with Quality Carriers, we still had an operating ratio for the year under 60, so we know what it's like to -- and that was not at our optimum performance level as we all admit. So, we believe there is a strong performance inside of this company that will continue to be delivered. The uncertainty is around some of those revenue pieces in this year and beyond. So, our challenge is to deliver real growth in the business, which does deliver strong incremental margins and continue to control our costs, utilize our assets well. And so, that should lead to very strong performance within an operating band of OR that we'll be comfortable with. At the end of the day, this company is very focused on delivering margins, delivering growth with -- profitable growth with margin improvement, which should lead over time to a good OR. Kevin, as we watch these service metrics improved significantly since really the middle part of last year, and this intermodal trip plan performance just consistently around 90 and industry best standards. It's a little confusing that even given the headwinds, maybe your intermodal volumes are running lighter on a year-over-year basis than most of the other Class 1s. Can you help us explain any disconnect between those improving metrics and some of those intermodal shortfalls that may be unique to you? And maybe that also ties in then to explaining a bit more on some of the strategic opportunities that you noted in your prepared remarks? Yes. I think when you look at -- and look, three years -- or three weeks doesn't make a year, so we've got a lot of work to do as a team. But we -- I think you'll see over the last two years and through the pandemic that we really outperformed the industry and a lot of that growth that we mentioned before came on the international side. And we don't pay -- we don't spend a lot of time thinking about the other Class 1 railroads, but I do believe we probably have a little bit higher percentage of our businesses, obviously, exposed to that international market where we've had a great, great success, and we see a long-term outlook that's very positive for us. So, I think that's probably contributing to some of the things we're seeing here recently. But we've obviously had great performance and continue to think we'll win share in the market. The team has got a number of initiatives that will take form later on in the year and that will drive incremental business to the railroad. So excited of what we can do in the quarters ahead. I just had a clarification for you first, before the question. I don't know if I caught what your GDP assumption is or which forecast you're referring to just in terms of how we anchor to the volume comment? And then, Joe, I wanted to see if you could offer some more thoughts about your comments on relationships? And I think tying into labor, how do you think about how you want that relationship to change? Does that cost you something to do that? And what's the benefit over time? Is it just pay attritions running 15% a year, we wanted to get down to 5%, and that saves us sort of help service. Just some broader thoughts on when you talk about relationships and labor, what do you mean by that? And how do you think about what that does over time? Tom, on your GDP question, roughly 0.5% growth is the GDP number that we're looking at. And so our guidance is to grow in total above that with intermodal headwinds and solid growth across the other markets? Yes. Tom, this is Joe. Thanks for the question regarding labor. So lots of thoughts here, but I'll try to be concise. First, just a reminder to everybody that this is a service business. And we provide our service to our customers. We move their goods from point A to point B, and we're proud of the way we do that. But remember that in the service industry and service business, it's all about the employees. You're not selling a product, you're not developing a product. You're really relying on your employees to represent your company in the service of your customers. I started there because that's so critically important to understand why it's so critical to have a really strong relationship with your employees, including those represented by unions because they are the individuals doing the work, providing -- moving goods from Point A to Point B and serving our customers. And so, the motive here isn't to try and leverage relationships to try and decrease costs or find a dollar here and there. It's all about building a culture where our employees feel valued and appreciated, included in the service of our customers in a way that we can demonstrate that CSX is unique and different from the other options they have, and provides a value proposition to our customers that we think can be very, very special. And so, there's a lot of -- I've been spending a lot of time out in the field, Jamie and I travel almost every week. And as I've learned a lot about this industry, about this business, there's a lot of variability and a lot of independence when it comes to the work that's done now in the field, because this is not a factory assembly line where you're stationed in a certain position and you've got a cycle time to meet, and if you don't make it, all bells and whistles go off. When you have your employees motivated, engaged and feeling valued, their efforts to support what your initiatives are, are greatly enhanced. And that's just human nature, and that's really what's important about this relationship is that listening to our employees, resolving their issues, working on things that improve their efficiency and their work life balance and their work life experience and safety and other things, leads to a better service product for our customers, which ultimately leads to a better business for everyone, including our employees. From the labor side, it's really about building relationships and generating trust and getting to the point where you're going to have real dialogue around solutions and around ideas and around understanding each other's desires and perspective so that we can find the best solutions. I have found in my past experiences that when you get to that point, you have a healthier business and you have happier, safer employees who are working better together to serve the customers. That's really the desire here is to provide that kind of opportunity for our employees. Now, what comes with that? Lower attrition, better recommendations for the referrals, for new hires and in the family and friend network, and just a better experience for everybody. So that's really a big part of the ONE CSX culture initiative is all around building this team, working all together and labor is a big part of that. And so, it's a little more complicated in the rail industry with 12 different unions. However, we feel really good about where we are with our team, Jamie and his team are working every day, having lots of good discussions. We voluntarily on our own, changed our attendance policy based on feedback. That's really impactful to our employees. That's a great first step in this relationship. We're listening to them every day. We're working on problem solving, and ultimately, with the purpose in mind of creating that environment where employees want to be a part of that and want to serve our customers better. And with that comes a much more efficient operation and, frankly, better service for our customers, which ultimately leads to opportunity for growth. Hey. Good afternoon. And thanks for the rundown there, Joe. Just maybe can we clarify? Sean, I guess you're looking for volume growth offset by accessorial and cold yield declines, efficiency gains with service costs gone, but inflation up. But I just want to clarify, you're not specifically committing to income or operating improvement for the year, right? There was no outlook on what that means for that or the EPS line? And then Jamie, the on-time originations fell to 54%. I think they've fallen now 12 of the past 13 quarters. Isn't the whole name of the game of what you're doing with precision railroading to leave on time and get that moving? Maybe talk to me about what the network needs to do to fix that? And Joe, I don't know if you've come in what your thoughts are on operations, what balance of operations versus top line growth. Okay. And you're right. The last couple of years, really, we've seen our on-time originations drop. And that's been -- it's been consistent, unfortunately, because of the manpower situation we've been in. I'm happy to say, over the past three weeks into this year, we started to get back up to our record highs. The team is hitting up over 85% on-time, which is great. It starts to get us balanced. And as we continue to onboard some more folks, we'll continue to get that driven up to that record of, I think, in 2019, where we're up around 89%, 90% on-time origination. And that's what we're shooting for. So, it is important. It's an important metric we'll watch. We made some decisions last year to back off a little bit on that, so we could connect as much traffic as we could and not leave things behind when we did have a crew and make sure we took advantage of that crew, and we maximized what we could on those train starts. Not saying that we're letting that go at all. We're going to maximize what's on each one of these trains that we run out there car-wise, but we've now got the people to balance the assets across the network, and you can see it. If you take a look at our velocity, and you take a look at our dwell numbers just in the past 3, 4 weeks, you can see that the network is running much more fluid. We hit that magic number just into the new year that we're looking for that 7,000 T&E count. And actually, as a matter of fact, we're at 7,100 today. And we're going to push that number a little bit more to cover vacation coming up in the next few months. So, we're going to make sure that we've got the right headcount. We're going to make sure that we've got the right people in the right places, and we continue to drive those metrics that will drive the rest of the service metrics. I mean, again, TPC, whether it's carload, intermodal, all the rest of it that you see that we've put out there, we're starting to get back to our -- as a matter of fact, we're beyond our record numbers on some of those service metrics. So, we're going to provide a product that Kevin and his team can go out there and sell and start growing this company. Yes. So Ken, thanks for the question. A couple of just additional comments. We spend a lot of time as a team talking about our customer service metrics, whether it's on-time, originations and arrivals, whether it's in the last mile, first mile, those kind of things. And I'm really pleased with how the team is looking at everything. And we want to make sure that we're seeing the world through the lens -- through the eyes of our customers, which is why we get feedback on surveys. And Kevin referenced, we've seen the best results in our customer surveys that we've seen in quite some time. So, I feel really good about that. Now, the balance between top line growth and operations, I think they're intertwined. And I said this in October. I feel even more strongly about it now. We have a phenomenal opportunity here at CSX to leverage our strength in our operational performance that you've seen pre-pandemic. You're seeing now again to earn the right to talk to our customers about getting more business. And that is a lot better than chasing top line growth, and to be able to demonstrate that you can rely on us with our capacity and our service levels and our prioritization on your service to be there for you. And I believe very strongly, there's business opportunity there. So, we can allow that to happen naturally organically because we have a better product. We have a lower price than most trucking. And we have a better ESG solution and to do that the right way. So that's why we've been so focused on getting the manpower where it needs to be and really getting -- making sure that we're focusing on the right metrics for the business, and I'm really pleased with where we are. So, I feel even more strongly today than I did in the call in October about this opportunity. We can't predict what's going to happen in the economy this year, and that's part of what you're seeing in some of this dialogue is we're not exactly sure what happens in the second and third quarter. We're very pleased with how the year has started. However, we don't know exactly where the economy is going to go, given rising interest rates and some of the other things that are going on. Actually, you could say that in the data that we've been seeing that some parts of the economy started slowing down really in October-November. And we just didn't see it in our business because we couldn't meet some of that demand back then. But we feel really good about where we are. We're not going to chase top line growth. We're continuing to leverage our operating model, but we believe it's there to be earned, and that's the conversation we're having with our customers. Maybe just on that last part about unmet demand. We heard that a lot across the different Class I rail conference calls. And is there a way, since you're counting on it and you're seeing some of it through surveys and clearly, the service has improved. Is there a way you can sort of try to quantify that for us in terms of what you lost or what you think is coming back with fill rates or anything else you can put around there in terms of a metric? And what gives you that confidence that you can count on that coming back, not just the interest level is there, especially when you have a softer macro and probably contract truckloads heading lower as well? Yes, Brian. Hey, it's Kevin. I think Joe actually touched on this really, really well. And I think what's probably a little bit underappreciated what's happened in some of the things that we've seen in some of the major markets that we serve today is -- and I had referenced this previously on other earnings calls, we were in that 60%, 70% type of order fill rates pretty much through most of 2022. What happened starting in, let's call it, the late third quarter, fourth quarter in some of these markets, we saw those orders come down. And obviously, our fill rates kind of remained -- or on mix or whatever our volumes that we're serving for those customers remained relatively flat. And so, we saw our fill rates start to increase, and they're at higher levels now and the markets we see maybe the demand, what they're requesting is down 30%, yet our volumes are slightly down today. What my expectation is and what we're starting to see is that they've already overshot what they saw what would be a normal demand environment, and we're seeing order flows start to increase. And so, that's encouraging that it feels like in some of these markets, we've established the bottom. Anything can happen in the economy, but it feels that way as of right now, and we'll see how it plays out. But a point on that is as those orders come back and as we're able to meet that demand going forward, that would imply growth versus last year. And so, that's embedded in what some of the guidance that we provided today and why we have a confidence around accelerating or beating that GDP number is that we're going to go and capture those orders and those demand that the customer has out there this year with the replenished workforce and all the things that the operations team is doing. And would you expect that to be more heavily weighted on the merchandise side because that probably was a carload before, or are you seeing real momentum on truckload conversion, maybe more on the intermodal side? Yes. I think you'll see it really start on the carload side. That's where we -- when I referenced the order fill rates, that's really carload specific. You'll remember on the intermodal side, it really was an equipment issue. Good thing is those equipment issues, whether it's chassis, containers, I think we have plenty of those in most locations now throughout that market. And you've heard different commentary around that, but there is some softness in the truck market today. There is some optimism, hopefully, as we get into the back half of the year that that will firm up a bit, and we have every intention of taking advantage of that market as it comes to us. We have the premier service in intermodal and it's been reflected in our growth over the last couple of years, and we continue to expect to capitalize on that. So, I wanted to stay on that topic. You mentioned some softness maybe in the trucking market. I wanted to ask to what extent that's an impediment to intermodal volume growth. And then, in a more normalized environment, how do you think about CSX's ability to kind of outgrow GDP or maybe something around kind of the magnitude at which you could outgrow GDP versus this kind of loose truck market? Yes. The truck market is obviously -- centers around our intermodal product. That's where we go direct with truck, not that we don't compete on our carload business as well, but that's where you see the sensitivity sometimes. In international market, as everybody is aware of, has been weak, and we've got -- we've had great growth there, and we have a great market that we continue to expect to grow over time. But, as I mentioned in my recent comments -- opening comments that that market probably will be down somewhat double digits in the first half of the year. And hopefully, as the economy stabilizes and there's some green shoots out there that we'll see some better growth into the second half of the year, at least, not the decreases that we're experiencing today. I think, every bit of intention here is across our portfolio that we're going to outgrow the macro economy. And I think there's a lot of things at tailwinds at our back. But we've had a huge success rate on our industrial development side. We have a lot of new projects that are coming online when you look out beyond this year. Big, big backlog, probably the largest backlog that anybody here can remember in a long time whether it's new auto plants, metals plants, all those across the board, we've really had a good success rate there, and that will give us growth going forward. So, our intention is to outgrow the economy. And I know that's not something that the railroads have been able to do. But I think there's -- with the service product that we're going to have, I think that's really, really possible going forward. Thanks for that Kevin. And then just really quickly on some of those projects, any thoughts on kind of what the incremental margins could look like around that? I think -- I don't know a business that we're bringing on where the incremental margins aren't very attractive and are in a very good rate of return for us. I put my finance hat on every time I look at the business, and we're not going to chase unprofitable business just to show top line growth. Maybe first on those two boxes and the guiding principles, and Joe, you highlighted improving customer service and developing the employees. And especially with respect to some of the conversation maybe you're having with customers, do you feel that there's going to be a lag between when you start demonstrating the success on the service side and really penetrating that share of wallet with these customers, or do you think there is really a quick potential turnaround between kind of making those improvements anytime, that market share improvement? And second, maybe a follow-up on the this conversation with Kevin, now like looking over into 2024 to 2025 and assuming we're back into a normalized GDP, given the backlog that you have and given some of these initiatives and the investments you've made in QC and Pan Am. Outside of coal, is there a reason why you can't grow volume mid-single digits as we get into this more normalized environment? Ex coal, obviously. I'll take -- this is Joe. I'll take the first part and ask Kevin to take the second since you directed at him. From my perspective, the opportunity here to grow the business really comes from increasing that service product. Now, your question around the timing of that, it's all really individually dependent on each customer, where they are, where their cost pressures, where their capacity issues and what are they looking for. So, we can't use a blanket statement that if we demonstrate these levels of performance for three months, the next comes from it. Really in our conversation with our customers, itâs really around their confidence in our ability to be repeatable and reliable. And so the answer to that question is different for each customer. But I can tell you, they're all watching and they're all noticing and they're all letting us to know that they're really appreciating the progress that we're making. So, it will play out over time. But there's nothing inconsistent that we're hearing from our customers about their appreciation for it and recognizing how important it is. Kevin? Yes. I think the question was, is there a reason why we can't grow mid-single digits. I think Jamie answered the question on the network side, we have a lot of capacity to grow into and it's -- we're going to use that capacity and go after wallet share with our existing customers and identify new customers. So, there's no constraints from that perspective. Obviously, that putting up mid-single digits volume and then with price is a pretty attractive algorithm, we'll see what we can do and what the market conditions are at the time. It's a more normalized GDP growth rate, 3% or 4%, then that's different than maybe 1% to 2%. So, we'll see how things materialize as we get out of '23, and '24, '25. The great thing is we have some tailwinds from new customers that will be on our railroad, and that will give growth above the economy, hopefully, that will add to that algorithm over time as we build the funnel of all the projects that we've been able to develop and that will be coming on line in the future. Two quick ones here. First, you've said you can grow GDP plus. Many of your peers are using industrial production as a benchmark. In fact, I think one of them has come out and said a couple of years ago that they don't think they can grow faster than GDP going forward, and they think they can try and outpace industrial production instead. So, a, do you think GDP is the right benchmark for you and kind of what gives you the ability and confidence to think that you can grow fast than GDP in the long run? And just as a quick follow-up. I think you had said that incentive comp was a tailwind to numbers in '22. How do we think about incentive comp in '23? Thank you. Yes. Ravi, this is Sean. So on your GDP plus comment, look, I think if you look historically and you run the correlations, our business tends to move more closely with the underlying IDP indicators, particularly across the merchandise segment, maybe a little more on GDP in intermodal. But you look at this year specifically, the projection for IDP is a decline and the projection for GDP is growth, and we think we can grow the business. So, it made a lot of sense this year to peg it off of GDP. On your question on incentive comp, I mean, the year has to play itself out. We always go into the year planning to hit the targets that we set internally. And so, on that basis, incentive comp would be down a little bit year-over-year versus 2022, but we'll see how that plays out as the year continues. A question on labor for me. Some of your peers have talked about taking a different approach to furloughs going forward, just given that labor has become more scarce and valuable. So, I was hoping you could offer some thoughts on how you would approach headcount in the event that freight demand surprises to the downside, so that you don't lose the investments you've made in hiring and training this year? Well, Cherilyn, thanks for the question. We've got the same stance as we did last quarter. Our T&E workforce is not a workforce that we would look at furloughing as we move forward. We're future -- we're looking into the future, really important that we -- Kevin and I obviously are -- as we stated here today, work really close together to see not only what's happening today, but what's happening in six months from now, what's happening a year from now. We know that there's customers coming on. And you're absolutely right. The conductors and filling those positions takes a long time. It can take up to six months to fill a conductor's position. And we can pull the trigger. Look, if there's a downturn in business, we can use the attrition that's there, which is up to 10%. So, it's easy for us to hold back classes if we need to, to bring those numbers down and rightsize it if we need to. But as we continue to move forward, we're looking at continuing to build our numbers up so we can get to a point where we can cover vacation time and making sure that our employees get the time off that at times they've struggled over the last couple of years. So, we're very close to that number, as you can see from our results that we're quite happy that we're moving in the right direction with our service. And it's a commitment that we've made that we're going to continue to be looking forward and not doing any knee-jerk reactions and pull that trigger with respect to attrition if required. Joe, last time you spoke with us on the October call, you had a few days on the job, that's a few months now. Can you talk a little bit about when you'll be able to -- or I think you'll be able to roll out your strategy to the Board and investors? And any events like an Investor Day, other format around that as you look forward to kind of getting to where you want to be to really kind of put your stamp on the business? Thank you. Yes. Thanks for the question. Just first, from a philosophy standpoint, this is a really talented team. And so, we -- we're doing all this together as a leadership team. We get together every Monday, we talk about the business, go through all elements of it. And so I want to just emphasize that. I'm one piece of that team, but this is a team effort. I'm really proud of the -- to get to work with every day. It has been 4, 5 months since -- role -- fast together. But 20-some visits out in the field and all the other discussions with all customers and regulators and everything else. I feel like I'm learning very quickly, but there's still a long way to go on that learning curve as far as the core business. I'm really excited about the emphasis we have on the customer, and I'm really proud of the progress the team has made on the operating side. All that to say, I'm not sure that -- I'm not sure it makes sense to have an Investor Day just to have an Investor Day. We want to do that when we really have some meaningful things to talk about from strategy or technology or some other things. So, we trust that we'll do that at the right time when it can be meaningful and not just something we put on the calendar every year just to do. We want it to be impactful. We know it takes everyone's time and we want it to be important. As far as the strategy and discussion with the Board, I hinted this a little bit in October, but I spent a lot of time with the Board as individuals and collectively in consideration of doing this in their consideration of me. So, we had a lot of good conversation over multiple months about the opportunity here and where to put the emphasis and where to really take advantage of the strengths that exist here. And so, I feel really, really good about the alignment we have with our Board, with our team here and the work we're doing. And I'm very pleased with the progress we've made on ONE CSX in just four months' time or so. You can feel the momentum on the culture side, you can feel the momentum on what that means for how employees are working together and then the resultant effects on our service. So, I don't feel compelled to come out with some major strategy just because to put my fingerprints on it in some short time period. I think the key thing is, we have a talented team here, we have a strong operating model, we have a good business. I mean we made $6 billion on less than $15 billion of revenue last year, and we didn't perform our best last year. So, we're now starting to demonstrate those performance levels that we showed pre-pandemic levels. So, that's a long way of saying that I'm very optimistic about the business and excited about it. And you'll see incremental ideas, initiatives come out, but we really have a strong foundation. And really executing off of that foundation and leveraging the strengths we have is our biggest near-term opportunity, as you've heard the team talk about tonight. So, just trust that when we're ready to have some more meaningful dialogue on some new initiatives and whatnot, then we'll have the right forum to do that. In the near term, you'll continue to see us on a weekly, monthly basis, talking about the things we're doing and demonstrating where our priorities are. And that's really around, as we've said many times, improving our customers' experience with us and our service we deliver to them. And the experience our employees have as team members of ours as part of ONE CSX and just getting the most out of working together to make that happen. So, those points won't change over time, but how we use technology, how we use our operations and other initiatives will change, and we'll talk about that at the right time. But just to summarize what our team is saying here tonight, we're very confident about the things we can control in our business, our operating performance, our capacity now with our manpower, team we have, the skills and the capabilities we have. There's a little uncertainty about the health of the economy this year. So we watch that very carefully. But we feel really good about how we come into 2023, how we're performing so far in 2023 and the feedback we're getting from our customers. And so, we'll leverage that to show that we can deliver growth and that we can build an even stronger business. Thanks. So, Joe, I wanted to ask you a question on the intermodal share take a little bit differently. I'm just curious about your thoughts on what kind of targets you're going to be holding the team accountable to delivering over, call it, a 3- or 5-year view. As you step back and look at the intermodal market in the East, it's grown at about 38 basis points a year for the last 7 years. you guys are doing about 3 million units, and you were doing about 3 million units in 2015, '16. What should we be thinking about on a 5-year view about how much share you could actually put onto the railroad. Not looking at the guidance for this year because the economy is weak, and I get it's tough to forecast. But I'm just trying to think like what kind of target are you putting out there for the team to hit? Yes. Thanks for the question. I'm not going to get into specifics about what our targets are long term. But just conceptually, let's talk about it. Just stepping back and learning about this industry and staring at it more closely over the last many months, even before I joined CSX. We interchange a lot with a number of our Class 1 colleagues. And so, this is an industry issue as well as a CSX issue, and that is around real growth, volume growth. So you referenced it. So how do we make that happen? We have capacity. We have a strong fixed cost base, a very -- a substantial fixed cost base and incremental margins are really good. So, that lends itself to really wanting to grow, like most businesses, those kind of -- and we have strong margins to start with. So, how do we grow? As an industry, as a company, I mean that's the discussion we're having and the opportunities we're pursuing over the next several years. So, from our perspective, we need to demonstrate to ourselves and to others that we can grow volume ideally above either GDP or industrial production, wherever -- ways you want to measure it year after year and bring the margins that come with that to show growth in the business, not just on pricing, but also on volume. That is something we're looking to do, and we'll continue to challenge ourselves to do. With that comes the customer service metrics and demonstrating continual progression there in things like trip plan compliance and first mile last mile, but also in with the way the customers measure things. Are the MPs there when they need to be there? Do the loads get there when they need to be there? So they can manage their manpower and their business, et cetera. So, continual progress, Jamie referenced it on the customer side. And then on the employee side, with our employee surveys and with our relationships with our union leaders and our union partners, et cetera, how do we become the kind of environment where -- back what we've had over time where you have just all this multigenerational activity because people are so proud to be a part of the CSX team and how we work together and the culture that we have around each other. So, there's ways to measure those things and challenge ourselves to be accountable with showing progress. But, if you bucket them into those areas and then, of course, we will never forget the financial results. Those are largely outcomes of all the things we're talking about, but continuing to look at our operating efficiency, continue to look at our operating income, of course, -- and our cash flow, we will always do that. So without getting into specific, you can just think about where the emphasis points are and where the priorities are. And then, I've referenced technology a couple of times here tonight, and I want to come back to that. How do we leverage technology to be more efficient, to be safer, to better serve our customers and to modernize our business across the enterprise, whether that's in the office or in the locomotive. And we see a lot of potential there. Steve Fortune has joined us. We've got a great technology team. We're excited about that, too. So, a number of things to think about and challenge ourselves for the future. And we'll have more to say about it over time. But when we get to a point where we are definitely where we want to be with our employee relationship and we have a safe, trusting environment with our union partners, where we look for solutions and work for both sides and then improve the work-life of our employees while also serving our customers better and having a more efficient business, we can achieve all those things together. Those are the objectives. And I believe we'll get there, and we'll do it the right way. Okay. Jamie, if I could just sneak a little follow-on in there. As you think about the headcount plan from where we are today, are you expecting to continue to grow it into the year, or do you think we've got enough sort of resource on the property to maintain the service improvements? I would say we are continuing to qualify conductors every week. We still have another 600 folks out there in training out in the field and some in Atlanta. And what we're doing as we move forward -- now remember, the retention rate has not been all that good with the new hires. So, if we continue to work on that retention rate, and we have a 10% all out with respect to just regular attrition as we move forward. I'm looking for another few hundred folks onto our headcount to get us into vacation season as we move forward and some of the growth that Kevin and the team see as we continue to move into the year. So, I'm comfortable with the headcount we have now, while the vacation season is low, but over the next few months, we're going to see that spike come up. And the way that we are guiding into that or gliding into that, our numbers are going to be able to hold up for what we need to not only continue where we are with our metrics, but to actually continue to improve on them as we move into the year. So, we are -- it's probably one of the first times in a couple of years, I've been on one of these calls, and I can say we're comfortable that our headcount is at a good spot and continuing to move into a good spot as we move into the year. Just want to circle back to that last question a little bit more. Joe, you had talked about some of the processes in doing business easier with rails. Could you maybe expand on that a little bit? Do you feel like in these customer surveys, the ease of doing business with rails is sort of a key limitation right now for some of that structural share gain? And is that something that's maybe within the next 2 to 3 years that you guys can attack that, or is it much longer-term opportunity there? Yes. Thanks. It's a great opportunity. And we do need to make it easier to do business. We recognize and we referenced that in our commentary tonight. I mean you think about the level of visibility that we have in the rail industry compared to packaged goods and UPS, FedEx, those kind of things, we have to improve in that area, and we will improve in that area. It's an industry issue as well as a CSX issue. That's an example. How do we get even more predictable and give more visibility to our performance and et cetera. So there's a number of ways we need to improve to improve the customer experience in our business, make it easier to do business with us. Kevin referenced, we've got some new things in ShipCSX to help with calculations for emissions reduction and those kind of things. How do we keep helping customers get better and be able to use our systems better and be able to work with those better. There's a number of ways we can make that happen. At the end of the day, the thing they want most from us, of course, is to be there on time and to deliver on time and to be reliable in doing that. So, that's obviously where our focus is. But clearly, we can make it easier for our customers to do business with us, and we can provide more information and visibility and that's some of the things that the industry is working on. My question for Kevin, looking back now at Quality Trucking, I know this was a little bit of an experiment when you made that purchase, and I see in your CapEx plan you're devoting a bit of capital towards it. So just curious as to what your take has been on it now that it's been under your umbrella for a little while now. Is it by calling it out in CapEx, are you expanding the fleet? Are you strategically looking at growing your trucking operation relative to your rail operation? And could you be looking for any other avenues outside of the company and from an M&A perspective into that trucking space if you see those opportunities pop up here in 2023? Yes. I mean, first of all, quality is a very, very unique asset in a lot of ways. First, it touches our most valuable market in our largest market, which is chemicals. And I can't tell you how insightful. They have different contexts than we do on the trucking side, where those purchase managers have never dealt with truck and introducing that product to them has been eye-opening and it's something very, very new. When we talk about the CapEx related to QC this year is really a rail product, it's not more trucks that we're investing in. It's the ISO tanks that go on the railroad. And I am -- if Randy was sitting here today talking about it, he is very, very happy with how it's gone so far. The customer uptake has been pretty incredible so far. We've seen a lot of success. And our only issue is we haven't gotten them fast enough. And so that's a good problem to have, and we're going to continue to take delivery of those. Randy has come from the trucking market for a long time, and he has even been surprised about the service product and how quickly we can turn these assets for him on each side. So, things have gone extraordinarily well there. The intermodal network is ideal to convert a lot of this traffic that moves over truck today. It's meeting the customer requirements, and we're getting more and more demand from those customers out there as it gets into the market. So, that's really where the focus and the uptick in the CapEx that we talked about earlier are coming on that rail product that we're extraordinarily excited about. And we just think that the chemical customers, in particular, are looking for a holistic solution and it's pretty powerful to go in there and be able to talk and look at their network and tell them what we think fits from a rail perspective and what fits from a trucking perspective. And just when you think about quality, even on the operating side, we're utilizing our current terminals. And yes, that CapEx is exactly right, where we're buying the ISO tanks and we're preparing. But everything else is already there, that fixed asset is there. So, this -- when we went into this, Kevin and I were somewhat hand-in-hand looking at this business saying is this what we want? Is this going to work, and it's really falling in really well. And I would say -- on the asset side is just we didn't get the ISO tanks. We'd like to get them quicker. We'd like to get more of them because there's more business, I believe that Randy and his team can get working with Kevin and his team. And our intermodal terminals have the capacity and the trains have the capacity. So it's just -- it's a great product on the operating side and very easy for us to move as well. So it fits really, really well. I'll just be quick. Sean, you were talking about employee levels, and it looks like cost inflation on the new contract, probably around 5% per employee. Year-on-year employees about 7%, 8% for the first half of 2023. So if I look away from fourth quarter where the incentive comp helped lower that and I looked at kind of what's the right run rate for modeling for labor cost inflation. Should I be thinking about something in the high single-digit, 10-percent-ish range for the first half of the year before productivity offsets that? Yes. Jeff, I think on a gross basis, right, on a full year basis, the impact of inflation on the labor line is in that ballpark, right, mid-single digits. And if you look at the headcount, if we didn't hire anybody additional all year long, we'd be up 4% year-over-year. Jamie talked about adding a couple of hundred to the headcount, so call that 5% up year-over-year. So, there's your 10%, but we are confident that as we -- as the network continues to spin, we'll be able to drive some efficiency on the labor line. Weâll also cycle, as you alluded to, the true-up that we had to make in the third quarter on the back wages. So, that will be a little bit of an offset. All right. So that will be a little better in the second half. But I guess at the end of the day, how much of that labor cost do you think you can offset through productivity? Is there a target out there? Do we just kind of see what we can achieve? Well, yes, we've got targets and we're going to reduce over time. We're going to reduce crude travel and some of the ancillary costs that go along with that as the network spins faster, and we'll be able to offset a good chunk of it, offsetting 5% inflation or sort of in that range and another 5% headcount would be a lot in a single year. So, we're on the right track.
|
EarningCall_1127
|
Dear all, thank you very much for joining Nidec's Conference Call. I'm Yoichi Orikasa, General Manager, Kyoto branch of Mitsubishi UFJ Morgan Stanley Securities. As we kick off the conference, I'd like to ask you to make sure all the materials are ready in front of you. If not, please download the files on Nidecâs homepage right now. Please note, this call is being recorded and the conference materials will be posted on Nidecâs homepage for the coming week for investors and analysts who are not able to join today's call. Now, I would like to introduce today's attendee from Nidec Corporation. Mr. Akinobu Samura, Senior Vice President and Chief Financial Officer. First, Mr. Samura will make a presentation. After his presentation, we will move on to a Q&A session and Mr. Samura will answer your questions. Mr. Samura now presents Nidec's Q3 fiscal year 2022 results, future outlook and the management strategy. Mr. Samura, please go ahead. Good day, everyone, and welcome to today's conference call. My name is Akinobu Samura, Chief Financial Officer of Nidec. I will be your main speaker today and answer your questions with the help of Mr. [Hironari Noguchi] (ph) as an interpreter. Please see slide three for the financial year 2022 nine months results. As shown on slide four, the nine months net sales stood at the record high of JPY1,699.7 billion, 20.8% higher year-on-year. The nine months operating profit decreased 6.8% year-on-year to JPY124.4 billion. But however, the nine months profit before income taxes and the profit attributable to owners of the parent increased 9.7% year-on-year to JPY141.9 billion, a 4.8% year-on-year to JPY104.1 billion, respectively. Both stood at record high. We are implementing double WPR-X, the drastic reform of profitability to tackle recent deteriorations of market environments with aims to reduce the fixed cost significantly and to make a V-shaped recovery in financial year 2023. Based on Q3 results and Q4 demand outlook, we have made revisions to financial year 2022 annual forecasts. On slide six and seven, you have step charts showing the net sales and operating profit year-on-year and quarter-on-quarter, respectively. By product groups, with exchange rate effect eliminations and the structural reform expenses, as you see the upper chart of slide seven, the quarterly sales of all of the segments, except for electronic and optical components and other declined due to recent deterioration of the market environments. The overall operating profit on the lower chart declined due to the decreased OP. In small precision motors, automotive and appliance, commercial and industries or ACI, as well as structural reform expenses. Now please see slide eight. We have started WPR-X, the drastic reform on profitability amid adverse market conditions in the second half of financial year 2022. As explained on slide nine, WPR-X is a drastic reform on profitability to tackle economic downtime caused by the expansion of COVID-19 in China and economic shrink in Europe through prolonged Russian invasion of Ukraine, as well as prioritization caused by technological innovation. With the idea of technology creates cost competitiveness in mind we are going to accelerate development of products that can overwhelm competitors with our technologies and to implement structural reform to reduce fixed cost through automation with our technologies and streamlining operations. Please see slide 14. The number of EV models adopting Nidecâs E-Axle has increased by three to 14 models compared with previous quarter. The annual sales of EVs with our E-Axle grew 175% year-on-year in calendar year 2022. And the latest December sales hit record high. Please see slide 15. The E-Axle market in China is about to enter the growth stage on a full scale. The number of market entrants, including OEMs, who self-manufacture motors is increasing. The increase in the number of competitors in such growth stage is within our at the time of strategy creation. As our strategies for this growing market, firstly, we ensure a speedy implementation of large scale capital expenditure before the demands arrive as countermeasures for market expansion. And secondly, in order to expand our customer base and geographical market areas. We will be targeting five major customers in China, two existing and three new customers and acquiring new orders from European and US OEMs. Please see slide 16. Our global sales volume of our E-Axle is expected to continue to increase at the pace that exceeds the growth rate of the battery electric vehicle or BEV market and we are targeting to sell 4 million units of E-Axle in financial year 2025, which consists of Nidec PSA eMotor, a joint venture with Stellantis and customers in China and other areas. Please see slide 17. We are preparing for V-shaped recovery in financial year 2023 by posting large structural reform expenses in the second half of financial year 2022. Please see slide 18. Paradigm shift from ICE or Internal Combustion Engine vehicles to EVs is rapidly accelerated in two wheels and small cars as well. We are focusing on the two largest markets of India and China in both electric two wheel vehicles and small EVs. We are planning the mass production in financial year 2022 for 11 projects, including six related to electronic two wheel vehicles and five related to small EVs. We have added in four-wheeled motors for electric motorcycles in India. And with regards to production, we have converted the former HDD factory in the province of Zhejiang, China to that of micro mobility and we are planning to double the floor area of our Indian factory. Please see slide 19. In the small precision motor segment, we are implementing business portfolio transformation amid HDD motor market structural change. Please see slide 20. In ACI, we're executing structural reform in overseas businesses and looking to enter a new phase of growth. While gaining market share outside Europe that is shaken by the conflict, we are going to accelerate top line growth through three new strategies in the fields of generators, battery generator storage system, battery charger for EVs, et cetera. And for the air conditioner market, we are going to expand the businesses globally, mainly for industrial use. Assuming higher raw material costs continues for the time being, like in the all businesses, we are going to accelerate the improvement of profit structure surpassing that on to selling price and reducing the manufacturing cost. Please see slide 21. Despite the weaknesses in appliance and commercial areas, due to loss of demand driven by COVID-19 and a negative impact of prolonged Russian invasion of Ukraine on the European market. We are going to continue our efforts to improve profitability. Please see slide 22. In other product groups, the operating profit ratio since our financial year 2021 is keeping high level of over 15%. Please see slide 23. Nidec's machine business group, which consists of Nidec-Shimpo simple as Nidec Machine Tool and Nidec OKK is going to expand and improve product portfolio through a steady organic growth and M&A, and realize high growth of the Machinery businesses. Firstly, in the machine tool business we are applying M&As to expand the product line-ups of machine tools and explore overseas markets and supporting overseas sales expansion of NidecMachine Tool and the NidecOKK by acquiring PAMA in Italy, which has strong sales network in highly growing markets such as China, et cetera. Now secondly, in the Press Machine business, our orders for machine for manufacturing cans and EV related parts, such as the motor core, battery, et cetera are increasing. We are going to strengthen production and the sales through collaboration among our major brands. And thirdly, in the Reducer business, we are launching Komagane business facilities in Japan with an aim to increase supply capacity of high-precision reducers and planetary reducers for the domestic market and aiming to gain market share of reducers for 6- axis robots. Please see slide 24. We have purchased the shares of Italian machine tool manufacture PAMA, and its nine affiliates and executed transfer agreement on the stock acquisition. PAMA is one of the most well-known companies in the machine tool industry for the wide range of product lineups and high level technology capabilities of its large machine tools, particularly horizontal boring and milling machines. The company has also known for its solid sales and service networks in Europe and other places, such as China, the U.S. and India. Following competition of acquisition of PAMA -- following compression of the acquisition of PAMA through reciprocal usage of management resources between PAMA and our two machine tool companies, NidecMachine Tool and Nidec OKK we are able to pass those synergies in all areas of sales, manufacturing and product development. After completing the stock acquisition, we are going to actively provide PAMA with resources and make necessary investments in PAMA to accelerate the growth of the Nidec Machine Tool businesses. Please see slide 25. We are targeting to build a strong corporate governance system. And following the establishment of sustainability committee that we announced in the previous quarter, we established a Nomination Committee last November as an advisory body to the Board of Directors. With the establishment of the Nomination Committee, fairness, transparency and objectivity are ensured in the deciding on the election policy. Data standards and the candidates are our directors and executive [indiscernible] with appropriate engagement and advice from our external directors. We will continue to improve our corporate governance system even further going forward. Lastly, on behalf of the entire management team, we would like to thank our customers, partners, suppliers for their support and commitment as well as our shareholders. At this time, we would like to open up the call for questions. Thank you very much, Mr. Samura. Now, we'd like to turn to the Q&A session. Mr. Samura will be pleased to answer your question. Today's Q&A session is conducted electronically. [Operator Instructions] Our first question today is from Mr. Ito of ARGA Investment. Mr. Ito, please go ahead. Yes. Thank you very much. So I have two questions. Regarding your big restructuring charges, I just want to first understand, is this primarily because of demand, macro-demand or it's also -- or maybe more because of pricing. So I think in previous quarters, Nidec has said that you expect higher raw material costs to be passed on to customers with a time lag. I don't really see this positive impact in the current numbers. So are you getting a lot of difficulty in passing on pricing and that is one of the reasons why you are embarking on the restructuring program? That's my first question. And so, my second question is just for a more detailed breakdown of your restructuring costs. I think I read somewhere that it's about JPY70 billion for the full year. So if you could confirm the number, how much is in Q4? And for which particular products these charges are going to be for? Thank you very much. [Foreign Language] [interrupted] First of all, I'd like to say that there is no direct relationship between price charging and the restructuring cost. And when it comes to restructuring cost, this 70% of this entire -- and the restructuring cost accounts for 70% of the entire downward revision, which is worth JPY100 billion. There are two factors for that: one of them is automotive related mainly in Europe and other places. In European automotive businesses, we have encountered with the quality defect issues and other issues in our business operations. And these issues have to be solved in the course of communications among the top executives and the others on a daily basis. And our corporate culture as well as our growth model is based on this type of communications that -- and this communication has enabled us to establish a very good relationship of traffic between our service and our customers. However, over the past few years, this type of communications between top management executives has been what we have been lacking, we are missing. Due to this lack of communications among top executives, relatively small problems has developed into a larger problems and issues in some cases. And one of the examples of such a case is the quality issues that has been developed into a compensation issue. And another issue is also related to our communications with our customers. As the production volume changes or fluctuates, sometimes we have seen excessive amount of equipment that is not in years. And these are the issues that are mostly with the automotive businesses in Europe and other places. One another major issue is the deterioration of the marketing environment. And at this circumstance, we are going to -- this year marks our 50th anniversary since our company's foundation. Therefore, to commemorate this 50th anniversary in this year of fiscal year of 2023, we like to make a V-shaped recovery after successfully and significantly reducing our fixed cost. And this is the main -- primary purpose of this WPR-X which is the initiative that I have explained in my presentation at the beginning of this speech. And this WPR-X is the initiative for us to significantly reduce our fixed standard cost. And during this process, we are going to slash -- we are going to face consolidation and we're going to incur restructuring costs and we are going to reduce the amount of so called slow moving inventory and these are all part of our ongoing restructure reform. Therefore, in commemorating our 50th anniversary as a company and in order for us to be able to have a very good secure and healthy growth for the next 50 years we like to go on to -- and go through this restructuring -- excuse me, this reform or structural reform so that we can establish a very healthy -- extremely healthy financial structure and we can go ahead as a healthy company. Those are my answers to your two questions. Okay. Thank you. Can I just confirm that the pricing increase to customer is going according to plan? And also, can I just confirm that when you talk about quality issues with European automotive business, this is related to maybe electronic power steering or the braking systems? And sorry, one last confirmation is, when you do -- when you mentioned restructuring, does this also include headcount reduction? Thank you. [Foreign Language] [interrupted] When it comes to the first point that you would like to confirm with us, which is the price charging. We are still having this huge amount -- we are still expressing the effects of this huge amount of price charging -- price charging is smaller compared with the price increase on a year-on-year basis, which is, in the amount, which is approximately JPY20 billion or so. That's one thing that I'd like to say. When it comes to quality related issues. I would like to refrain from -- refrain you to specifics, but approximately 50% of the entire amount has been solved in Q2 and Q3 and the remaining 50% is still remaining in Q4. When it comes to the third point that you would like to confirm with us, which is the possibly headcount reduction as part of the restructuring and streamlining. Of course, under the one Nidec policy, weâd like to utilize our equipment as well as people on a groupwide basis, but some headcount reduction is part of our restructuring plan. Mr. Ito, thank you very much for your questions. And our next question is from Mr. [John Hall] ph) of [indiscernible]. Please go ahead. Yes. Hi. Good evening. Thank you very much for making time Mr. Samura. I wanted to ask you about the E-Axle business. Maybe you can describe for us the changes in the forecast for this year and next year that you had made from the last quarter that drove that change? And how we assess the prospects going forward on the E-Axle business? Thank you. [Foreign Language] [interrupted] When it comes to the E-Axle business, our prediction is that, we are going to reach a critical point in year 2025 and our forecast at that time is $4 million units to sell. And this forecast remains unchanged. It's all the same. But when it comes to fiscal years of 2022 and 2023 due to the spread of COVID-19 and other reasons, it is true that the market is shrinking. And as I understand, when it comes to fiscal 2023, some people predict that there will be a slowdown in Chinese market. According to what I have heard from our people working in the local places, it is also true that one of the every -- one out of three, every three cars are EVs already. Therefore, even though the rapid growth rate of two times or three times a year is not going to be maintained anymore. But it is, I believe, there is no doubt that the growth will continue. One important point for us is to make a quick transition or replacement or quick transition from Gen 1 to Gen 2. Now when it comes to Gen 2 products, it utilizes quite a few new technologies. And we had to take a little more time than expected in checking the performances of Gen 2 products. Therefore, this is why we had to postpone the debut timing of Gen 2 products from Q3 to Q4. Therefore when it comes to fiscal year 2022, the rate of the Gen 2 products is going to be lower than the initially expected. However, when it comes to fiscal year 2023, our forecast remains unchanged. In other words, on average, three out of every four vehicles will be using Gen 2 products. And therefore, as we have been saying from a long time ago, our plan is to generate a profit for our traction motor business in fiscal 2023. This plan itself also remains unchanged. Alright. Can I just follow-up to ask a few questions? The growth rate as you said for EV penetration is slowing and many OEMs, particularly in China, really not making money. And recently, the OEMs like Tesla and others are cutting prices. Does that put some pressure on negotiation of our Gen 2 prices? Can you give us some color on how pricing negotiation is going with our customers? [Foreign Language] [interrupted] Now when it comes to price reduction as the quantity increases is something we have already been thinking about as part of our strategy. And as Mr. Nagamori, our Chairman has been saying long time ago, the average price of the cars will be one-fifth of what it is now. And what we need to understand is that, we need to be able to increase the volume and try to reduce price and we need to wait -- we need to be ahead of other people and we wait for the arrival of the demands to come to us. That's our strategy. Therefore, Tesla's ongoing price reduction is part of this movement, in my opinion. And therefore, in comparison with the Gen 1, Gen 2s cost is 35% less. And when it comes to Gen 3, its cost is 50% less than Gen 1. And that's the type of product development strategy that we have in place. Therefore, as the volume increases, there will be a growing number of companies to enter the business and across the competition we will become faster and faster. Thatâs type of thing that happens in many different markets, in my opinion. Thank you. And then one last one on the E-Axle question. Is it true that some of our customers are in sourcing or second sourcing from other suppliers? How do we think about that? [Foreign Language] [interrupted] And of course, some customer are making these E-Axle in house and for some other customers we provide them with motors or even other components. There are quite a few different types of cases. But what we are focused on achieving the most is to secure a good amount of quantity of our products, because thatâs most beneficial cost wise. Therefore our strategy is to deliver a large amount of E-Axle units, but not only that we will continue to deliver to our customers other components or individual components, that's how we like to -- that's how we try to secure our large amount of products. Thank you very much. So if I can ask one question about the restructuring initiatives. My understanding is, Nidec always have cost reduction and operational efficiency plan. How is WPR-X different to our ongoing reduction plans? Can you tell us why aren't we doing it already? Why do we have to start something new now? And how much of the restructuring cost will be just writing off assets that we will be paid for versus requirement for cash investment for restructuring? Thank you. [Foreign Language] [interrupted] When it comes to WPR-X, it is not really the same from -- same as the WPR-X initiatives that we have held or started in the past. Currently, we are in midst of huge, large scale technological change. In other words, currently, we are in the midst of a huge technological change in -- for example, the ICE or internal combustion engine is -- are replaced by EVs. And AI or artificial intelligence is replacing human when it comes to labor. That's a type of a technological change that we are currently experiencing. Therefore, instead of trying to reduce the cost all across the board in the entire unit, we like to focus on certain businesses that we would like to focus on. And this is -- we like to establish competitive advantage over other companies. Therefore, the conventional WPR-X activities are aimed or intended to reduce procurement cost and increase production efficiencies, but currently the current WPR-X activities or initiative is to change our product themselves. Thank you. So I have a couple of questions. So firstly on E-Axle guidance. So we have reduced our guidance from 550,000 units to 420,000 units, roughly. So 24% decline in the units. As well as if we compare on quarter-on-quarter basis, it is almost 70% decline from Q3. So can you explain why there is a downgrade in the guidance? [Foreign Language] [interrupted] Primary reason for the reduction is the reduced demand from our customers due to COVID-19 and other elements. And another reason is that, we had to delay the debut timing of Gen 2 because we then need to take time to inspect and check the performance of technical -- technological performance of Gen 2 products. And on other questions, so sorry to stress on this, on the restructuring question regarding the quality issues. So is it related to EV related business or traditional automotive business that we have? Okay. Thank you. And lastly, on the traction motor business or E-Axle business, it seems like Q3 had recorded close to JPY10 billion losses. It is accelerated from the previous quarter. So can you give some color on why the losses are ballooning in Q3? [Foreign Language] [interrupted] And of course, I believe you're talking about this difference between Q2 and Q3. And the reason for this loss is not our customers, including [GSE] (ph) is â are in a very struggling situation at this moment. Therefore, selling price is making some increasing again. That's one of the reasons. And another reason is that, when it comes to highly profitable models, we tend not to deliver such models and that led us to produce less of those models. That's another reason. And another reason is that, the operation ratio of the factories during the month of December, for example. Hi, thank you very much for taking the time to speak to us. I have a few questions. I guess, first, just wanted to know what was the operating margin for the HDD segment in the December quarter? [Foreign Language] [interrupted] In the HDD business, the quantity dropped significantly. So usually 30% when it comes to margin, but due to this [indiscernible] loss, now this percentage is down to 20%. 20%. Okay. Thank you. And I think just follow-up to earlier question. I don't think I heard the answer correctly, but of the JPY70 billion restructuring charge, how much of that amount is for inventory and other asset write offs? [Foreign Language] [interrupted] Our calculation rate is as follows: when we have a slow moving inventory for which we had to spend a JPY10 billion and we have stagnant accounts receivables. And all in all, it's approximately JPY20 billion in total. [Foreign Language] [interrupted] The latter is correct. In other words, JPY10 billion for a slow moving inventory, another JPY10 billion for stagnant accounts receivable. So it's JPY20 billion in total. Thank you. Thank you. And then just the machinery segment, I was just wondering in there like for the sales in Q3, how much of the sales was from the acquisitions from OKK and the Mitsubishi? I think it was about [JPY19] (ph) billion in Q2. That's great. Thank you very much. Just one last question for me. I guess, I was surprised by the comments around the Gen 2 performance testing. I guess, we've been hearing about Gen 2 for several quarters now and I guess I was kind of surprised that you delayed the launch by a quarter because of the testing. I would have thought that was in your plans and forecast that it would require testing. So I guess what happened with the testing that you weren't expecting. [Foreign Language] [interrupted] When it comes to the production, Gen 2 is started from the end of September, that was as initially planned. But as I've said before, Gen 2 includes various new technologies. Therefore, some customers are extra sensitive and extra cautious and they requested us to test extra cautiously when it comes to these new technologies. Therefore, these requests differ from our customers, but when it comes to our primary and most important customers, which is GSE, they gave us a request to be extra careful about checking these performances at the very final moment. And this -- because of this request, we had to delay the start of our mass production of Gen 2 product. Now these issues have almost all been solved already and has been already decided that the mass production will start in the month of February. Mr. Schneider, thank you very much. As we have run out of time. The next will be todayâs final question. Mr. Ito again, please. Thank you. Just want to confirm again. So for your restructuring costs of JPY70 billion, so we know that at least JPY20 billion is non-cash, plus it's related to inventories and receivables. But can you tell us how much in total would be cash and non-cash. Thank you very much. [Foreign Language] [interrupted] And of course, the examination of these numbers are still ongoing. But overall, 15% of that amount is cash related and remaining 85% is non-cash related. Mr. Ito, thank you very much. Now, we'd like to conclude the conference call. I'd like to appreciate all your participation. If you have any further questions, please do not hesitate to contact Nidec Corporation or your sales representatives at Mitsubishi UFJ Morgan Stanley Securities. Thank you again for joining the conference call. And now you may disconnect.
|
EarningCall_1128
|
Thank you, Drew, and good morning, and thank you to all of our listeners for joining us. Joining me on the call this morning is Mike Keim, our Chief Operating Officer and President of Univest Bank and Trust; and Brian Richardson, our Chief Financial Officer. Before we begin, I would like to remind everyone of the forward-looking statements disclaimer. Please be advised that during the course of this conference call, management may make forward-looking statements that express management's intentions, beliefs or expectations within the meaning of the federal securities laws. Univest's actual results may differ materially from those contemplated by those forward-looking statements. I will refer you to the forward-looking cautionary statements in our earnings release and in our SEC filings. Hopefully, everyone had a chance to review our earnings release from yesterday. If not, it can be found on our website at univest.net under the Investor Relations tab. We reported net income of $23.8 million during the fourth quarter or $0.81 per share. The highlight of the quarter was our continued strong organic loan growth. Loans grew $274 million or 18.8% annualized, excluding PPP loans during the quarter and $842.8 million or 16% for the year. This strong growth, along with the increasing interest rate environment during the year, resulted in net interest income increasing 25.5% in 2022 compared to 2021, excluding PPP activity. We are very happy with our results for the quarter and 2022 as a whole as we reported solid growth and financial results while also investing in long-term strategic initiatives in our digital strategy and expansion into Western Pennsylvania and Maryland. Before I pass it over to Brian, I would like to thank the entire Univest family for the great work they do every day and for their continued efforts serving our customers, communities and each other. As Jeff indicated, we are very pleased with our performance throughout 2022. I would like to touch on four items from the earnings release. First, we continue to see the benefit of our strong loan growth in recent years, coupled with our asset sensitivity in the rising rate environment. Reported margin of 3.76%, increased 9 basis points compared to last quarter. Net interest income increased $3.7 million or 6.3% on a linked-quarter basis. During the quarter, deposits grew $116.8 million or 8% annualized. This included growth of $69.1 million in noninterest-bearing deposits. Second, during the quarter we recorded a provision for credit losses of $5.4 million. Our coverage ratio was 1.29% at December 31 compared to 1.28% at September 30. Net charge-offs for the quarter totaled $908,000 or 6 basis points annualized. For the year, net charge-offs totaled $3.9 million or 7 basis points. Consistent with the prior quarter, despite general concerns regarding the economy, we are not seeing signs or indications of credit quality deterioration in our portfolio. During the quarter, we continued to see stability in nonperforming assets and criticizing classified loans. Third, noninterest income increased $1.3 million or 6.6% compared to the fourth quarter of 2021. The fourth quarter of 2022 included $1.2 million adjustment related to investment in advisory income, $1.2 million of swap fees related to the conversion of certain LIBOR-based loans to SOFR and $526,000 of BOLI death benefits. Offsetting these items was continued pressure on wealth management revenue, driven by reduced assets under management and supervision due to market volatility and reduced gain on sale income from our mortgage banking business due to the current interest rate environment. Fourth, noninterest expense increased $4 million or 9.2% compared to the fourth quarter of 2021. This includes $434,000 related to our digital transformation initiative, $370,000 of incremental expense resulting from the inclusion of the Paul I Sheaffer Insurance Agency, which was acquired in December of 2021; $430,000 of fraud losses; $318,000 related to our expansion into Western PA and Maryland; and $184,000 of restructuring charges related to the planned consolidation of two financial centers. Excluding these items, noninterest expense increased $2.3 million or 5.5% versus the fourth quarter of 2021. I believe the remainder of the earnings release was straightforward, and I would now like to focus on five items as it relates to 2023 guidance. First, for 2022, net interest income totaled $218.3 million. For 2023, we expect loan growth of approximately 12% to 14%, and we expect this to result in net interest income growth of approximately 13% to 15% of the base of $218.3 million. This assumes 125 basis point increase in February. Each additional 25 basis point increase is expected to result in annualized net interest income of approximately $250,000 to $500,000. Second, the provision for credit losses will continue to be driven by changes in economic forecast and credit performance of the portfolio. At this time, we expect the provision for 2023 to be approximately $18 million to $20 million. Third, for 2022, noninterest income included $977,000 of BOLI death benefits. Excluding these BOLI death benefits, noninterest income totaled $76.9 million in 2022. In 2023, we expect noninterest income growth of approximately 4% to 6% of the base of $76.9 million. Fourth, we reported noninterest expense of $186.8 million for 2022 and expect growth of approximately 7% to 9% in 2023. This includes core expense growth of approximately 5% to 6% plus 2% to 3% related to our expansion markets. Lastly, as it relates to income taxes, we expect our effective tax rate to be approximately 20% to 20.5% based on current statutory rates. Can we start with your loan growth expectations? I think you guys kind of raised it just a little bit from, I guess, sort of in the same range of 13% to 15%. Can you talk about kind of like the main drivers you're seeing and -- what -- did anything help affect the acceleration to 19% annualized this quarter? And like is there still upside do you think to maybe your guidance of economic trends don't deteriorate? This is Mike Keim, Tim. Good morning. I think the range that Brian communicated is an appropriate range for where we're looking at. We continue to grow our teams in our existing markets, and that's helping us to maintain volume. And then in our new markets in the Western PA and Maryland, we believe that, that's allowing us to have upside growth relative to our peers. In our mortgage operation, we had put on hybrid ARMs in 2022. We believe that will occur -- continue to occur at a rate in 2023, but we'll see where rates go and we would -- because we much prefer to get back to our primary mode, which is selling and reaping the gain on sale on our mortgage production while retaining the servicing rights. So all in all, I'll come back to the fact that we're comfortable with the range that Brian communicated. I would not say we have dramatic upside to that, but we're confident in what we're doing and we -- as we move forward here. Okay. And could you -- the NII guide is really helpful. But could you talk about kind of the trajectory of that in the NIM? I know it might be hard to hit like actual -- like an actual target number on the NIM itself, but can you help us think about how like the rising deposit costs are going to help? Last quarter, you guys mentioned it would probably peak this quarter and next and then move back into like the 3.50%, 3.55% range. Is that range higher now? This is Brian Richardson. We're really holding in that same range. We expect the kind of NIM behaved exactly as we would have expected in the fourth quarter. We do expect this to be the peak and expect it to pull back in that mid-single-digit basis point range next quarter and in the subsequent quarters and settling probably right at mid-3.50% to 3.60% ranges, where I think we will end up. Really the function of the deposit beta, current cycle to date, looking on interest-bearing, we're at roughly 28%. If you look all in, on deposits, we're up closer to 15%. Historical norm on interest-bearing for us would it be in that 40% to 45% range. So we still have some room to go there. And if we're looking at historical norm on total deposits, that'd be closer to the 30% range. So again, about halfway there on the deposit side. So I do think contraction will continue to occur for the next several quarters. I got you. Okay. So a little bit of NIM contraction in the next few quarters and then kind of stabilizes, hopefully, with the Fed pausing or something. I think the last question I had for you guys, your guide for $18 million to $20 million on the provision, if you kind of annualize the number you guys had this quarter? It's a little bit above that. What -- like charge-offs and NPAs are still like pretty solid. So what kind of drove the provision this quarter? Yes. So we look at our coverage ratio, you look at specific assets, there's various things that play in there. And that's why, I mean, I do -- as I indicated, is event-driven. There will be some moving parts that would continue as we navigate forward. But again, we think that $18 million to $20 million range is appropriate -- Right. Yes. I mean the loan reserve percentage didn't really move up all that much. But I just wanted to ask. All right. Thank you. Thank you, Drew, and thank you, everyone, for listening in on our call today. As I said in my comments, we're very pleased with our results for 2022. A lot of strong financial performance, a lot of growth and we're excited about the momentum we carry into '23 even with pending economic concerns out there. We're in great markets with great people and really strong customers. So we look forward to a successful 2023 and talking to you at the end of the first quarter. Have a great day.
|
EarningCall_1129
|
Good morning, and welcome to the Renasant Corporation 2022 Fourth Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note that this event is being recorded today. Good morning and thank you for joining us for Renasant Corporation's Quarterly Webcast and Conference Call. Participating in this call today are members of Renasant's executive management team. Before we begin, please note that many of our comments during this call will be forward-looking statements, which involve risk and uncertainty. There are many factors that could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements. Such factors include, but are not limited to, interest rate fluctuation, regulatory changes, portfolio performance and other factors discussed in our recent filings with the Securities and Exchange Commission, including our recently filed earnings release, which has been posted to our corporate site, www.renasant.com at the press release's link under the news and market data tab. We undertake no obligation and we specifically disclaim any obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events, or changes to future operating results over time. In addition, some of the financial measures that we may discuss this morning are non-GAAP financial measures. A reconciliation of the non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Thank you Kelly. Good morning. We appreciate you joining the call today and your interest in Renasant. Before Kevin and Jim discuss results for the fourth quarter, I want to reflect on the past year and the opportunities ahead. 2022 was a successful year for our company. We produced solid core earnings attributable to margin expansion, expense management, loan growth and the benefits of a good core deposit base. I am very proud of our team that successfully adapted to changes in this operating environment and continued to put each other and our customers first. We are also excited to welcome the team from Republic Business Credit to the Renasant family. The management and sales teams have a history of managing a profitable and credit worthy portfolio of assets and we look forward to their contributions in the years ahead. We end the year with a liquid and strong balance sheet that positions us well for 2023. While economic uncertainties are present, we operate in attractive markets that continue to show growth and meaningful net in migration. We are optimistic about the year and look forward to sharing the results with you. Thanks Mitch. Our fourth quarter earnings were $46.3 million, or $0.82 per diluted share compared to $46.6 million or $0.83 per diluted share in the third quarter, excluding certain items which we will cover later in our remarks. Our adjusted diluted EPS for the fourth quarter was $0.89. We recently announced that we completed our acquisition of Republic Business Credit or RBC on December 30 2022, which added $77.5 million in loans on the date of acquisition consistent with our acquisition of southeastern commercial finance earlier in 2022, this transaction advances our strategies of building more scale and reach in some of our specialty lines of businesses. Earnings from RBC will be included in our results beginning in 2023. However, provision and merger expenses associated with the acquisition reduced our results this quarter by $0.04 and $0.02 respectively. In our legacy business, another quarter of strong loan growth coupled with the Fed rate increases drove an increase in interest income of nearly $22 million on linked quarter basis. Competitive pressures on deposit pricing impacted our deposit costs this quarter, driving an increase of $14.4 million in interest expense from the third quarter. We don't expect these pressures to abate in the near term and anticipate that our funding costs will continue to increase. But we still boast a strong core deposit base and believe it positions us to manage our deposit costs in this volatile right environment. Our Capital Markets, Treasury Solutions, Wealth Management and Insurance lines of businesses were solid contributors to our earnings this quarter. And consistent with recent quarters, our mortgage division continues to experience volatility. Although we see some indications that volumes are beginning to normalize, margins remain unpredictable. In response to the rapid decrease in volumes during the year, we have prudently managed our expenses in this division. Nevertheless, while overall headcount is down for the year, we are still investing in strong production talent and expect our mortgage team to continue to be an important part of our business model. Non-interest expense was essentially flat on a link quarter basis. We incurred $1.1 million in merger expenses associated with our acquisition of RBC, and we recognize expense of $1.3 million related to the FDICâs recently issued guidance to banks regarding representing NSF fees. We expect to make a voluntary reimbursement of such fees previously charged to customers in 2023. With the revenue lift from margin expansion coupled with our expense discipline, our adjusted efficiency ratio, which excludes non-recurring income and expense items continue to improve coming in at 56.3% for the fourth quarter. Our improvement on the link quarter and year-over-year basis provides evidence of our commitment to improving operational efficiency. We are not immune to inflationary pressures and expect non-interest expense to increase somewhat in 2023 before consideration of RBC. However, with continued expense, discipline, and appropriate attention to loan and deposit pricing, we maintain our goal of operating with an efficiency ratio below 60%. Thank you, Kevin. As we walked through the quarterâs results, I will reference slides from the earnings deck. Total footings are up nearly $500 million, due in large part to another strong quarter of loan growth. The acquisition of RBC added $77.5 million in loans while legacy Renasant has not contributed $396 million in organic loan growth. Excluding the loans acquired from RBC, loan growth in the fourth quarter represents an annualized growth rate of 14.4%. Competition for deposits within our markets picked up significantly this quarter. We experienced a decline and non-interest bearing deposits of $268 million from the third quarter and we borrowed $233 million in brokered time deposits in the month of November. The company's core deposit base and our overall liquidity position remains strong. All regulatory capital ratios are in excess of required minimums to be considered well capitalized and share the strength of our capital position. The decline quarter-over-quarter is directly attributable to the acquisition of RBC. We've recorded a credit provision of $10.5 million, which includes $2.6 million for loans acquired from RBC, and experience net charge-offs of $2.6 million. The ACL as a percentage of total loans increased quarter-over-quarter to 1.66%, driven in large part by the acquisition of RBC. Credit quality metrics are shown on pages 14 through 16. Although past dues moved up, criticized and non-performing asset measures remained relatively steady. Net charge-offs were nominal. Net interest income increased $7.5 million quarter-over-quarter. Our core margin which excludes purchase accounting accretion, income recognized on PPP loans and interest recoveries was 3.75%, up 25 basis points from Q3, and 104 basis points from the low in Q1. The deposit pricing pressures impacted us more heavily this quarter. The cost of deposits increased 31 basis points from Q3 to 52 basis points this quarter. We expect these competitive pressures to persist in 2023 and believe funding costs will continue to increase in the coming quarters. Non-interest income is down $7.8 million quarter-over-quarter. The decline is largely linked to our mortgage division. You may recall that we sold a portion of our mortgage servicing rights portfolio in the third quarter for a $3 million gain. There was no such sale and Q4. Additionally, volumes declined in the quarter and accounted for the remainder of the decrease in mortgage banking income. Non-interest expenses with exclusions declined $2.5 million from the third quarter. We are proud of our team's efforts to manage expenses in this environment and remain committed to improving operational efficiency. However, we do expect expenses to increase modestly from these levels given persistent inflationary pressures in the market. Thank you, Jim. Our focus remains on the basic tenets of sound banking, retaining attractive core funding, maintaining a diverse and granular loan portfolio from high quality borrowers and having a capital position that provides optionality and affords us protection against potential industry headwinds. We will now begin the question-and-answer session. [Operator Instructions] And our first question here will come from Michael Rose with Raymond James. Please go ahead. Mr. Rose, is your line muted? I wanted to see if you could provide us an outlook on how you're thinking about the margin. A lot of other banks, we've seen reports so far. I'm thinking about this, this quarterâs margin as the peak and our forecasting a pretty significant decline as we move through next year. How are you thinking about it in terms of NII growth and also just the margin trajectory? Thanks. Good morning, Catherine. This is Jim. So good morning. So I don't know if it was the peak. But if it wasn't, it was certainly close to it. A couple of data points that may be helpful to you, as you think about margin as we think about where it goes from here. So, core NIM for November was 3.78%. Core NIM for December was 3.76%. And I think for the quarter it was 3.76%. Our outlook for margin is that for the for 2023 is that I would characterize it as flat to slightly down, probably behaving no surprise to you but probably behaving better in the first half of 2023 than the second half. And I would say to similar story on NII Catherine. I would say flat to slightly down for 2023. And other deposit costs have been higher for everybody. Have you changed your view on what you think the cumulative over the cycle beta will be for Renasant? So we're using deposit beta of about in the low 40s for the cycle for Renasant and loan betas are a touch higher than that. So that's probably up from where we were six months ago, Catherine, but that's what we're using. Okay, great. And then maybe moving over to expenses. I know you've mentioned in your prepared remarks that you expect growth from this level. What is there that you're also managing that 60% efficiency ratio goal? Is there a kind of a range of expense growth that you think is appropriate to think about this year? And how much flexibility do you have in that outlook if revenue comes in lighter than expected? Hey, Catherine, Kevin. So as we look at -- hey, good morning. So as we look at expenses, that that continues to be one of our one of our main initiatives. And again, not so much to just eliminate expenses, but to maximize the return on them. And I think you've seen that over the last couple of quarters, as well as rates have helped us -- help bring margin back in through -- revenue back into the margin. Our efficiency ratio now sits in the mid-50s. As we look at our expense outlook, and again, we're going to have inflationary pressures on our expenses. So just if you take our non-interest expenses of $101.5 for the quarter, if you're using that as a baseline, again, there's some non-recurring items in there. There's a $1.3 million that we called out on refunding some NSF fees, there's $1.5 million in merger expenses. But if you're just using that the reported as your baseline, we think expenses are up close to 2%, 1.5%, 2.5%. If you back out those items, kind of our core run rate of expenses are going to be closer to 3.5% to 4% increase. And all of that is before RBC. That's just the legacy Renasant expenses. So we will have some pressure on expenses as we look at headwinds on revenue. It doesn't detract us from our goal of our efficiency ratio. We've made a lot of progress. There's a lot of momentum in the company. There's a lot of energy around maximizing returns. And we don't think that that subsides in 2023. It continues to remain one of our main initiatives, and if revenues adjust, our expenses will adjust accordingly. Hey, guys. Sorry about that. Morning. Just wanted to kind of touch on mortgage. Good morning. Just wanted to touch on mortgage here. It's down to about 3% of revenues, obviously, a lot of headwinds, but itâs a lot higher, a couple of years ago. It seems like the headwind has been fully absorbed. But how should we be thinking about the mortgage business, here, both on the expense side, and then on the, the origination side, just given expectations for gain on sale margins, hopefully, we'll see some rebound in the back half of the year. But just wanted to get some broader color and commentary on mortgage. Sorry, if I missed it in the prepared remarks. Thanks. You're good. Look, as we look at mortgage. And you're right, if you go back, a couple of years ago, mortgage as a percentage of revenues was much higher than the 3% to 4% that it is today. If you look at it on a more normalized basis, so if we go back to pre-20, mortgage revenues represented about 6% to 8% of total revenues, and we expect mortgage to revert back to that average revert back to that mean. It's still a volatile time. I don't think that's a surprise or a secret that mortgage is still volatile. But we are actually seeing opportunity that comes with that volatility. The disruption in the markets created opportunity for hiring. And I reckon we recognize that that's a little bit counter to maybe what the trend should be. We have reduced our headcount in mortgage since the end of 2021. We reduced our headcount about 30%. And that includes some hiring some strategic hiring that we've done on the production side. And as we see that strategic opportunity or the hiring of strategic opportunities we'll continue to look at that. We're seeing some positive trends just in the beginning of the year. Margins continue to be tight. But we have seen our pipeline grow about 30% since the beginning of the year. Our pipeline â mortgage pipeline is about 130 right now. Itâs about $100 at the beginning of the year. So there are some signs that production is coming back. But again, it's variable on rate, and it's variable on product, and product and inventory. And all of those just feel a little bit volatile right now. But we feel good with where we're positioned for mortgage. And I think back over as we look over time, mortgage revenue is going to, again, come back to about that 6% range of total revenues from its current position in that 3% to 4% range. Very helpful. And then I just wanted to dig in, and again, sorry, if I missed this into the reserve build this quarter. If I look at slide 17, it looks like the reserve was built in the commercial space, which I guess was a I was a little surprised about and actually down in construction. Can you just give some color on the reserve build? You guys are pretty healthy. Was this more of a kind of a proactive conservative move, just given the credit metrics are still pretty benign? Or is there something greater that you're seeing in your either in your pipeline or just more broadly in the economy? Thanks. Hey, good morning, Michael, this is David. And I can address page 17. But I'll direct you first to page 19 just kind of give you a high level overview of the build quarter-over-quarter and you can see it kind of breaks down into from a from a legacy Renasant standpoint, charge-offs $2.6 billion -- $2.6 million provision legacy at $7.9 million. So on a pre-RBC basis, if we exclude RBC, our provision went from 1.57% last quarter to 1.56% this quarter. So basically, it was flat quarter-over-quarter from a legacy Renasant standpoint. The difference being that the build in PCD, non-PCD loans related to RBC and that's really what you're seeing that increase in the commercial bucket, is that that provisioning and that PCD, non-PCD provision for RBC quarter-over-quarter. Sorry, I missed that. Thanks for clarifying that. I appreciate it. And then maybe just finally, for me. I know you guys have talked about more moderate loan growth. Mitch, I'm sorry, I missed the update on the pipelines in the prepared remarks. But what, what is more moderate growth mean to me? And how much of it is, you guys pulling back in either certain asset classes and, versus what the market is maybe, giving you in terms of opportunities? Thanks. Yes, Michael. And maybe the best way to have that discussion as we look forward is maybe look at the prior quarter. We did indicate there would be moderation, and we have seen that. We started the quarter with a 30-day pipeline of $200 million, that's down from $270 million at the beginning of the prior quarter. The production for 4Q was $700 million. And that moderated down from $753 million. So what we expected occurred. And, of course, that $700 million in production yielded, as Jim mentioned earlier, $396 million in net growth. I think the important thing here just thinking about our ability to produce the granularity both from a geographic as well as our various business lines. I'll give you some percentages of that $700 million in production. 17% came from Tennessee markets, 18% from Alabama, Florida Panhandle, 20%, Georgia, Central Florida, 19% in Mississippi, and 28% came from our corporate commercial business lines. So like say geographically, we're still pleased while it continues to moderate with production. I think equally important, as the geographic is the types. And as I mentioned earlier, just the granularity of our ability to produce and our consumer, which is more one to four family that represented about 26% of that $700 million small business credits, which continues to be a strength in our markets, and that's loans that would be less than $2.5 million in size represented another 10%. And then larger commercial credits about $2.5 million just core C&I owner occupied type credits was another 35%. And then as we've continued to build out and grow our corporate and our specialty lines, which we, of course had an addition there this past quarter, that represented 29%. So we continue to hit on many different cylinders, relative to our ability to produce. The other thing I should mention here is we think about going forward, while production while pipeline production has moderated, so at payoffs. And we saw that again, this past quarter for the last two quarters. We saw payoffs below what we've saw on average in 2022. And well below what we saw in the year 2021. So we certainly remain disciplined in underwriting as well as pricing. And we remain optimistic about our ability to produce driven the markets, business lines, talent. I mentioned in opening comments, just the in-migration that continues in our markets. I think, also previous economic development activity and manufacturing distribution, medical government, education, it's a good definition of where we do business. And certainly that's not looking past at all the economic uncertainties that that exists today. But just a testament to where we do business and our talent. I appreciate the color. So balancing the puts and takes is something like a high single digit from this quarters, 14% annualized growth somewhat in the ballpark? Yes. So Michael, it's hard to be that specific given the -- the variability that we're seeing in pipeline and production. But I think, and the component of payoffs. But I think if you just look at the current pipeline, and, and the change quarter-over-quarter, I mean, it would lead you to that type conclusion. We saw a bit of a tick up in past two loans in 4Q. Can you give us any color there? Hey Tom, this is David, good morning. A little bit of color. For the most part that was that was made up for and when we turn to the first of the year, when we get we look at the first of January. The amount of loans that paid current kind of brought us consistent back with where we would have been in prior quarters. So we don't think it's a -- at this point, a long term trend. It was largely in the consumer space. Our commercial book continues to hold relatively flat quarter-over-quarter. So it's largely driven to consumer. Again, we saw that number return to more of our normalized quarter, quarter in past dues after the turn on. All right, thank you. And then just a bit of a modeling question here for me. With the RBC acquisition, I'm just kind of thinking about the purchase accounting accretion in 1Q. Can you give me any color there, what we should expect? Tom, this is Jim. There likely will be some in terms of the amount of that. I would say it would not be material, but there will be some as we go through 2023. And with no remaining questions, this will conclude our question-and-answer session. I'd like to turn the conference back over to Mitch Waycaster for any closing remarks. Thank you all to -- that have joined the call today. We welcome your interest and look forward to talking again soon. We next plan to participate in the Janne CEO Forum next week.
|
EarningCall_1130
|
Greetings. And welcome to the Prologis Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note that this conference will be recorded. I will now turn the conference over to our host, Jill Sawyer, Vice President, Investor Relations. Thank you. You may begin. Thanks, Diego, and good morning. Welcome to our fourth quarter 2022 earnings conference call. The supplemental document is available on our website at prologis.com under Investor Relations. Iâd like to state that this conference call will contain forward-looking statements under federal securities laws. These statements are based on current expectations, estimates and projections about the market and the industry in which Prologis operates, as well as managementâs beliefs and assumptions. Forward-looking statements are not guarantees of performance and actual operating results may be affected by a variety of factors. For a list of those factors, please refer to the forward-looking statement notice in our 10-K or other SEC filings. Additionally, our fourth quarter results press release and supplemental do contain financial measures such as FFO and EBITDA that are non-GAAP measures and in accordance with Reg G, we have provided a reconciliation for those measures. Iâd like to welcome Tim Arndt, our CFO, who will cover results, real-time market conditions and guidance. Hamid Moghadam, our CEO and our entire executive team are also with us today. Thanks, Jill. Good morning, everybody, and welcome to our fourth quarter earnings call. Let me begin by thanking our global team for delivering an excellent quarter and year. We have had outstanding results despite challenging headwinds from the capital markets and the overall economic backdrop. In the face of this, our focus has been to serve our customers and investors putting our heads down and executing on our long-term plan. As you see in our results, our portfolio is in excellent shape, driven by still strong demand and a continued lack of availability. This foundation for our business not only drove our nearly 13% increase in year-over-year core earnings, but it also sets up the company for sustainable growth for years to come. Turning to results. Core FFO excluding promotes was $4.61 per share and including promotes was $5.16 per share, ahead of our forecast. In the fourth quarter, our operating results again generated several new records. Occupancy increased to 98.2%, with retention of 82%. The Prologis portfolio excluding Duke added 30-basis-point of the 40-basis-point increase over the quarter. While we tend to quote occupancy, it is notable that the portfolio is 98.6% leased, a record that underscores the tightness across our markets. Rent change for the quarter was 51% on a net effective basis. The step down from our third quarter rent change of 60% is a reflection of mix and not market rents. In fact, market rent growth exceeded expectations during the quarter, increasing our lease mark-to-market to a record 67%. These results drove same-store growth to 7.7% on a net effective basis and 9.1% on cash. The Duke portfolio having closed on October 3rd, is fully integrated in these results, with the exception of same-store growth, which will not be reflected until the first quarter of 2024. On the balance sheet, while access to the debt markets have remained challenging for many issuers, we successfully executed a number of transactions during the quarter, raising over $1.1 billion at an interest rate below 3%, including $700 million of new unsecured borrowings out of Japan and Canada. Our credit metrics continue to be excellent and we have maintained over $4 billion of liquidity at year-end with borrowing capacity across Prologis and the open-ended funds of $20 billion, expanded significantly due to our balance sheet growth from the Duke acquisition. With regard to our markets and leasing activity, the bottomline is that conditions remain healthy and there is little we see across our results or proprietary metrics that point to a meaningful slowdown. We see a normalization of demand and when combined with low vacancy, it continues to translate to a meaningful increase in rents. Across our markets, rent growth was nearly 5% during the quarter, driving the full year to 28%. Proposal activity for available space was consistent with our recent history, and given persistent low vacancy, there is simply a very small number of units to even propose deals on. As evidenced, over 99% of our portfolio is either currently leased or in negotiation. Utilization remains high at 86%, near its all time record and deal gestation ticked up over the quarter, indicative of more careful consideration and time being taken in leasing decisions. While we are watching e-commerce carefully, its share of overall retail sales have increased to 22%, which is 600 basis points above its pre-pandemic level. Putting the nuance of mix, timing and other factors aside, as measured by retention, occupancy or rent change, it is clear that customers need to commit to space to market conditions, which offer them very little choice. In terms of supply, the development pipeline across our market stands at 565 million square feet and our expectation for the year is that the pipeline will decline. Deliveries will put modest upward pressure on vacancies from 3.3% today towards 4% later in the year. However, new development starts are slowing in response to the market environment, which will reduce vacancies in late 2023 or 2024. In Europe, we expect deliveries to outpace absorption by approximately 30 million square feet, expanding the current 2.6% vacancy rate to approximately 3.5%. Finally, and as expected, our true months of supply metric grew to 25 months in the U.S. from 22 months last quarter. As a reminder, this metric has averaged roughly 36 months over the last 10 years. In capital markets, transactions continue to be slow in the fourth quarter, making price discovery challenging. That said, return requirements are trending to the low-to-mid 7% range. This expansion further affected appraised values in our funds, although continued rent growth has mitigated some of the effect. Our U.S. values, which were appraised by third parties every quarter, declined 6% this quarter and 7% over the entire second half. In Europe, values declined approximately 12% during the quarter and 16% over the half. Our open-end funds have received only modest redemption requests, less than 3% of net asset value during the quarter, totaling 5% across the second half. Our flagship funds have strong balance sheets with low leverage, largely undrawn credit facilities, cash on hand and undrawn equity commitments. While we believe the value declines over the second half reflect market, investors are still adjusting to a new environment. Because we strive to be consistent in our actions and fair to all investors, we will redeem units call equity and resume asset contributions when price discovery has run its course. We expect that to be one quarter to two quarters away likely sooner in Europe. This will ensure certainty, fairness and consistency to all of our investors. Turning to our outlook for 2023, while our macro forecast assumes a moderate recession, which may put headwinds on demand, our business is driven by secular forces and long-term planning by our customers that should limit the impact unless such a downturn becomes significant and protracted. As mentioned earlier, we believe vacancy will build in the market and our portfolio, both of which are unsustainably low. Putting this sentiment together with our outlook on supply and demand, our 2023 rent forecast calls for approximately 10% growth in the U.S. and 9% globally. We acknowledge that our rent forecasts have proven conservative in recent years, but we are comfortable with this starting point given the environment. Specific to our portfolio and on an our share basis, we expect average occupancy to range between 96.5% and 97.5%, roughly 50 basis points lower than the 2022 midpoint. Combined with rent change, we forecast to generate net effective same-store growth of approximately 8% to 9% with casting store growth between 8.5% and 9.5%. Given these assumptions, we believe our lease mark-to-market will be sustained or even increased over 2023, ending the year between 65% and 70%, and providing visibility to an incremental $2.9 billion of NOI after the more than $300 million that will become realized over the course of this year. We expect G&A to range between $370 million and $385 million, reflecting not only inflation in wages and other corporate costs, but also additional investments we are making in our Essentials business particularly in the energy teams. In that regard, we expect the contribution to FFO from Essentials to range between $0.07 and $0.09 this year. This reflects 70% growth in revenues and tax credits from 2022, but offset in the near-term by our higher Duke related share count and the G&A investments just mentioned. In terms of operational metrics for the business, we expect to add 115 megawatts of solar power over the year driving the portfolio to approximately 540 megawatts by year end. Itâs worth noting that we closed 2022 as the second largest on-site power producer in the U.S., a position we will build upon with our plan for 1 gigawatt of production and storage by 2025. We also forecast to have over 20 EV charging clusters installed and operational by year-end. In deployment, we will continue to be disciplined in our approach to new starts. We have over $39 billion of opportunities to select from in our land bank and between our expectations for build-to-suits and logical markets prospect, we see an active year of starts initially to range between $2.5 billion and $3 billion with a real opportunity to grow as conditions warrant. As mentioned earlier, we plan for redemptions to be cleared out over the year and private fundraising to resume. Accordingly, we forecast contribution activity to occur primarily in the second half and resulting in combined contribution and disposition guidance of $2 billion to $3 billion. Finally, in strategic capital, we forecast revenues excluding promotes to range between $500 million and $525 million, which is impacted by valuation write-downs across 2022 and the first half of 2023. We are forecasting net promote income of $0.40 based on an assumption that U -- that values in USLF, primary source of 2023 promotes will decline further from values at year end, every 1% change in asset value equates to slightly less than $0.02 of net promote income. Putting this all together, we expect core FFO excluding promotes to range between $5 per share and $5.10 per share. At the midpoint of our guidance, this represents approximately 9.5% growth over 2022. We are guiding core FFO including promotes to range between $5.40 per share and $5.50 per share. In closing, this guidance builds upon an exceptional three-year period of sector-leading earnings growth. At our 2019 Investor Day, we presented a three-year plan, targeting 8.5% annual growth, we achieved nearly 14% over this period, 550 basis points of annual outperformance. We expect 2023 to be a year where headlines continue to be disconnected from our business and ability to deliver strong growth and valuation. While there are many unknowns generally, there are more knowns in our business that are clear, such as our lease mark-to-market, significant and visible opportunity in our land bank, a need for excitement for -- a need and excitement for a new generation of sustainable energy solutions, and a dedicated team that is the best in the business and laser focused on delivering leading results. Yeah. Thanks. I guess good morning out there. Tim, I just wanted to clarify in your kind of going through your guidance, you throw out a lot of numbers. I just want to make sure on the mark-to-market numbers that are embedded in your same-store NOI growth of 8% to 9% GAAP and 8.5% to 9.5% cash. Just what are you expecting for cash and GAAP leasing spreads and I just want to make sure thatâs different than the kind of overall portfolio mark-to-market you talked about 65% to 70%? Yeah. They are going to be stronger. As you think about the lease mark-to-market, itâs all of the leases, so it represents old leases and leases just done. So, clearly, everything that will roll next year is going to be above the 67% reporting today. Itâs a little bit flatter than you might expect as we have looked at it. I think leasing spreads next year are going to be in the high 70s to low 80s on a net effective basis and then as we know that the cash basis of that has trended towards about 1,500 basis points or so inside of that. Hey. Good morning, everyone. I just want to hit on the capital deployment side of things, maybe a two-parter here. Just first on the stabilization, so just the kind of the -- what you guys have stabilizing the $2.8 billion at your share, can you just bridge that gap versus the $5.5 billion that you have on page 20 of expected deliveries or completions in 2023? And maybe just give us some sense of timing on that, I know I think about 30% of those are build-to-suits. So also how you are thinking about where the preleasing is on the balance of that as well and kind of how that layers into your occupancy assumption? Yeah. I will take -- Craig, itâs Tim. I will take the first half and Dan can help with the second. This is really a date issue, I would say, not even an issue, but just a function of the date. We have a large amount of that group of stabilization we believe will occur in the first quarter of 2024 and I think there is a very real possibility that if we improve some of the leasing timing by just a month or two, we could see a decent amount of that actually fall back into 2023. So itâs just a function of crossing over a calendar year to lay up the mix of all of our projects is landing. And this is Dan. I will just pile on there. The pre-leasing in that portfolio, as you see, thereâs 29% of that thatâs in there as a build-to-suit. The pre-leasing is better than that 29%, and I would say, on track with historical averages even on a bigger data set here. So we feel really good about delivering our stabilization at this year and next. Thanks and good morning. I was curious about the investment capacity that you show in your supplemental of $1.5 billion is down from $4.2 billion. I just want to understand what that actually represents? And tying that to your comments about contributions perhaps picking back up if conditions settle out, how does that comment compared to the $1.5 billion capacity and how much river room [ph] do you ultimately have an increase on that capacity? Thank you. Hey, Ki Bin. So what I would do with regard to investment capacity is relying more on the way I am describing it in our prepared remarks, the $20 billion and $4 billion or $5 billion across the funds. The number thatâs presented in the sup, which is what I think you are referring to is a bit technical about the current amount of equity that can be drawn in the funds and then that number is levered slightly, so thatâs why itâs a bit understated. The number we supplemented with in prepared remarks is looking at the overall leverage of the fund and how much more capacity sits beyond just that of committed equity post-leverage. So, for example, our USLF venture is very low leverage, just about 10% and that creates an incredible amount of debt capacity, as you can imagine. And I think that winds up addressing your second question, which is the liquidity and the funds for contributions, thereâs a lot there for us to have over time. Hi, everyone. How are you doing? Can you give us an update on the markets in Europe, the mark-to-market there, any leasing trends? I think you touched briefly on the private market transaction backdrop. We definitely see the U.S. mark-to-market getting wider. I guess how do you view demand in Europe and the differences between the U.S. and Europe unfolding in 2023? Thank you. Yeah. Let me start with some general comments. Europe is generally a mild and more muted version of the U.S. both on the way up and on the way down and the market is -- has a lower vacancy rate than the UAE -- than the U.S., if you can believe it. So thatâs a general backdrop. Thatâs very consistent with the way Europe has behaved in the last 10 years or 15years. As to the specifics on mark-to-market and alike, Dan, do you want to cover that? Yeah. Sure. Mark-to-market -- lease mark-to-market in Europe is about 28%, and I would say, just overall, we feel very good about the leasing demand in Europe right now. We talked about at the -- in the remarks about an expansion in the vacancy, but overall, we feel really good about where itâs headed. And the -- you might ask what about the U.K., because thatâs the one you hear about all the time, and actually thatâs really strong, too, so far. So we have actually been surprised on the positive side with the U.K. The other place that is really held up well is actually Germany, which you would have guessed with energy issues would be softer, it hasnât been and thereâs virtually no vacancy in Germany. And some of the manufacturing coming back, particularly autos, et cetera, are really strengthening Central and Eastern Europe the markets, particularly in Poland, where thereâs this perennial vacancy. Itâs sort of tightening up. Thanks. I want to dig in a little bit to the sectors that you are seeing driving leasing demand, letâs say, in the fourth quarter and so far this year, whether you have seen any changes in types of customers taking space versus a year ago? And then, I guess, when we think about the broader retailer bucket, where you did see some retailers reporting year-over-year sales declines in the back half of last year, wondering if any pieces of that category are you seeing less demand? Yeah. The only category that is significantly below the trend and is likely to be that way is housing, because the starts are slowing. But with respect to other detail, Chris, do you want to take that? Yeah. Itâs absolutely right. Generally, Nick, it was diverse. So whether we look at consumer products, whether we look at apparel, food and beverage customers, we have a diverse range of customers leasing space from us beyond the housing categories, which would include construction, it could include home goods and alike. Yeah. And retail sales on a real basis, notwithstanding the weaker for instance December and November are good. I think itâs between 2.5% and 3% up compared to the year before. So, yeah, you do hear the headlines of the weaker with retailers, but I think if you look at it overall, itâs actually pretty positive. Itâs more positive than the headlines. I wouldnât say, itâs super positive, but itâs much better than the headlines. Good morning. Good afternoon. Thanks a lot for taking my question. You clearly laid out the building blocks of your same-store NOI growth of 8.5% to 9.5% in 2023, where you have a high level of visibility, obviously, a lot of macro uncertainty out there. Can you provide the specific assumptions you have used for your initial 2023 outlook and then just where and how a change in the macro environment could provide upside or downside to your initial guidance? Thanks. Macro environment other than, call it, defaults or something that has an immediate effect are not going to drive the numbers big time in 2023, because a lot of the leasing that needs to take place in 2023 is already in progress or been dealt with. We are dealing with very high occupancy levels. To start with, there is not a whole lot of space to lease and the real driver of those same-store numbers is the huge mark-to-market in the portfolio that already exists. So thatâs -- so donât expect, even if we change the assumptions by a lot, the numbers for 2023 are not going to move that much. They will, obviously, move as you get further along into the future. So thatâs one comment I would make. The second comment I would make is that in every year in the last three years or four years, we started the year with rental assumptions that we have exceeded sometimes by a factor of 3x to 4x. So I am not saying thatâs going to happen this year, but there is absolutely no reason in the world to go crazy on our assumptions with respect to rental rates, particularly they donât have an effect in 2023 anyway. So we will see how it plays and if we see evidence of stronger rental growth and my bet would be a surprise on the upside of our assumptions, not the other way around, then we will let you know and you can adjust the numbers accordingly. Tim? Yeah. Just building on that, Michael, if you, within the supplemental, you can see our lease expiration schedule. Out of that, you will see we have about 13% rolling and thatâs a mix of what is stated as expiring, which is another 9%, but also things that we have already addressed ahead of entering the year here. So the footnotes will tell you that. You get to 13% there. SME said, start with the 67% lease mark-to-market. You have got 10% market rent growth for the year. You assume we will get that halfway through the year. One thing we see people get wrong is that will take you to a certain amount of rent change. You actually get half that rent change this year, you get half of 2022âs rent change as well. There is a mathematic thing that you need to be mindful of given the quantum of rent change we are talking about lately. That will all get you to close to 9% and then we backed off an assumption on occupancy loss, which we couldnât point to right now, but just feels prudent in the environment, so we have taken our guidance down there a bit. Hi. Good morning. How should we think about the organic same-store NOI growth for the legacy Duke portfolio in 2023, given them thatâs outside of guidance? Is it lower than guidance for the legacy PLD portfolio in the same ballpark, just given the thought that you do any color you could share would be helpful? Well, it will be lower for one reason anyway, which is that they started at a higher level of occupancy. So putting even rent aside on a same-store basis thereâs less opportunity. They generally had longer term leases because they generally have bigger spaces. So that affects the mix, but Tim? Well, I think, an important thing to remember here and we have seen some people not have this entirely correct modeling is just understanding that on a GAAP basis there will be very little same-store. Thereâs potential for some, but because we mark the leases up to market now at the close on a net effective basis there will be very little same-store growth, thatâs contemplated in our guidance. On a cash basis, I expect it would look quite similar to Prologis. By the way, if I can continue that. One thing that you didnât ask, but itâs important in this context, and Dan can elaborate, is that the rental performance of the Duke portfolio on the few spaces that have come up for releasing or were in progress during the time we were doing the transaction are trending significantly higher than what we had underwritten. Dan, can you quantify that? Yeah. I actually go as far as saying we expect to outperform the operating portfolio to 11% to 13%, call it, now 8% of that is going to come from market rent growth, so really 3% to 5% of that comes from just operating that portfolio in the Prologis platform. Thanks. Tim, you mentioned in your prepared remarks that the outlook for 2023 assumes a recession and if we look back to previous recessionary cycles, usually we get declines in consumption, which drives lower demand for industrial space. But we have also never started a cycle with kind of persistently low vacancy like we have right now or tailwinds from e-commerce and supply gain reconfiguration. So kind of within that backdrop of assuming a recession, how do you think it could be different this time and kind of what do you have baked into your numbers for that for 2023? So given that Tim was in kindergarten when cycle started, Tim and I are a little bit different than our recession outlook, but I donât think it matters. I think Tim would tell you that if thereâs a recession, thereâs a very mild recession and my bet would be that we wouldnât have a recession, but it would be close to zero GDP growth for a while. So call it recession or no recession, but the same outcome. I think whatâs different about other cycles and I say that with a lot of dislike for the phrase thatâs different this time is that, there were really two situations where we had negative absorption in the U.S., which is where we have data. One was on the hill of dotcom and there you had a high vacancy rate. On top of it, you had a very low utilization rate because there was a lot of capital for these dotcom, particularly e-commerce retailers and they were taking space way ahead of demand, so there was a lot of shadow space too. So when you add those two, it was a very, very high vacancy type of market during that time, so 2000, 2001 timeframe. The next time you had a pretty significant negative absorption with 2008, 2009, and we all know the reasons for that. And there, you also started with a significantly higher vacancy rate. I think it was 7% or 8% before the music stopped and all I can tell you is that, Prologis -- the old Prologis with the funny LA loan [ph] had 52 million square feet of vacant spec space that they had to lease. I think AMD at the time have like 8 million square feet or 9 million square feet. So nothing like you are talking about here, particularly given the different scale of the company and how lease we are starting out. Now even in that situation where we are normally at about 95% occupancy, we went down to about 91% in both cases. So I donât see anything near that. I mean itâs mathematically impossible. Even if absorption goes to zero right now, we donât lease any more of the under development spec space and absorption goes to zero, I mean, you will be under 5% vacancy, which used to be considered a great strong market. And the capital up, we didnât have this kind of mark-to-market. I mean the mark-to-markets in those days were in the mid single-digit range and now we are talking about 70% almost. So a very different picture. Yeah. Hi. Thanks. Good morning. I just had a question about market rents actually, so the 10% market rent forecast in the U.S. Can you just discuss that or break it out a little bit for us in terms of coastal versus non-coastal in terms of your expectations just in the context of supply growth that you are seeing and the demand backdrop in general? Yeah. Hey. Itâs Chris Caton. So indeed we expect 10% in the U.S. thatâs going to vary. Typical spread between coastal, non-coastal is 300 basis points to 500 basis points, at least thatâs where it was running, say, pre-pandemic and we expect a wider spread in the current environment. So whether you look at vacancy, whether you look at the under construction pipeline, whether you look at the momentum in pricing in the back half of last year including fourth quarter that leads you to conclude on the coastal outperformance continuing at a greater than historical average in 2023. Hey. I just want to go back to some of the comments on the third-party management. I think you talked about valuations being down 7% in the back half of last year and potentially continuing into this year and the redemptions potentially ending in the first two quarters of the year. I just want to get a sense, any more color how are you thinking about that, is it because the valuations have been repriced that you expect sort of the redemptions to stop? What should we be looking for to get more confidence in that? Thanks. Yeah. There are two things that usually drive redemption requests. One is sort of the denominator effect and people needing and two is some folks want to arbitrage the lag between the -- how quickly the public markets adjust and the backward looking appraisal process. In our experience in past downturns, the second has taken about three quarters to be fully reflected in appraisals. So we really donât want to disadvantage one group of investors. By the way, the vast majority of our investors, 95% of them, because a couple of points of people want to arbitrage that difference, so we want to make sure the valuations are right before those things transact. We think Europe has actually adjusted quicker than the U.S. and thatâs why we think thereâs maybe another quarter to go before Europe fully adjust. So we are committed to taking care of those redemptions in the next quarter. And we think the U.S. may take another quarter to adjust and we will take care of those in the second quarter. Here is whatâs important and people donât get about the structure of our funds. First of all, our leverage is in the low 20% range on these funds. So thereâs oodles of liquidity in these firms to basically be able to handle any redemption requests -- any reasonable redemption request. And secondly, we started with the Q and we started with some cash on hand. So, again, there are lots of sources for addressing those redemption requests. I think you should assume that redemptions that have been effective as of the end of this quarter will, by and large, be taken care of by the middle of the year and sooner in Europe. So you can model that math beyond that. Now I will tell you one other thing, which is kind of interesting. Prologis could be a buyer up in these fronts, and in fact, even in the global financial crisis, where the old AMB was in a tighter spot with respect to leverage, we actually stepped up and bought on very attractive terms with adjusted values, a couple of hundred million dollars of real estate and we actually offered it to our outside investors first and then we stepped in and bought it. And you know what, the next quarter, all the redemptions went away, because people realized that the people who know the most about this portfolio are buyers at these prices. So itâs really about getting the values, right? And we started writing down these portfolios a quarter or two ago and our appraisal process is independent. We have nothing to do about it and thatâs very, very different than some of the redemption situations that we have all been reading about. Hi. Good morning. On your development guidance, can you give us some color on how much conservatism is built into your development starts? And also you are expecting another year of strong stabilization, what assumptions are you making in terms of timing of these projects and is any of the increase in guidance driven by projects from last year taking longer to complete due to longer construction time lines? This is Dan. Let me start with this yearâs development start guidance. We are coming off our largest year of starts ever, and just given the macro headlines, we decided to take a little bit more balanced approach where we slowed our starts at the end of last year. We donât expect to start up in earnest until the last half of this year. We think the build-to-suit business will pick up at the same time. So call it conservatism, I call it discipline and just feel really good about our approach, given the volumes over the last year or two. And then stabilization next year, stabilization this year, Tim mentioned it earlier, we think we can outperform. What we have in the books right now, demand continues to be strong. We talked about the development starts plummeting in the marketplace in the fourth quarter. We think they are going to be slower in the first half of the year and we think that bodes well for absorption in the last half of this year into next year. So we feel very good about our guidance. Yeah. There has not been a material delay in any of our construction project, if you look at them on an aggregated basis. So that is not -- that has not shifted stabilizations from 2022 to 2023 or anything like that. Yeah, I canât even think of an example that comes close. And even on the cost side, because we have been thoughtful about procurement and securing some of these type supplies ahead of time. Thatâs been actually something that we use as a competitive advantage in marketing to build-to-suits, because we have got a bunch of steel and we have got a bunch of air conditioning units and electric panels and things that are insured supply are already sitting in our warehouse waiting to be deployed into our land bank. So no, thereâs nothing funny going on about that, and by the way, the stabilizations are not just a function of completion of construction, but also leasing being stabilized at 90% or more and that factor hasnât delayed stabilizations either. We have been leasing actually ahead of plan to this day and I think we will -- I expect to continue to do that. Thank you. On the subject of fund redemptions, there are some unlisted funds or non-traded REITs with a different leverage profile than yours, different investor base that are seeing a significant amount of redemption requests and I was wondering if you anticipate this will lead to increased asset sales on the block and potentially some more opportunities for you on the acquisition side? I hope it does. I am not optimistic that it will, because if you look at even the denominator problem for most institutions and the fact that they generally have to reduce their exposure to real estate, they are likely not going to want to reduce their exposure to industrial. So I think and with these -- most of the open-end funds, where it would be -- where their mix, they are different property types, the industrial is whatâs holding up their performance. So for them to disclose those would put them in even a more difficult situation. So I donât think there will be a lot of for sellers in industrial, because to the extent that you are dealing with a leverage issue or a liquidity issue, if you sell your highest yielding assets, you keep tightening the coverage and noose around your neck. So as much as Iâd like to, I donât think we will see a lot of that. I think where we could see opportunity is actually within our own open-end fund availabilities. If the redemptions continue and we think the values are good, first, we will offer that to all the third-party investors and then we will step in them buy and we like that real estate. We know it well, and we operate it, and if itâs priced right, we are all buyers, no problem. Yeah. Thanks. I guess, Hamid, I understand that PLD in the industrial space in general are pretty well positioned in the current environment despite the uncertainty, but is there anything that you are watching out for any specific risks that you foresee for this space here in the next year plus or so? Yeah. We are watching everything really carefully. I mean I am not -- believe me, we have been through enough cycles and enough where things can happen that none of us predict that we want to be vigilant. Thatâs why we are starting out the year with very conservative assumptions and things that we can deliver. I mean, I think even on this basis, we are going to, I think, put up unbelievably good numbers. I mean, who can think of almost a digit kind of returns or growth off of such strong growth, 14% per year earnings growth consistently for the last three years. So I think the arrow is up. But, yeah, I mean nobody predicted Putin going into Europe last year. Itâs usually the stuff that you donât -- you canât predict. I mean, am I worried about inflation really thanking our numbers? No. Am I really worried about recession thanking our numbers? No. Am I worried about e-commerce going out the window and people going back to shopping deals the way without that percentage going up? No, I am not worried about those things. But I am worried about things that I donât even know what to worry about. You get my drip there, anyway. So, yeah, thereâs always bad stuff that can happen that are out of the realm of normal projections. Hi. Good morning. Question on utilization, which increased in the quarter, what drove that growth given all the headlines we see about port volumes were not declining and how big of a driver of the higher utilization is for your outlook for this year given the strong outlook this year? Yeah. I donât think utilization actually moved that much. I mean the peak utilization ever all time was 87%. And I think that 1 point is well within the sampling bias that can take place, because itâs not a perfect data set. Itâs a sample of large data sets. So I donât think thereâs a meaningful trend in certainly not a decelerating trend in utilization. With respect to port volumes, I think, port volumes are pretty meaningless in the last -- really since COVID started, because there were so many fits and starts and play things being in the wrong place and all that. And yeah, the West Coast ports have lower volumes today than they did before, but the East Coast and golf ports are getting a lot more volume than they did before. So on an aggregate basis, port volumes are just fine and if you look at the lag that it takes too many empty containers on one side of the ocean, and factories shutting down on the other side of the ocean and all that. I think until the market normalizes, you canât really draw any conclusions from port volumes. So I donât see either one of those two trends affecting demand. Chris, do you want to? Yeah. I will just build on that by saying two things are also happening. One is market vacancies in the U.S. are 3.2%, 3.3% lower in Europe. That, in its own right creates some pent-up demand and so thereâs a need to push utilization within the facilities. And then second, look, inventories are up 15% on a year-on-year basis -- on a nominal basis and 9%, 10% on a real basis. So there is real structural demand, lifting new demand, as well as in-place customers. Yeah. Notwithstanding that increase in real inventories, we still think we are less than halfway towards equilibrium level of inventories about 45% of the way there. So we think thereâs a lot of tailwind behind inventories, too. Great. Thanks. So related to that last question, and Hamid, your comments on that progress towards equilibrium inventory, can you just talk about your recent conversations with customers? Whatâs your sense for how they are balancing this investment need and CapEx spend against concerns about the economic slowdown or recession and higher overall cost of capital? Yeah. I will pitch it to Mike for more detailed comments on this. So my sense is that customers are -- donât have quite as much fomo as they did before. In other words, they are not in the hard mentality of letâs go get this place, because if we donât, somebody else will and all that. I think the market has rationalized with respect to pace of leasing demand and people are being more thoughtful about how they go about their thinking space, because forget about what they pay us in rent. I mean every time you open a new large warehouse, thereâs a lot of CapEx that goes into it and all that, real estate is the least of your worries. Itâs all the other stuff that you have to put in. So I think people are cautious, but they also realize, particularly on the e-comm side that this was a theoretical threat before the COVID. Now they see what really happened to their business during COVID. So they are very anxious to build out their full e-commerce supply chain, which is oftentimes a different one than their bricks-and-mortar supply chain. So I would say, demand has broadened, itâs much less all about Amazon, itâs much broader than that. But itâs pretty strong. Is it the strongest itâs ever been? No, itâs not as strong as 2021. But compared to any 10-year period you want to look at, itâs -- we would consider this a very strong market. Mike? Yeah. I would just to pile on. I mean, on a net basis, the activity is still very strong, decision time line is definitely have stretched out of people to be more cautious. But remember, these structural configurations we have been talking about for two year or three years continue to march on, perhaps, at a bit of a slower rate, but ultimately, it comes down to the fear of not having the right space when you needed to hear from now is overwriting, taking space thatâs a little bit too early. So broadly we feel pretty good about this overall activity. Hey, guys. I just want to follow up on these demand discussions, because this is a constant question I get from clients here and maybe itâs more of a Chris question, but Hamid feel free to jump in, too. Just in terms of in these era of low vacancies were really not in the least, so net absorption is not necessarily the best leading indicator of demand. I mean what are you guys using at least to kind of use as your forward-looking indicator on and destruction or something that the market could look to, because it just seems like retentions are still high, availability is low, construction could fall off, but everyone is talking about inventories big higher, utilization will be higher, so people needing less of the space, but itâs just from your commentary, it seems like this is not really filtering through what you guys are seeing and just some thoughts there. Then related to that, Chris, I mean, what would it take for market rents to actually turn negative, because thatâs a question I get a lot as well and I am just kind of curious in your modeling kind of what inputs with that to really turn to get that from the positive 10% you are seeing to somewhere below zero? Okay. Let me start. I am sure Chris can give much more color. I would state this, in 40 years ago on this, this is the biggest disconnect that I have seen between the macro economy and the prospects for our business. Usually, those things -- two things are much more aligned and this time around, they just appear to be completely disconnected for a variety of reasons that we talked about at nauseam. So I think where pricing goes away is, vacancy is going to 7% to 8% and staying there. And if you do the math on that, you need another in the U.S., I donât know, 2 billion, 3 billion square feet of unleased construction coming online and you canât do it overnight, maybe 1 billion something median. We can do the math. But itâs a big number and you are not going to keep doing that if space that -- if the first 100 million feet doesnât lease, you are not going to do that. And by the way, this cycle, you have a couple of big players in the business that have much more to gain from the fundamentals of the business being stronger, rents being stronger than a few bucks they may make on additional development. So there is an economic incentive to be disciplined. In prior cycles, mostly driven by merchant builders and private developers, they donât really care what their rental market was. They just wanted to build the product and sell to somebody else and that will be their problem. Today, those two sites are connected to one another. So I think that the motivations are really different and absent the nuclear work type of scenario. I just donât see vacancy rates going to a level that will lead to a reduction in rents. Itâs either going to be a demand collapse or a supply explosion and I donât see either one of them happening. The other thing I would say is that we are -- we leased 1 million square feet on a daily basis. Just -- letâs get our heads around that, 1 million square feet on a daily basis. We throw these big numbers around without really fully appreciating what the scale of that is. I mean that is 10x the amount of space than anybody else in leases in any sector in real estate. So by watching these customers and their behavior, obviously, we will figure out if some back stuff is about to happen and wonât be waiting for the quarterly report to analyze that. So, Chris, do you have specifics? Yeah. A couple of specifics, I would lead with our proprietary data leads us to these conclusions. So for example, our sales force pipeline, if we look at the vacancy that we do have, 46% has deals working. Thatâs in line or above the average that we have experienced through COVID to say nothing of the conversations that Mike and Scott and our customer led solutions team have. In terms of public data, which I think I heard you ask about, Craig. We do publish our IBI survey and our utilization data and so figures like 60, on our IVI, itâs a diffusion index. So thatâs consistent with this good or great tone that the team has struck and 86% on utilization, which was discussed earlier are ways that you can see that in the marketplace. And then as it relates to what it would take for rents to fall, Hamid described it very specifically. And Iâd add one piece of data that, I donât see commonly discussed in the marketplace, but itâs important to know, which is development starts rather than development completions. Starts in the U.S. were off by a third in the fourth quarter relative to their 2022 trend and on the Continental Europe, they were off by 45%. So we are seeing a sharp marking to market at the capital market environment, the valuation environment and what those buildings might be worth for some of those other folks building buildings. By the way, banks are a lot more disciplined, because now they have risk-based capital requirements. So putting out a lot of construction loans on buildings that donât lease like used to happen in prior cycles less likely to happen. So I think the market is generally smarter. Thereâs a lot more data. Conversations like we are having today never used to take place two decades ago. So the cycles were much more amplified. I think itâs pretty hard for that to happen. But something can come out of left field. I am not discounting that possibility. Something really bad to come out of left field and change all this, but I just canât think of what that thing would be. But none of us predicted the pandemic I donât think. So things can happen. Hi. Thanks for taking my follow-up. I just want to get any color on recent market rent growth and how that may differ between suite size, like are you seeing any differences in performance between bulk buildings and smaller more infill facilities? I would generally tell you that the smaller spaces are having a tougher time to the extent of anybody having a tougher time, but Chris is looking up the specific. They are not radically different, but why donât we do this, why donât we go to the next -- you got it. Right. No. Glad to help you out here. First off, market rent growth had great momentum at the end of the year with 5% growth in the U.S., 3% in Europe. When we look at rent change, which is a great way to understand performance in suite size, itâs strong across the board. But in fact, late in the year, we saw an improvement in those smaller units, when -- which might be where you are your question is coming from, so it⦠Okay. Thatâs different than I would have guessed and I bet you itâs because there was more available space to absorb in those categories. Those categories were less leased. And by the way, we have them, too. I mean we have some smaller than 100,000 square foot unit. So I would say, occupancy was a little bit lower, so there was more room to lease product at the higher end. If we flip it to submarkets and we look at, say, infill which tend to have those smaller units, infill outperformed in the U.S. by 500 -- 400 basis points last year, so say, 34% and in the U.S. in the infill submarkets versus 30% for the whole of the United States. Great. Thank you. Just a quick follow-up from Blaine and myself. So where do you expect to make the most progress on the Essentials business in 2023 and how does that factor into your guidance and earnings? And then also if you could just say where you think cap rates are today versus the peak of the cycle, how much they have moved? Thank you. So two things. I think the Essentials business, in terms of percentage growth, I think, our mobility business would be the biggest, because itâs the smallest right now to start with. So any growth will be the biggest. But in terms of dollar contribution, I would say, solar and storage are coming on the strongest today and operations is to close second behind. I will pitch it to Gary if he has any more to say about that after this. Second part of the question was -- oh, cap rate. So cap rates are really misleading. So we got to be careful about that. Cap rates at market, assuming that you had a building a year and a half ago at market and you have a building at market today, I would guess itâs 50 basis points to 75 basis points maybe 100 basis points, okay? Itâs -- call it, 50 basis points to 100 basis points. But you have had all this rental growth in between. So the observed cap rates for the same building this year versus last year with rents that are higher by, I donât know, 10%, 15% or something, would not have moved as much. So, and if you get into weird situations, like some building that was leased five years ago when it comes on the market and itâs -- and the in-place rent is less than half of what market is, that building could have a lower cap rate than it would have had a year ago. IRR is whatâs really important based on reasonable assumptions and my guess is that if I were going to pick a number, I would say, low to -- low 7, 7.25-ish in the U.S. and maybe a little bit lower than that in Europe with growth of, say, 4%-ish percent across a 10-year projection, something like that, approximately. Gary, anything on. I think you got it exactly Hamid. I mean to say, in 2023, our mix is going to be about 50% operations and about 50% energy and mobility. The growth rate, obviously, mobility is going to be much higher because itâs coming off of basically a zero base. Where are we investing? We are investing in our energy and mobility businesses. And thatâs where we are doing the capability, because actually see the most significant growth of 2025 and beyond. But I mean, just to put a set of stake in this, we are very, very convicted about the potential for these businesses. We are on track to generate our $300 million in revenues and tax benefits by 2025, which we have talked about before and that is going to deliver about $0.25 per share in FFO. And that would be a little bit above our -- that will be about 100 basis points of growth per year compared to our 2019 Investor Day estimates of about 50 basis points. So net-net, look, we are in great shape, that business is growing right on plan and we are going to continue to make investments in that business and this year itâs going to be in mobility and energy. By the way, that 2025 number that Gary just mentioned, itâs going to be recapturing maybe 15%, 20% of the total opportunity within our portfolio. So there will be a huge runway for growth, and frankly, we are beginning to see more deals out of our own platform, because customers are taking us to buildings that they lease from other people to do the same level of service to them in those other situations. So I canât even begin to quantify that out of platform opportunities. So we are really excited about our Essentials business. Okay. I think we are at the top of the hour. I know we have one more question, but maybe we can take that outside the call, Anthony, with our apologies. But thank you for your interest in the company and we look forward to seeing you next quarter. Take care.
|
EarningCall_1131
|
Greetings. Welcome to ConnectOne Bancorp Incorporated Fourth Quarter 2022 Earnings Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. At this time, I will now turn the conference over to Siya Vansia, Chief Brand and Innovation Officer. Siya, you may begin. Good morning, and welcome to today's conference call to review ConnectOne's results for the fourth quarter of 2022 and to update you on recent developments. On today's conference call will be Frank Sorrentino, Chairman and Chief Executive Officer; and Bill Burns, Senior Executive Vice President and Chief Financial Officer. I'd also like to caution you that we may make forward-looking statements during today's conference call that are subject to risks and uncertainties. Factors that may cause actual results to differ materially from expectations are detailed in our SEC filings. The forward-looking statements included in this conference call are only made as of the date of this call and the company is not obligated to publicly update or revise them. In addition, certain terms used in this call are non-GAAP financial measures, reconciliations of which are provided in the company's earnings release and accompanying tables or schedules, which have been filed today on Form 8-K with the SEC and may also be accessed through the company's website. Thank you, Siya, and good morning, everyone. We appreciate you joining us today. ConnectOne just completed another solid year. We generated high quality earnings, achieved extraordinary organic growth, gained traction in our markets and continue to digitize our infrastructure. As we think about our results, I'd like to emphasize our ongoing commitment to supporting our client's needs. Despite the ups and downs of interest rates or the economy, ConnectOne's client centric business model has continuously -- has continually served us well. And like I've always said, if we do that right and we do things for the right reasons, we can create long-term shareholder value. And so notwithstanding the challenging economic environment, we once again delivered strong financial performance for the quarter. Return on assets exceeded 1.3%, while our return on tangible common equity was nearly 15%. Our PPNR as a percent of assets exceeded 2%, the 10th consecutive quarter that PPNR has been higher than 2%. Tangible book value per share advanced another 4%. Our efficiency ratio again was below 40%. Capital ratios remained strong. And while much of the industry has experienced weakness here, our tangible common equity ratio stands at over 9% at year end. We also capped off a record year for both loan originations and deposits. Our loan portfolio increased over 19% year-over-year, while our deposits grew in excess of 16%, benefiting from the recent investments in our team, infrastructure and the digitization that we've shared over the last few quarters and seeing a healthy diversification in our portfolio. Our originations were spread amongst all segments of our markets, including Southeast Florida and Eastern Long Island with additional synergies driven through BoeFly in both SBA and non-SBA lending verticals. ConnectOne's strong performance in 2022 is a testament to the success of our culture, the technological foundation we've built and our relationship focused origination franchise. That said, it's important to note that despite consistent performance, each quarter has its own set of challenges and opportunities. Like many banks, we had a challenging quarter with respect to net interest margin. The deposit competition significantly increased reflecting the Fed's intensified battle with inflation. In addition to the rapid and significant rise in short term interest rates, quantitative tightening has removed liquidity from the financial markets, even if the economy continues to grow. As a result, by decreasing the money supply, there is an overall decline in deposits within the banking system and this has led to historically fierce competition for interest bearing deposits among both large and small banking institutions. With our loan portfolio -- while our loan portfolio rates are increasing at a nice pace around 50 basis points sequentially, credit spreads for bank loans continue to remain low from a historical perspective. And finally, while the inverted yield curve puts additional, albeit temporary pressure on the NIM, we made the decision to maintain and support our client relationships [indiscernible] main focus on serving our clients, supporting our staff, delivering value to our shareholders and improving and building upon our distinctive operating platform, all while maintaining our results oriented client centric culture. Our business model has performed well across a variety of economic interest rate environment. We always set ourselves apart by making it easier for our clients to do business with us, while empowering them with the latest technology to meet their evolving needs. And we enter 2023 well positioned to build on our strengths and achieve our long-term objectives. Speaking of technology, several of our investments are moving through to implementation and are focused on providing a better experience for our clients, while driving increased productivity and efficiency. Our partnership with MANTL to deploy a new modern omnichannel deposit origination platform is underway and this partnership allows us to expand our reach in supporting commercial, small business and consumer clients, while optimizing our workflows. Our partnership with Nymbus, the launch venture arm, the new branded business vertical on a lean and nimble cloud-based tool is nearing launch and will provide bespoke banking services designed to meet the demands of high growth venture backed technology companies. Turning to BoeFly, our online business lending marketplace, we continue to enhance its infrastructure, add new users, increase our client's overall workflow efficiency and drive revenue. Now turning to credit, our credit performance remained strong and while Bill will provide some additional detail shortly, we saw improvement in credit metrics during the fourth quarter. Our NPAs declined by more than 20%. Our delinquencies as a percentage of total loans remain near zero and we continue to prudently maintaining reserve levels commensurate with our organic growth and the changing macroeconomic forecast. We ended the year with a very strong capital position across all regulatory ratios, in addition to the cam -- tangible common equity ratio, which is hardly been impacted by AOCI. We've also been investing in our business. And as we enter 2023, I'm excited to build on the early successes we've seen from the launch of our new healthcare team and our expansion into Southeast Florida and Eastern Long Island markets. With that, we remain confident in our ability to drive value for our shareholders. And similar to previous years, that could include our board evaluating future dividend increases and reinforcing our belief that ConnectOne shares are undervalued potentially utilizing share repurchases, all subject to market conditions. So to wrap things up, we're dynamic, highly valuable franchise and we're pressing forward and leveraging our client first operating model. Enter 2023 with a deep capital base, strong earnings that can support multiple growth initiatives. And in short, I'm confident that we'll continue to produce opportunities for our clients, our team members, and our shareholders. We look forward to sharing our progress in the quarters ahead. All right. Thank you, Frank. Good morning, everyone. I'm sure many of you are waiting my commentary on the net interest margin, both for the current quarter and give you some guidance for 2023. But before I get there, I'd like to review what was a stellar year for ConnectOne. Our operating earnings were a record representing 2.2% of average assets and they were up nearly 12% from the prior year. Period end loans grew by 19% and deposits by more than 16%. Our tangible book value per share increased another 8% in 2022 after increasing by 15% in 2021, that's close to 25% in two years. And that reflects not only our strong core earnings, but also effective management of our securities portfolio and the result in AOCI and the fact that we've grown organically and not through M&A. Credit quality, those metrics improved even further with our nonperforming asset ratio decreasing for the fifth consecutive quarter to 0.46%. And as many of you are aware, some of those non-performing assets include a small and declining exposure. We have tax medallions, which by the way already have a very comfortable reserve recurring value. Excluding those taxi loans, our NPA ratio was cut in half to 23 basis points. And delinquencies that is loans past due 30 days or more were next to nothing, just 2 basis points of total loans. Our net interest margin, which has been under pressure recently came in at 3.70% for the entire year, that's a record for ConnectOne and higher than most in the industry. And our efficiency ratio was 39% for the year even as we invest in technology, reward and build our staff and prepare for crossing the $10 billion threshold. So when you combine our strong growth with a wide margin, an efficient back office, strong credit and balance sheet management, the result is upper quartile, if not higher returns on asset, equity and tangible book value per share growth. And that kind of performance gives us the flexibility to manage for the long-term, which is nothing new at ConnectOne. For example, while some of the industry achieved efficiency by cutting costs, ConnectOne's best-in-class efficiency is based on strong revenue and a scalable operating platform as we invest opportunistically and where needed to ensure the long-term success for the company. In a similar light and turning to today's challenges, we reviewed the landscape and made a strategic decision to be more aggressive with deposit rate competition to proactively both retain our existing clients and grow our core commercial client base, which we believe will drive long term benefit. We are one of the top commercial and business banking franchises headquartered in the Metropolitan New York region. We don't focus on ancillary business lines that can be both volatile and troublesome, rather those businesses, segments, and clients we know and serve best. Now let's dive a little deeper into some of the factors impacting our margin, many of which either have or will be impacting many others in the banking industry. And as I said before, we had previously anticipated pressure on the margin, given that we're already operating at record highs. Now let's talk about the two primary tools to the Fed's disposal contained inflation, which are: one, increasing the Fed's funds target rate; and second, open market access to contract money supply. First, that short-term rate -- that rise in short-term rates has provided greater incentive to the positive, the transfer of balances out of noninterest bearing accounts. We are seeing this, the whole industry is experiencing it. And that intentional upward push on short-term rates had the effect of inverting the yield curve. And that too is putting pressure on loan spreads and margins. Second, the tightening of money supply, which results in increased competition for deposits, competition that heats up during the fourth quarter and that is essentially what is accelerating deposit betas. One more item impacting the margin is a significantly lower level of loan prepayments and therefore the associated prepayment penalty income is lower. These items have combined to cause a larger than expected compression to our margins. But keep in mind that net interest income for the quarter was about flat sequentially and is up 11% from a year ago. Now, going back to some of Frank's comments I want to reiterate, that although we carefully watch and are cognizant of Federal Reserve policy and do all we can to lessen the impact of economic condition, those things are somewhat out of our control and tend to be temporary. Where we are keenly focused is on managing things in our control, which is more specifically serving our clients. And we have been extremely effective at maintaining and solidifying strong client relationships and then capturing new market share, especially where clients are feeling particularly displaced by M&A. Ultimately, that will continue to make us a consistent earner, maintaining a prudent approach to growth in terms of both credit and spreads, managing our expenses and maintaining our culture, all those together over the long term will continue to drive shareholder value. Now looking ahead, we're going to continue to focus on gaining market share of market rates. We do believe things have calmed down slightly, however, there was still potential for several rate hikes and continued contraction in liquidity, so there will likely be continued pressure on the NIM in the short-term. However, when condition settles down, when the yield curve resumed its normal upwards stuff, we aim to be back to where we are today or even slightly above. Now moving to other items impacting the financials, we saw modest seasonal provisioning this quarter related to both organic loan growth and a slightly continued deterioration in Moody's economic forecast across a range of specific metrics. The quarter's charge offs relate to the successful workout of non-accrual loans identified and reserved for in previous periods. And therefore, it did not materially impact the provision this quarter and certainly are not any indication of an upward trend in charge offs, the net charge off rate for the year which is just 7 basis points. And just to reiterate, all indications at the present time point the solid asset quality metrics. As far as noninterest income, we are probably just a little light versus Street estimates, but we have a pipeline of SBA loan sale gains building through both BoeFly and traditional sources and we are optimistic that that will be increasing source of revenue for ConnectOne. In terms of other expenses, inflationary pressures persist and are impacting our numbers to some degree. As it's typical for ConnectOne, there usually is an increase in sequential expenses heading into a new year and I'm estimating that to be about 4% for quarter one. But I'm targeting relatively minor expense increases for the remainder of the year. We finished 2022 with the 13% increase in staff over that -- over the course of 2022. I expect that rate of staff increase to be much lower in '23. I also wanted to mention that we will be calling $75 million or 5.2% sub debt on February 1, in just a few days. We pre-funded that in 2021 with a non-cumulative preferred stock issuance. So we end the year with a nice capital level and assuming solid growth. We would plan to recommend dividend increases and stock repurchases for 2023. Thank you, Bill. So, as you all heard, we made some significant strides in 2022 and from market expansion through the addition of new talent and business lines and leading investments in technology and infrastructure. We certainly laid a lot of groundwork to capitalize on new growth opportunities in 2023. Even with the number of uncertainties hanging over the industry, our strategic priorities for 2023 are very clear. We're prepared and geared to continue to smartly gain market share. We have a dynamic team of bankers with a proven ability to execute. And I'd be remiss if I didn't acknowledge all of our team members who made 2022 the success that it is. We had a scalable operating model that continuously evolves by leveraging technology. We continue to view 2023 as a year that will be riped with opportunities for continued expansion of our prudent growth [Technical Difficulty] given the M&A disruption and our proven success at capitalizing in these moments. So we're excited for the future ahead. And in our view, ConnectOne continues to generate meaningful shareholder value and remains a very compelling investment opportunity. Thank you. [Operator Instructions] Thank you and your first question is from the line of Frank Schiraldi with Piper Sandler. Please proceed with your questions. Just wanted to start with the margin and I always looking for any color I can get, but, Bill, in terms of mentioning, we got a -- it looks like another couple of rate hikes potentially here early in 2023, at least that's what the forward curve is saying in them. You mentioned additional contraction from here. Just wondering if you can give any color on your thought either, just the deposit beta you guys are using now through cycle or alternatively where you expect the NIM could kind of bottom out if that's the trajectory of things in sort of the rate outlook? Yeah. Listen, first, I think the major concern is the contraction of liquidity, which is forcing competition and we monitor that all the time and it continues -- that continues to strength our balance sheet and decrease the money supply even as the economy is growing. So everyone is facing that competition. And if they haven't faced it or their deposit betas are slow today, I believe that they will start to increase if the Fed continues that. In terms of our margin compression going forward, I think it's going to beat a little bit. I just want to be conservative here. We're putting loans on at 7%. We are still funding anywhere from 350 to 450. So the spreads on new business are pretty good. But again, I just want to be conservative because I think the Fed is continuing -- going to continue to be aggressive. Okay. I guess, when we think about that 350 to 450 level of funding, just curious if you can put a little bit more color around what sort of duration you're focused on in terms of the CDs you're putting on the books? And if that's -- what it was in the quarter and if that's likely to continue -- Right, it's hard to say what the duration of all funding is going to be in the future, but what we're going into the marketplace is in the one to two year range for those CDs. Listen, I believe so, there could be continued competition that could make things a little bit more difficult. And you know, there is always potential for outflows of noninterest bearing deposits, which I see you're seeing all your -- all the banks recovering as the same sort of situation is happening. And then lastly, just on capital return, you mentioned the stronger capital side of things. You mentioned buyback and potential dividend increases. Is there -- where we sit today? What the stock rate is today? Is there preferred method of capital return? And also can you just remind us any sort of targets you had have on the -- into the TC or regulatory capital side for 2023? Well, without getting into a specific target, I think that our capital generation is going towards seeing our asset growth. So there's going to be the ability to return capital. The second thing is, our dividend payout ratio remains one of the lowest out there around 19% or 20%. So we have room to move that dividend up just on that basis alone. All right. So I follow-up to kind of the last line of questioning around [indiscernible] and Bill taking into account your expense guide kind of thoughts. I mean, is it fair to kind of summarize that by saying, obviously, this was the first quarter in a while where you guys saw the efficiency ratio dip over 40%, but it seems like it's going to be in that low 40% range for this year with the hope that maybe you could improve that a bit. Once the rate environment stabilizes and the rebound as you kind of guide -- kind of gave the build out towards Bill. Is that generally kind of a fair [indiscernible] be thinking about it at this point? I think it could be that we are -- we've always said that we could be a little bit below 40%, a little bit above 40%. But over the longer term, I believe with our scalable operating platform that we're going to continue to drive that efficiency ratio down over time. Yes, it's impacted by the margin. And I did mention in my comments, when the yield curve returns to its natural state will be a lot better off and our margins will expand at that point? Okay. And just on the growth piece, I apologize if I missed this specific number or view, but I felt like I kind of heard two different tones. There was a comment I think Bill you made about how you guys are going to be aggressive at maintaining customers at kind of building share, but then I think there was also a comment about environmentally like scaling growth back because of the funding environment. Maybe I misheard that latter one, but just -- can you remind us what the growth expectations are for 2023, just more specifically taking into account those kind of broader backdrops? Yeah, I -- Mike, I'm sorry if there was any confusion, but from our perspective, we're not looking at growth as a function of the NIM. We're looking at supporting the existing clients we have, taking opportunities in the marketplace to grow new clients. And the NIM will be what the NIM will be. I know there are a number of institutions that have made the decision to allow large amounts of deposits to walk out the door, we just seem to feel that we are working too hard to gain high quality clients. We're not going to let them walk out the door and there is a price to pay for that. That being said, if you look at this economy and where we are and where we do see growth opportunities, there's just less of them in totality. We see opportunities within the marketplace, but I think 2023 is going to be a more challenging year for, not just us, for the economy, itâs the interest rate environment, it's the lack of liquidity, it's business formation, you name it, it's going to be a challenging year. I think we'll do well in it, but I don't know at what level. I wouldn't want to predict that we grow faster this year than last year or anything like that. So I think it's a combination of those things, but I think the fundamental message we want to get out and that both Bill and I talked to was this idea that we are going to stand by our clients irrespective of where the interest rate environment is. Got it. That's helpful clarification, Frank. Thanks. And just -- where is the pipeline I guess today? And how does it look kind of by product or geography? Just curious if there's any more detail you can provide there? Yeah. I mean, I would say that our pipeline is quite strong even today and it's still pretty well diversified across the various aspects of the different verticals that we typically lend in. There is a little bit more emphasis in the C&I space. We're seeing some improvements there, but I'm not sure it's big enough to make enormous change in the balance sheet, but there's definitely a higher focus there. And we are seeing probably more opportunities in some of those newer markets that we put some resources around or that we've made investments in, namely the Florida market, which has been performing extremely well for us, both in the size of the market we've created there and the loan to deposit ratio within that specific market as well as the Eastern Long Island market. Those markets have been pretty exciting for us to watch throughout and we're expecting really good things from both of those as we move into 2023. And additionally, all the other projects that we had around, whether it'd be a new vertical or a new place where we're putting emphasis, the healthcare business being an example of that. Maybe starting on the credit quality with reserves down to 1.12% here, just could get your thoughts on where you could see that ratio trending through the year given the economic uncertainty and the loan growth you're expecting? Well, listen, with CECL, it's really contingent upon where the forecast come out. And for now, although some of those metrics, those forecasts are declining, especially in terms of -- projected GDP growth sales, those where the negatives are. But the unemployment rate is not really changing much in terms of economic forecast. Until you see that, you're not going to see a ton of provisioning around the industry. So I think there's a lot of misconceptions out there, but our CECL works and people think that it's how we feel about where reserve levels used to be. And I think most bankers would agree yet, wouldn't hurt to add to reserves, but that's not what CECL is really allowing these days. So other than having specific reserves for specific credits, which we don't have any, it's all really contingent upon this black box model. So if you think that at some point the unemployment rate forecast is going to increase, then you'll see fairly significant increases in reserving. If you don't, it's probably going to be pretty much benign. Okay, great. And I appreciate that. My only other question is just around the $10 billion in asset threshold. And you're thinking that was likely you would cross this year, that's still the case or if that's changed at all with the economic forecasts? I think there's a good chance we cross the $10 billion threshold. We've been preparing for it for a while. There are some costs associated with going over, but it's pretty small for ConnectOne, those costs, and we've been building for this along the way. So I don't really see too much change in our financial performance. And regardless of what's going -- one of the things I just want to add here is that, we've entered times before where things are a challenge, but we continue to produce year in year out very strong return metrics and credit quality metrics and I see no difference this coming year. I wanted to go back to the NIM and NII. Bill, historically we've discussed kind of in a higher rate environment where the NIM floor could be. I think you've mentioned that perhaps in that 350 range was a good floor. It feels a bit lower now. And just how -- touching on your incremental loan yields of 7% versus funding cost, it feels like incremental spreads are where the NIM is today or 100 bps lower quite a range. So I was just hoping you could give us some updated thoughts on realistically where you think that NIM could floor. Yeah. The thing that I have concerns about Matt is the increasing competition for deposits as the money supply continues to contract and it's still is. I watched this every week as the numbers come out. And so, you have a couple of things. You continue to have more competition for interest bearing deposits. And secondly, there continues to be a flow out of noninterest bearing deposits for all banks, not just us. And so, this happened, really started taking effect in the middle of the fourth quarter and it was much more severe than I expected, the competition for deposits. And I'm sure you're seeing in some other banks that you cover. So yes, on the margin right now, the new book -- the new business we're putting on is that spreads that are going to maintain our margins. I am just concerned about those other factors that could cause a little bit of pressure. But this is a temporary situation. Things should settle out. The yield curve being inverted does not help anybody. If the yield curve goes back to its normal shape and the long end remains higher than it was a year ago, we -- the banking industry and margins should be in good shape. You had mentioned that incremental loan yield are in that 7% range, I am curious what are they rolling off at? Okay. The other question just around NII, just thinking about 4Q NII $78 million, a little over $300 million annualized. Is that a number you think you can grow off of in 2023? Yeah, I would expect that we will grow that. Iâd say, that the growth in the balance sheet will exceed any percentage decline in the net interest margin. Okay. I'm sorry if I missed this, Frank, your earlier commentary around. Did you mentioned any loan growth guidance for the year? I did not. I mean, sitting here, I would tell you that based on our pipeline, based on what we see relative to payoffs, I would tell you that it would be my anticipation we'd be growing in probably mid to high single digits. Okay. Other question is, I know credit quality metrics today look very solid. As I think about new paper coming on at 7%, I would think there is also changes in cap rates. I mean, do you have any underlying concerns with the ability to keep NPAs and charge offs at these levels just given the higher interest rate environment or should we expect some normalization in those figures? I would tell you that this doesn't appear normal to me that all banks have virtually no delinquencies. I do think that there has to be some normalization around delinquency metrics and that there will be some level of credit issues going forward. I think it would be unrealistic to expect them to remain at zero. However, I do believe this is a very different environment than what we saw in 2008. I think real estate acts differently in this particular environment. I think there's a lot more capital in real estate transactions than they were before. I think the inflationary environment has put a lot more money in people's pockets. So I just think we're going to see different types of credit issues. I just don't have my crystal ball polished up to figure out where exactly that's going to happen, but I just -- just from history, it just can't stay at zero, something's got to break. As you're underwriting new real estate, how have cap rates changed or trended and debt service coverage ratio has changed or trended. And I feel like you're alluding to there might be some different kind of performance change or MPA increase here, I'm just not quite sure where it is, is it on the valuation reset or the fundamentals of the property? Yeah, I think there has been a valuation reset. And I do think that cap rates have gone up. And I think that's pretty apparent in lot of places. But debt service coverage ratios have remained pretty strong. Rents had gone up in the residential arena, the places where there is some weakness is, obviously, in office, not necessarily that the lease rates have come way down, but that the occupancies are lower and businesses are cutting back on the number of square feet that they need to operate their business efficiently. So I think there's a lot of challenges in there, but clearly cap rates are up. Valuations are either stable or down in a number of places. I think LTVs are still pretty strong relative to the industry as a whole. I don't know that there's been a whole lot of movement around that debt service coverage ratio. I mean, ours has been pretty consistent pretty much since we started the bank at the north of 125. And I think our average on the portfolio is closer to 150. So there's a lot of room in there for some level of weakness or temporary weakness. I think one of the areas that, of course, we watch very intently because it's -- a good part of our business is construction, because there's a lot going on there, not only with the cap rate, not only with what the potential debt service coverage ratio will be a completion, but the cost of the construction, inflationary pressures on the execution of getting a project on the timeframe in which to get it done, so those are things that we're watching very, very closely. Well, I want to thank everyone for taking the time today to hear our remarks about the fourth quarter of 2022 and we're excited to speak to you in the future quarters of 2023 as we continue our journey. Thank you all.
|
EarningCall_1132
|
Good morning, everyone and welcome to this Fourth Quarter Presentation of Gjensidige. My name is Mitra Negard and I am Head of Investor Relations. I have the pleasure of introducing our new CEO this quarter, Geir Holmgren. He will give you the highlights of the quarter and the year, before handing the word over to Jostein Amdal, our CFO, who will be discussing our numbers in further detail. And we have plenty of time for Q&A after that. Thank you, Mitra and hello, everyone. My name is Geir Holmgren and I am the new CEO of Gjensidige. During the past few weeks, since joining the group, I've had the pleasure to gather insights and learn about our great organization. I have met with many of my new colleagues across various functions, markets and locations where we are present. Listening to the input and witnessing the way they work, there is no doubt that the talented and hardworking people of Gjensidige and the strong culture here are the key to our success. I have met an organization with high competence, a strong performance culture and customer centricity. It's an honor and a privilege to be a part of an organization with such an important social mission and good values and that deeply cares about its employees and customers. I have great respect for Gjensidige's strong legacy and I'm very excited to embark on this journey to further develop the market leader in Norway and realize our profitable growth ambitions. I also believe that we can continue our strong track record of solid, high-quality operations and further improve cost efficiency. On that note, let us take a look at our solid fourth quarter and full year results before Jostein discusses these numbers in further detail. Please turn to Page 2. Gjensidige generated a profit before tax of NOK1.694 billion in the fourth quarter. The underwriting result was a solid NOK1.174 billion, reflecting healthy growth in premiums and good cost control. We continued to put through price increases at least in line with claims inflation. Even though we had an increase in medium-sized claims which were within a normal range for our winter quarter, the underlying frequency loss ratio increased only slightly. Large losses were higher but broadly in line with what we had expected for a quarterly average in 2022. The comparison figures from '21 also include a positive effect from COVID that brought down the loss ratio. Improved conditions in the financial markets resulted in a return of NOK560 million on our investments in the fourth quarter. Bear in mind that the investment results for the fourth quarter 2021 included NOK1.2 billion related to appreciation in the value of Oslo Areal's property assets, as you know the divestment of the company was completed during the first quarter in 2022. Annualized return on equity came to 19.3%. And then turning to Page 3 and looking at the year as a whole. Gjensidige generated a solid underwriting result of NOK5.856 billion and delivered on all financial targets. The combined ratio was a very strong 81.4%, significantly below the target of 85%, thanks to very strong performance in Norway and progress in Sweden. The transformation efforts in Baltics are gradually coming through, although it will take some time to see this in the results. The full year cost ratio was 13.7%, well within our goal below 14%. You have an efficient capital base with a solvency ratio at 179%, within our targeted range of 150% to 200%. As mentioned, annualized return on equity for the year was 19.3%, a strong achievement considering the challenging financial markets. Our Board has proposed a regular dividend in line with our dividend policy. Jostein will speak more about the dividend proposal in a moment. And then over to Page 4. I'm highly convinced of the importance of integrating sustainability in all aspects of our operations. I have seen that Gjensidige has done a great work so far. Gjensidige plays an important role in the Nordic society and I am deeply engaged to make further progress in this area. The group continued to put through strong efforts through 2022, implementing numerous measures within the 3 focus area: safer society, sustainable claims handling and responsible investments. Gjensidige will contribute to a safer society by building and sharing knowledge about the consequences of climate change and the loss of nature. That is why we work to implement good incentives in products and services so that our customers and society are better equipped to adapt to climate change. We will continue to cut climate emissions in our investment portfolios, claims processes and internal operations. We will continuously work to reduce waste and support measures for the reuse of materials and in repair processes. We will work for our path to reach our climate targets to be approved by science-based target initiative and with that, reach a new milestone in our work and create the confidence that we are on a steady course towards net 0 emissions in 2050. Gjensidige has received valuable and motivating recognitions confirming that our work is acknowledged by the outside world. We will continue implementing necessary initiatives going forward and I'm looking forward to keeping you updated on our progress. Thank you, Geir and good morning, everybody. I'll start on Page 5. We delivered a profit before tax of NOK1.694 billion in the fourth quarter. The underwriting result reflects continued strong operations. We generated significant premium growth and delivered further improvement in our cost ratio. We saw an increase in the underlying cost ratio this quarter, mainly due to an increase in midsized property claims in commercial. The amount of such claims will have some natural variation from quarter-to-quarter. This also applies to large losses which have been -- which were significantly higher than the fourth quarter in 2021 but still within what we should expect to occur from time to time. We do not see any particular trend in these claims numbers. The financial result reflects improvements in the financial markets during the quarter. Our pension business generated record high results. Turning to Page 6, a few words about the operations. I'll start with inflation. Claims inflation so far has been in line with our expectations and we continue to be able to pass on necessary price increases to stay ahead of the inflation curve. There are signs that the inflationary pressure may be subsiding in some areas. The pressure on building materials prices seems to have peaked because of demand cooling off, lower raw material prices and more stable supply chains. Based on our latest analysis, we expect claims inflation for private property in Norway in the 4% to 6% range going forward. This is 1 percentage point down from our expectation back in October last year. For motor in Norway, we still expect inflation in the range of 4% to 7% at the higher end in the short term. We'll continue to put through price increases at least in line with expected claims inflation. Demand for our products and services remain strong and we expect this to continue, thanks to low risk of a grave recession in our region and resilience in demand for insurance products. But of course, if the recession turns out much more severe, this could have an impact on our top line growth as well. We have put behind us a year with very strong performance in Norway and the development in the fourth quarter was also very good. Premium growth in private remained high despite tough competition. We have managed to continue to put through necessary price increases while maintaining our high customer retention and profitability is very good. Our commercial segment also generated solid result this quarter despite the high level of large and midsized claims. Premiums continued to grow strongly and retention remained at a high level. Our top brand ranking in the IPSOS survey is a strong vote of confidence from commercial insurance customers in Norway. We are very encouraged by the solid January renewals, proving a continued hard market into 2023. Thanks to our strong position, we will continue to raise prices to reflect expected claims inflation and we are confident that we will be able to put this through. For certain pockets in the large corporate portfolio and in certain other segments, there is still a need for price increases beyond inflation. Performance in Denmark was somewhat weaker than the same quarter in 2021. I'm very pleased with the premium development in the commercial portfolio. Growth in the private portfolio reflects both competition and lower Danish motor and property sales. We continue to move forward with a new core IT system, getting closer to a complete migration of the private products. We expect to start migrating the commercial products next year. This will strengthen operational performance when fully implemented. I'm very pleased with the continued progress in Sweden. We have succeeded in putting through necessary price increases. Our risk selection has improved considerably and we have implemented effective cost measures. We will continue our efforts to further increase profitability going forward. We have also seen improvements in the Baltics, thanks to tariff improvements, pruning and operational efficiency measures. But we have not reached our goal yet. Profitability needs to improve. We have strong expectations from our ongoing measures despite tough competition and high inflationary pressure. For 2023, we expect the combined ratio to move below 100% and then further improve in the following years but recognize that we have a more vulnerable position in this relatively small segment. Turning to Page 7. The strong development in premiums continued in the fourth quarter, up 8.4% adjusted for currency effects. We saw a strong increase in premiums for the private segment driven by price increases for motor, property and accident and health insurance as well as by slightly higher volumes for motor. I'm very happy that we maintained our strong competitiveness and continued to hold our superior market position. The significant rise in premiums in the commercial segment followed effective pricing measures, solid renewals throughout the year and volume growth for motor, property and accident and health insurance. Premiums in Denmark increased by 8.8% measured in local currency, driven by growth in the commercial segment. Dansk Tandforsikring was consolidated from October 1 which also contributed to premium growth. Premiums in the private segment, excluding the contribution from NEM Forsikring, were somewhat lower, impacted by a 2.3 percentage point decrease in customer retention. Premiums in Sweden, measured in local currency increased by 5.3%, driven by growth in the commercial portfolio. Customer retention increased by 1.2 percentage points. Earned premiums in the Baltics increased by 5.4% measured in local currency, with growth in most insurance lines. The customer retention rate decreased as a result of the implementation of higher prices. This is something we have been prepared for on the path to improved profitability. Turning over to Page 8. Adjusted for the positive COVID-19 impact on claims in the fourth quarter of 2021, the underlying frequency loss ratio increased by 1.8 percentage points. This was primarily driven by the mentioned increase in midsized property claims in commercial and higher frequency claims in Denmark. Private generated a slightly improved underlying frequency loss ratio when adjusting for the COVID claims in 2021. Sweden and the Baltics also showed an improved underlying frequency loss ratio. Large losses were significantly higher than the same quarter in 2021 but broadly in line with our long-term expectation. Together with slightly higher run-off gains, this brought the loss ratio for the quarter up to 71.6%. This quarter, we have come to an end with the planned releases of the excess reserves identified back in 2015. Starting from the first quarter of 2023, with IFRS 17 coming into effect, it will no longer be possible to make planned releases of excess reserves. But although our reserves reflect our best estimates, they will also in the future be run-off gains and losses, in line with previous experience. Let's turn to Page 9. We recorded NOK1.141 billion in operating expenses in the quarter. Our cost ratio moved further down by 0.4 percentage points to 14%. And if you exclude the Baltics, the cost ratio was 13.4% for the quarter. The main drivers of this improvement are premium growth and strong cost discipline across the group. Our cost ratio in Norway was stable at 11.2%, thanks to premium growth and continued focus on cost efficiency. Sweden and Baltics showed an improvement, as you can see from the chart on this slide, with the main drivers being effective cost-cutting measures and higher premiums but also including some positive one-off effects. The acquisition of the dental health insurer, Dansk Tandforsikring, drove the increase in Denmark's cost ratio in the fourth quarter. A few comments on our pension operations on Slide 10. The pretax profit increased to the record high NOK73 million, thanks to a continued growth in number of pension members and higher assets under management. An increase in the risk result related to the paid-up policies also contributed to the good results. Assets under management increased to NOK55 billion, reflecting the acquisition of a portfolio with effect from November, in addition to an increase in the number of pension members. Annualized return on equity was 15.1%. The solvency ratio at the end of the quarter was 143% after taking account of NOK400 million in proposed dividends to the parent company. I'm very pleased to see how we succeed in growing our business and generating strong results even with the significant changes in the market brought on with the launch of the individual pension account in 2021. We have an agile and highly cost-efficient pension business set for further growth going forward. The new core system which is currently being implemented in pension, will provide further opportunities for digitization and automation of processes. We expect profits to increase over time. Moving on to the pension -- sorry, to the investment portfolio on Page 11. Our investment portfolio generated a return of 1% in the fourth quarter. The match portfolio returned 0.9% and the free portfolio returned 1.1%. The result for the quarter was positively impacted by higher equity markets, lower interest rates and lower credit spreads. All asset classes, except private equity funds generated positive returns. As a reminder, there is a 1 quarter lag in valuation for this asset class. The risk in our portfolio was broadly unchanged this quarter. It is worth mentioning that our exposure to listed equities was NOK200 million lower than the NOK1.9 billion recorded as carrying amount at the end of the quarter due to derivative positions. We kind of rule out further market turbulence and we are prepared. Although we can't avoid the impact, we have a balanced portfolio and a solid fixed income portfolio with a large majority having investment-grade rating. Our investment strategy remains firm. Over to Page 12. Our Board has proposed a regular dividend for 2022 of NOK4.125 billion corresponding to NOK8.25 per share, up 7.1% from the regular dividend for 2021. The proposed dividend represents a payout ratio of 90%. For Norwegian general insurance customers, this once again bodes for distribution of a solid customer dividend from Gjensidigestiftelsen. With this, our solvency margin is at a good level, providing us sufficient flexibility to maintain our S&P rating, capacity for smaller acquisitions, organic growth and a buffer for regulatory changes. Our dividend policy remains unchanged. We aim to pay a high and stable normal regular dividend. Over to Page 13. We had a solvency ratio of 179% at the end of the fourth quarter, down 11 percentage points from Q3. Eligible own funds came down with the Solvency II operating earnings and returns in the free portfolio more than offset by the proposed dividend. The acquisition of Dansk Tandforsikring had a small negative impact on the funds as well. Capital requirements rose slightly with premium growth and effects from the annual update of the internal model, partly offset by a lower market risk as a result of lower private and emerging market equity exposure. The change in the reinsurance program also had a small effect on the capital requirement. A few words on the latest developments of our operational targets on Slide 14. Customer satisfaction continues to be at a very high level, although the annual survey in 2022 showed a slight decline from 2021. The high score confirms our strong customer offering, particularly in Norway. We will continue to seek further improvement in all our markets. Retention in Norway remained at a high and stable level. Outside Norway, there is still room for improvement. Retention in Denmark and Sweden was stable during the quarter and came somewhat down in the Baltics as a result of the pricing measures I mentioned a few moments ago. Digitalization and automation are key measures to maintain cost efficiency. Our digitalization efforts continued throughout the quarter. Our digitalization index measuring progress in digital sales and service, interaction with customers exceeded our annual goal. I'm particularly satisfied with the development in digital sales this quarter. We also saw a further slight increase in automated claims. Our operational KPIs are important to support delivery on our strategic priorities and financial targets. We'll continue to improve delivery on all these metrics going forward. And finally, on Page 15, just a reminder that we will be reporting according to IFRS 9 and 17 from the first quarter of 2023. We have been preparing for this transition for quite some time and we're ready to report according to the new standards. We will provide you with the fourth quarter 2022 figures based on the new standards as soon as possible and at the latest by the end of March. Thank you, Jostein. Let me share with you a few words about our direction going forward on Page 16. You can see this strategy remains firm, centered around our mission to safeguard life, health and assets. It's based on our vision to know the customer best and care the most. Gjensidige has a clear set of priorities towards 2025. These are centered around building on our strong and unique position in Norway, improving profitability outside Norway and demonstrating capital discipline with a rational approach to M&A and capital returns to shareholders. We will continue to pursue being a leading general insurance provider in the Nordics and in the Baltics. Macroeconomic factors such as inflation, climate risk and industry trends are creating uncertainty but most of all, opportunities. Our response to this is to maintain a high innovative spirit, strong customer orientation and continue our strong track record of having solid and high-quality operations. At the same time, I will ensure that we also improve our cost efficiency which already is a competitive advantage. We will continue to seek profitable organic growth potential in all our markets and I will make sure that Gjensidige seeks growth pockets and value-enhancing inorganic growth opportunities in our markets, including both bolt-ons and larger transformational M&A deals. In addition, we need to make sure we have the ability to execute quickly and with agility to stay ahead of market cycles. My key motivation and commitment is to ensure that we focus on this path to create value for all our stakeholders. To sum up on Page 17. We are very pleased with the solid results Gjensidige has delivered and I'm very confident that we are on the best possible trajectory to continue our strong performance. We will stay ahead of claims inflation. And unless the current geopolitical situation becomes dramatically worse, we do not expect to see any significant negative spillover to our underwriting result. We will continue to create value for our stakeholders, including paying out attractive dividends to our shareholders. Over the next few months, I will focus on gathering a deeper understanding of our business and I'm looking forward meeting with our key stakeholders. I had 3 questions. The first was on the underlying frequency loss ratio development, in particular in commercial in Denmark. It seems to have deteriorated over this quarter and it seems to be quite broad-based. I just wanted to understand what's driving that? Has something changed in this quarter versus sort of the previous 9 months? And the second question is on the solvency ratio, SCR development. What is this and how much of the NOK300 million was due to sort of reinsurance program versus sort of premium growth? And my final question is on your comment around inorganic growth. I just wanted to understand your view in terms of life and pension, if that is something that you're looking at as a market? I'll start with the first two and I think Geir will handle the third one. It's correct that we have an increase in the underlying frequency loss ratio, both in commercial and in Denmark. And as we mentioned in the report, a quarter is a fairly short period within nonlife insurance and there is natural variation in also losses below what we report as large losses externally, what we call midsize losses here. And we've seen that there's been a higher number and amount of these losses, especially in the commercial Norway part in Denmark. That's recorded as underlying frequency loss or it affects the underlying frequency loss ratio as we reported. We regard this as pure volatility, no trend, nothing to read forward from those numbers. This is just the nature of business. There are variations and a number of fires in any given quarter. Yes. Solvency II, the growth in the SCR. If you take away the reduction in the SCR due to some derisking on the asset side, there is approximately NOK0.5 billion increase in the SCR from the kind of operational side which is the main driver for that. That is growth in the exposure, partly volume, partly -- but more also inflation driven. And that is more important than the reinsurance part. And then also remember that there is a small increase by this Dansk Tandforsikring in the quarter included there. But if you kind of just list them, growth is more important than the changes in the reinsurance program. Also -- I mean, yes, we do disclose somewhere in the report, well hidden, the changes in the reinsurance program. So it's a small increase in the retention level for the first loss on the pure risk losses from NOK100 million to NOK200 million and then a small increase on the catastrophe reinsurance program from NOK200 million to NOK250 million for the first loss. This has a minor effect on the capital requirement. When it comes to inorganic growth regarding life and pension, we do have a solid operation here in Norway. We do actually have a very good year back in 2022 with good growth and a great profit from this operation. We do some investment on the technology side which also will improve our value proposal to the customers. What we see in the Norwegian market is that the life and pension proposal connected to this P&C proposal in the commercial market has been very successful. We do end up with having customers which are very satisfied with the total delivery. So we see definitive pockets with the possibilities here or opportunities to grow further regarding life and pension. But that's -- I'd also like to say that this is ambition for the Norwegian market. We do not see any -- do you have any ambition to talk about life and pension outside Norway. All right. And just to come back to the underlying development. I understand that there's variability quarter-to-quarter. Some of it is sort of large losses leaking into the underlying. But when I look at the commentary -- you sort of mentioned a number of lines, motor accident and health insurance, in particular. I would have assumed there would be less growth in sort of variability. Have I misunderstood that? The mid-sized losses that we talked about are mostly focused on commercial property. So that is correct. There is some variation also in the pure frequency loss ratio. But I think it's important to remind that we get through the price increases necessary to meet the expected claims inflation and we have done so for many quarters in a row. So the main reason there is some natural variation within losses and not kind of read over to what you should expect for the years to come. Yes. Can you hear me, please? Yes. So first question is just -- just back on the commercial business but just also trying to understand the runoff in commercial were indeed a bit higher than last year and also overall group runoff. I'm sorry if I missed the comment in the early update of the call but is there anything worth noting in the runoff that you can point to, please? And second question is just on your chart showing the retention levels which is Slide 14. It looks like the Denmark line, for example, is falling a bit away from the strong Norwegian line. Is there any comment there that you would like to flag, please? The runoff on the commercial. No, there is nothing particularly to read out of those numbers, I would say. There is a combination of the last quarter of the planned reserve releases related to workers' compensation on the commercial Norway portfolio. And then there is some variation in runoff gains based on kind of cases being closed at lower amounts than what they were originally reserved for which is -- that's the reason behind this. Again, sorry to state that there is kind of no trend you should read from this neither. Okay. When it comes to retention in Denmark, as mentioned in the presentation, it's a decrease compared to earlier year. We are not satisfied with that development. And I also like to say that we are doing an IT investment in Denmark. It's an ongoing project. It will definitely improve our value proposition in the market. And we are committed to improve the results in Denmark going forward. And I'm also confident that we will make progress in our work which will also improve the results from the Danish business. Two questions from me. And the first one is to Geir. I know it's early days but can you talk a little bit of what will be your key focus as CEO? And if you will do anything differently from what has been done in the past? And the second question on reinsurance. We've seen that prices there has come off quite meaningfully. How is that impacting Gjensidige? Gjensidige's strategy remains firm. It's centered around our mission to safeguard lives, health of assets and it will continue that way. And we also see and I see some considerable organic growth potential in all our markets which is very interesting and we probably include many opportunities. Gjensidige has a clear set of priorities going forward and we're aiming for being one of the leading general insurance companies in the Nordics. So we seek profitable growth outside Norway but with a rational approach to M&A and capital returns to shareholders. Nordic position is attractive and I also think it gives scale, risk diversification and competent synergies. So going forward -- what I've seen in Norway, we have a very strong value proposition in Norway. We have excellent underwriting competence. We have great analytical skills which also improves the value proposition to the customers. So trying to get these skills and competence to work also in Denmark and in Sweden to improve the operations in both Denmark and Sweden is something I think is very, very important going forward. But at the same time, I will make sure and ensure that we will still focus on cost control, improving cost efficiency which, as you know, is already a competitive advantage. So my key motivation and commitment is to ensure that we are actually focused on this way to create values going forward. On the reinsurance side, yes, there was a tough market. The talks has been of the toughest market for several decades, this renewal in January 1. Luckily, our strategy has been -- or luckily it's been a strategy for many years to focus on reinsuring on the kind of peak losses, both in terms of single risks and events which means that our reinsurance program is a fairly small part of -- or share of the overall premiums, approximately 2%. And that means that even a fairly high percentage increase in reinsurance premiums has a limited impact on the total profitability. Having said that, it's important that we manage to get all the necessary kind of security and the capital backing that we need from the reinsurance market in this renewal. So that's kind of nothing uncovered. And we see this also as a potential opportunity because companies that are more heavily dependent upon reinsurance will have a higher cost increase than we have seen. My first question is just a follow-up. Like what has your cost increase in reinsurance been? Could it be in the size of NOK100 million, NOK200 million going into next year? And is it particularly catastrophe reinsurance that has gone up in price or other programs too is my first question? Yes, the increase has been higher within property -- or kind of property -- both single risk and cat coverages higher than what we've seen in -- you can say we have reinsurance against large liability risk, personal accident, catastrophes and motor and the increase there has been smaller than for the -- what you could call property which is kind of all kind of fixed buildings everywhere. In terms of the amount of increase in reinsurance, we haven't disclosed that. Mitra is shaking her head there. So -- but it's a significant percentage point increase here. You see an external report talking about 30% to 40% price increases in the reinsurance market. Okay. So I guess you don't want to disclose any P&L effect what would change in the reinsurance program either, just to make sure. Yes. The main point, I think if you start with a 2% overall reinsurance premium as a percentage of gross premiums and you can add on whatever percentage you like there. There's going to be a small effect. Yes. And then secondly, on the commercial segment in Norway. I was -- we know what you expect on the private side but what level of claims inflation on an underlying basis have you actually seen in the commercial segment in 2022? And how was the repricing in the 1st of January this year compared to last year? Okay. Starting with the kind of inflation we have seen and then maybe Geir will comment on the January 1 renewal afterwards. But we -- the actual realized claims inflation that we have seen in '22 has been very much in line with what we have given you as forecast throughout the year. And sorry if we were a bit imprecise, I think, in our comments on the property claims inflation going forward. We see a similar picture for commercial as we see for private on the property side. I think maybe I said private property claims inflation but it was meant to be property in general. But this is -- as you know, we give a range because it's 5 to -- or 4 to 6. It's a range because we are uncertain about the future. So a similar picture. And as you remember from what we have told you in the previous 4 quarters, we started the year with a higher expectation of claims inflation that we're now talking about going forward. When it comes to commercial market in Norway and price increases, we have price increases for the renewal in January which is at least in line with claims inflation. And we have also seen that it's a very successful renewal with only a few customers leaving the company. So we have a renewal rate of mid-90. And just a last one. Sorry for a lot of questions. But how should we think about the SCR development going forward? Do you see any potential to reduce market risk further? And I was also wondering if you could just give us an update on what the running yield on your bond portfolios are now? Yes, I'll start with the SCR. And it's -- as I said, the investment strategy remains firm which means that we will kind of continuously monitor market developments and make asset changes to the allocation as we see fit all within this investment strategy that has been, I would say, more or less unchanged from over a couple of years. So it's -- we don't guide on any kind of specific development of SCR. In general, SCR from the insurance side will grow slightly less than the overall growth in the portfolio because there are some diversification effects as we continue to grow. The running yield in the portfolio is approximately 3.5% at the moment. Reinvestments during the quarter made, of course, at a higher rate because the interest rates have been going up over the last 12 months. So they were at 4.7% in the -- what we reinvested during this quarter. And then, of course, you remember that from 2023 everything will be mark-to-market. So the difference between kind of the amortized cost and the other bonds is then gone from first quarter. I wonder if you could start with reminding us of the dynamics of the risk margin in the solvency calculation. It seems to be a change there of around NOK400 million quarter-on-quarter. So I'm just wondering if you could give us some insight as to the change there. Secondly, you commented to the need for repricing certain pockets within the corporate portfolio. Could you give us some color on which pockets that is? And lastly, if you can discuss somewhat about the competition in private Denmark. Is there any changed share Q-on-Q from market participants? Or is it more of the same picture we have seen for a couple of quarters? The risk margin on the reserves in the solvency calculation which is kind of different from the risk adjustment that we'll start presenting from Q1 in the IFRS 17 calculation. And no principal changes there and it is typically going in line with the underlying growth. But if there are some changes in the product composition, there could be some changes. I don't have a breakdown of the increase this quarter compared to last quarter at hand now. We could look up -- look at that at a later stage, Vegard. But there is kind of a principle of these changes and no specific things this quarter around that side. Yes. We pointed to that the large corporates is one of the areas where we need still to continue with the pricing that is above expected claims inflation. And pockets means that there are much more differentiated parts or a segment or a split of the portfolio than what we communicate externally. The pricing measures will be differentiated based on our view of claims inflation and the view of these customers or customer segments' profitability historically. No, it's more customer segment than product type. And third one was competition in Denmark. No change in the competitive picture quarter-on-quarter. The first one is on this partial internal model which shows 230%, if I recall correctly, on the slides. What kind of limitation would it have for you to get an A rating when you look at your PIM versus sort of the -- in the normal model you have today of 179%. So is this A rating your sort of requirement or limitation when it comes to dividend distribution? Or is it so that you could go down to 150% in the internal model and still be within a A rating? Could you shed some light on that? That would be great. Yes. I think we are -- have set our solvency margin range with a view on our financial target of being at least A rated. So that means that we have some flexibility within that solvency margin range. Yes. And then -- yes, I'll stop there. And when it comes to the paid ups, how much do they tie up now? You said some quarters ago that they tied up around NOK1.4 billion. With the higher rates, I would assume that they would tie up less than that. So could you just update us on what's this timeline? And also what kind of diversification you have with your nonlife business? I don't have the number of the capital requirement on the paid ups at hand here now. And I think we talked about the capital requirement for the pension business and the diversification benefits between the pension business as such and the nonlife insurance business being quite high. And of course, higher interest rates is good for this portfolio and that is reflected in the capital position of the pension company. And as I mentioned, we are -- the Board of the pension company is proposing a dividend of NOK400 million to the parent company for 2022 which, of course, is higher than the accounting profits due to the favorable development of the solvency margin which is again dependent on also the interest rates margin -- the interest rate level. Okay, perfect. Finally, you mentioned some potential issue on the top line if you went into a recession. Could you just shed some light into how you -- the private side will develop and how the commercial side could develop if you sort of see more difficult times for the household and the commercials in Norway? I mean, from what we've seen from previous kind of minor recessions, this has no impact on the private demand for nonlife insurance. So if it's grave -- and I'm talking about Scandinavia. Mainly in Baltics, the picture has been a bit different, where a more immediate effect on the insurance demand. On the commercial side, the volume of business is slightly more dependent on kind of just the business volume on Norwegian or Scandinavian businesses. There could be turnover-based insurance premiums, premiums that are dependent on the number of employees on the personal insurance side and so on. And there, there will be some more direct effects. But given the fairly shallow recession which is kind of the expectation, I think, widely out there, then this should have -- not have a large impact on the demand for commercial insurance neither. Okay. Have you seen anything -- because we are aware that where some cars being -- taking the license off because you could do it on the Internet rather than deliver it on the station. Have you seen an increased sort of level of plates being delivered back on the Internet rather than what you have seen in the past due to people only have one car rather than the two cars? I'm speculating a bit on it but I think the main reason is that it's much more convenient to deliver it, not because of any economic development here. Yes. I've got two questions, please. The first one, if I may, if I could go back on the development in the frequency loss ratio in the fourth quarter. I appreciate that midsized property claims can be quite volatile quarter-on-quarter. But looking at your commentary, in Denmark, you are flagging kind of frequency across a number of lines there, motor, property, commercial, even health. So are you also attributing that to just like bad luck? Or do you think there are lines there where maybe you need to actually take some pricing actions or reduce costs? That's my first question. The second question is on M&A, actually. I think in your opening remarks, you talked about a disciplined approach to M&A and rational how many transactions. So I was wondering if you could give us a sense of how much you want to spend in the mobility and health insurance space in the coming maybe 3 to 5 years. And can you remind us what your hurdle rate is when you assess any transactions in this space, please? I'll start with the Danish question and then I think Geir will take the second part, Youdish. You're absolutely right that we point to midsized -- kind of volatility in mid-sized claims. Especially, for the commercial property, there's more property-related midsized claims. There is something in the other lines but there is also some which is kind of pure underlying volatility as I answered to one of the previous questions. So there is a mix of both. When we look at the pricing measures that we have in place in Denmark, they are at least in line with claims inflation all across the board, all products. And the January 1 renewal that Geir mentioned a couple of questions ago, was strong also in Denmark which kind of bodes well that we are managing to cope with the kind of claims inflation picture. But there will continue to be some volatility in the actual claims number as we realize them. Okay. Regarding M&A and opportunities, we'll continue having a strong capital discipline. Yes, we are looking for companies that could improve our underwriting result. You mentioned if there could be any more investment into the mobility. We are continuously looking for companies or targets that will improve our margin results. So that's important to say when it comes to M&A. You mentioned also the hurdle rate when it comes to -- actually, I'll have a look at the positive net present value. And the hurdle rate, we have set to 6.5% cost of equity after tax. So this is something we bear in mind when we actually go out and try to assess and consider any M&A opportunities. Is that not too low of a rate considering interest rates have increased quite a lot over the last year or so? Could be discussed there. This is the cost of equity hurdle and we need to create positive value above that. And this is a kind of a costing bit, not a return on investment input as such, if you see the difference. I just have one question on reinsurance from a slightly different angle. How should we think about the volatility of earnings going forward given that you're also a bigger company now due to the strong growth over the past couple of years but also, in particular, in light of the higher retention on your first year loss given the reinsurance change. Should we expect more volatility? And I guess related to that, the question -- the decision on you retaining more risk. Was that because there wasn't enough capacity in the market? Or was that because it wasn't sort of worth paying more to access that capacity. So it was more of a balanced act for you guys. So any comments would be appreciated. There's a slight increase in volatility given that retention was raised for the first loss from NOK100 million to NOK200 million in the kind of the main property risk and reinsurance program. But I mean it's very limited. It's one loss -- NOK100 million for a year. And then on the cat side, from NOK200 million to NOK250 million retention which again is -- yes, it's a slight potential increase in volatility if there's an actual catastrophe but very limited. The reason for increasing the retention was kind of a cost benefit decision. We believe these layers of reinsurance programs very too costly. We could have gotten them but they were just not price efficient, I would say. So it's a pure rational decision based on the reinsurance prices. Okay. And then you also increased your aggregated thing from NOK500 million to NOK600 million. I'm assuming that your aggregated cover given the company now is -- probably the challenge of meeting the aggregate probably will be higher. How we should think about that in light that you're actually a bigger company given the growth you had over the last 2 years? I think -- I mean, your point, it's a good point to make, because given that we have increased in size over a number of years and these retentions have been fairly stable. And kind of in reality, we have been more or less more conservative as the company has grown and the retention level has stayed fairly stable. Also as a larger company, we have -- are continuing increasing the amount of diversification benefits from -- by being a bigger company. So I mean, it's a good point to make there. This is in that, too, even less of an issue. So a lot of my questions have already been answered. But just quickly in Norway, both for the private and commercial segment, are you seeing any signs of different competitive behavior? Are you seeing anyone gaining market share or pushing prices? Just curious on your thoughts for Norway. Okay. There are no major changes in the come-to-market dynamics in Norway. And we are quite confident that all the major players are having -- or staying to their ambitions. And we also see that we will come through with our price increases. But you also see some activities from Fremtind, you see some activities from SpareBank in the private market. But we are quite confident on what we have done into 2023. We see that all the price increases are going through and keeping up with having a profitable business. Yes. So you point to that your solvency position is strong. So why do you not suggest an extraordinary dividend this time? It's still some way down to the mid of your targeted range. And of course, there's more room down to the lower part of your range. And to put the question another way, how should your solvency be before you are suggesting paying out excess capital? I think we always say our solvency is strong, Thomas. And it is at 179%. It is fairly close to the midrange. We stick to our dividend policy of high stable ordinary dividends or regular dividends. We increased it by 7.1% compared to the last year which is okay. And we'll stick to that going forward. If there is kind of what the Board deems kind of too much capital, there will be a special at that time. And that is a continuous analysis or evaluation that the Board does throughout the year. Okay. But are there any sort of risks sort of outside the model that you are sort of concerned about, I think, about geopolitical issues, etcetera and wanted to have sort of an extra buffer compared to a normal state? No. As we see the geopolitical situation at the moment, we are not worried about the impact on our business. If it is dramatically worse at one time, it can have some consequences. But at the moment, as we see it, we don't see any special impact on our business and we don't try to keep any capital in the business to meet such a situation. Most of my questions have been answered but I've got one question left. Just on the dividend outlook, both regular and special, I guess, you've now reached a 90% payout and you're looking ahead to albeit a new accounting regime but also about $1 billion less profits because of lower prior year development. So I was just wondering how -- does that then become more challenging to sustain your wish to pay a stable nominal dividend going forward? If you have any element of bad luck at all, then it might be challenging to do that. And therefore, is the comfortable capital position in the future more going to be used to supplement your regular dividend as opposed to paying special dividends? The main driver or determinant of how much we can pay out in dividends is not IFRS, either the previous or the new regime. It's the solvency development which is kind of the guiding of the dividend capacity. And so the change in the accounting regime doesn't change the solvency calculations. Also bear in mind that the planned reserve releases that are taken into account in the IFRS accounts are not -- do not have that effect on the solvency development. As we communicated when we started this development, the whole planned reserve releases for the whole period was taken into account at the moment we communicated those to the market. So that's a big difference between the IFRS earnings and the solvency capital generation. Hence, the stop of the planned reserve releases does not affect the dividend outlook either. Okay, great. That's very clear. And what would then be the threshold -- coming back to some of the earlier questions, what would then be a threshold for special dividends? I notice consensus expectations going forward is for special dividends, albeit relatively small. I just wonder what's the threshold for what defines excess capital. I think we demonstrated here that when solvency margins get kind of quotation marks too high, then we will pay out specials. To take off the theme, we also have an eye on capital efficiency here to generate a fairly high return on equity, I would say, with a new target of above 20%. So there is a pressure that we have put on ourselves to deliver on the return on equity target, at the same time as having this financial flexibility that makes us able to act if there are good opportunities and there will be in our mind at least always value creating for the shareholders. That's how we operate. I think most of my questions have been answered as well but just 2 brief ones. You mentioned that the planned reserve releases don't impact the solvency generation but you're consistently delivering higher runoff gains than your planned releases. So I'm assuming that does impact the solvency generation. That's the first question. And secondly, more short term. Just wondering -- we've been reading a lot of newspaper reports about water damages -- claims related to water damages and motor being at a much higher level this year than usual. How do you see this winter shaping up so far? Are you concerned about claims development in Q1? That's the 2 questions. Yes, the -- you're correct, Roy. The unplanned releases, to put it that way, they do affect solvency calculations. So they are kind of helping us in generating dividend capacity as well. And as we talked about on numerous occasions that there is -- on average, historically, has been a positive run of gains over and above the planned releases. So that's been a very long-term average, I will say. And Geir, for this... Yes. When it comes to claims frequency or effects from fluid and kind of being in a winter quarter, we have seen some volatility in the fourth quarter, as explained, some more midsized claims but still in line with what we probably can expect. And we have done price increases into 2023 to at least be in line with the expected claims inflation. So I'm not worried about the loss ratio going forward. Yes. The -- my question regards the -- your mobility ecosystem, your mobility offering. You did an update on this in June 2022. I was wondering if you can remind us the contribution to the underwriting result for this initiative for 2023? Yes. First, to kind of how it should improve the improvements in the underwriting result which I think is your question, is of the result as such in the company but how it improves the underwriting result. And the main and most important part there is how it works through the claims handling operation, where we, through having the roadside assistant which we've named from Falck to RedGo, is actually being the first point of contact in many claims situation and makes us able to gear the claimant towards our preferred workshops and so on. So it has an effect on the claims side and also on the -- also, I would say, on the sustainability side, because then we can guide them to our licensed garages or repair workshops. So it's good from that perspective. Then the toll road companies fleet, the main effect there is on the top line there, because through this toll road connections or the ship, we are having contact with a large number of car drivers which is also not our insurance customers in the first hand and we can use that as a good cross-selling base for the insurance side. So it should increase growth in the longer term. So that is kind of the main drivers on the underwriting side. And then, of course, we are looking at developing services on top of that, new services that are catering to the mobility needs of our customers. So that will be -- we'll tell you when we are launching them. We've said that number wise that we do expect annual effects from the second half of 2020 -- I mean -- remind you, annual effects at around NOK100 million to NOK150 million in reduced claims costs, annualized effects. And then on the top line, we said around NOK40 million in underwriting contribution annualized from 2023. Three, please. And first one on -- is on claims trends in Norway. I guess looking at private versus commercial, it is showing different underlying frequency trend. You are highlighting the motor class as being unfavorable in most of -- really in 4Q. I guess, what claims trend are you seeing in motor in Norway in terms of frequency and severity of claims? There's a slight increase in the underlying there. But I mean, I would say -- more or less answer there is no particular trend there. In the fourth quarter -- for the fourth quarter -- I mean, the quarter is typically a bit higher on frequency but lower on severity because they are -- yes, due to the weather and driving here slightly more kind of small accidents happening in this type of weather. But if you compare fourth quarter of 2022 to fourth quarter of 2021, one, I think, the difference is -- there has maybe -- especially, December of 2022 was slightly tougher than December 2021. But if you look at the quarter as such, I think it's more or less washes out some -- that's why we haven't tried to kind of quantify any effects or anything like that in the -- weather effects in the fourth quarter. There might be something there but it's too small to make a big note of it, I think. That's very helpful. And also on the reinsurance side, I mean, the increase in retention. I guess, was it more because of cost consideration? Or it is because just reinsurers simply do not want to offer the same coverage as before? We could have it replaced but at a much higher cost. And we deemed it not beneficial from a pure economic perspective not to keep the same retention levels. Okay, makes sense. And also lastly, on IFRS 17. I mean, you previously said the risk adjustment sat at 89 percentile in terms of the confidence level. I guess are you looking to keep it at this level? Or it's subject to review at some stage once you see what the industry level is? And would that decision influence your view of technical -- the strengths of your technical provision plus the risk margin on a Solvency II basis as well? A difficult technical question. I think we chose a confidence level for the risk adjustment -- sorry for the building work. No claims. It is -- we have what we think is a best, appropriate level for this risk adjustment. Whether -- or with time there turns out to be some kind of industry consensus, that is different. We'll, of course, look into that. But so far, we have no plans for changing it. I think we will need to close the call now, operator. We are well over time. I would like to just make a statement towards the end here. Is that okay? Okay everyone, we've received a few questions on where we have described our reinsurance program which has received a few questions today. This description is, as always, in our appendix section of the quarterly presentation. This quarter, on Page 31 you will find the details there. We will be participating in a number of road show meetings this quarter, among others in Oslo, London and Frankfurt. You can have a look at our financial calendar on our website for more details.
|
EarningCall_1133
|
Good morning. My name is Rob, and I will be conference operator today. At this time, I would like to welcome everyone to the Customers Bancorp Fourth Quarter and Year-End Earnings Report Conference Call. All lines have been placed on mute to prevent any background noise. After the speakersâ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Thank you, Rob. Good morning, everyone. Thank you for joining us for the Customer Bancorpâs earnings call for the fourth quarter and full year of 2022. The presentation deck you will see during todayâs webcast has been posted on the Investor Relations page of the Bankâs website at www.customersbank.com. You can scroll to Q4 2022 and year-end results and click download presentation. You can also download a PDF of the full press release at the spot. Our investor presentation includes important details that we will walk through on this morningâs webcast. I encourage you to download and use the document. Before we begin, weâd like to remind you that some of the statements we make today may be considered forward-looking. These forward-looking statements are subject to a number of risks and uncertainties that may cause actual performance results to differ materially from what is currently anticipated. Please note that these forward-looking statements speak only as of the date of this presentation, and we undertake no obligation to update these forward-looking statements in light of new information or future events, except to the extent required by applicable securities laws. Please refer to our SEC filings, including our Form 10-K and 10-Q for a more detailed description of the risk factors that may affect our results. Copies may be obtained from the SEC or by visiting the Investor Relations section of our website. Thanks, Dave. Good morning, ladies and gentlemen. Now welcome to Customers Bancorp Q4 2022 and year-end 2022 earnings call. Joining me this morning is our President and CEO of our bank, Sam Sidhu; Customers Bancorp CFO, Carla Leibold; our banks CFO and Head of Corporate Development at Customers Bancorp, Phil Watkins; and the companyâs Chief Credit Officer, Andy Bowman. As some of you may know, we are actually pleased to share with you again that about 10 years ago, Customers Bancorp became a publicly traded company using what was a troubled small $150 million asset Pennsylvania based bank as our charter and we invested our personal money into it and today this little troubled bank has been transformed into one of the 100 largest banks in the country. As you can see on Slide 3 of our deck, we are today a $20 billion asset super community bank focused on superior customer service by executing on our high touch supported by high tech model. Today, we have a very simple but unique business model, operating with community banking, corporate banking, which is â which includes specialty banking and then last digital banking franchise. It is our belief that forward thinking banks must be execution driven, clearly defined the markets that they wish to focus on as well as what they will not focus on and have a superior tech forward digital strategy. These are the things that we are focusing on every single day. It is by sticking to these fundamentals that customers has grown its assets, its loans, its deposits, its income and shareholder value by an average of 20% to 30% a year since becoming a public company just 10 years ago. Iâd like to take a minute to provide the perspective on the current external environment. As you all know, the historic base of interest rate increases by the Fed inverted yield curve as well as the quantitative tightening has created a very challenging environment, especially as it relates to deposits and especially for institutions or banks like ours, which are principally focused on serving business customers. All of these factors have led to an increase in our deposit cost over our expectations and the sophisticated nature of our primary depositor base expects market rate deposit. So we have focused tremendously on also market rate lending and our loan data is far in excess of what you normally see in the banking sector. We expect this challenging environment, however to persist and with the Fed fund rate peaking at for about 5% in the first half of this year. As a result, there may be very temporary some pressure on our margin for just a quarter or so hitting an inflection point as the Fed tapers followed by NIM expansion beginning sometime in the second half of the year. We will go over our guidance with you today in some detail. In this challenging rate and inflationary environment, we believe that we â that you need an explanation of some of the few non-recurring items and Carla, our CFO will go over those items with you in some detail. Now onto our current performance, we are pleased to report to you that Q4 2022 earnings from the core bank were $1.37 per diluted share and that beat our internal targets and we believe theyâre beat by about $0.10 the normalized consensus estimates. This brings our full year 2022 core earnings per share to $6.51, and when you exclude PPP and the provision release benefit from the sale of $500 million of consumer installment loans in Q3 our adjusted earnings per share for the year were $5.65. Our reported earnings beat the upper end of our own 2022 core earnings per share guidance of $4.75 to $5, and we beat that by about 13%. Our responsible organic growth strategy is laser focused on credit quality with 90% of our growth over the past year in very low credit risk as well as variable rates, specialty lending verticals, and thatâs resulted in us achieving an above average asset beta. Asset quality remains exceptional and credit reserves are extremely robust at 425% of total non-performing loans. Weâve taken prudent risk management strategic actions over the past several quarters to ensure that we are well-positioned from a capital point of view, credit, liquidity as well as earnings, and we will believe we are very well-positioned as we head into this uncertain 2023 and beyond. We are very focused on improving our margins, improving our capital ratios, and we will do that by moderating our growth in 2023, improving the quality of our balance sheet while we control our expense base, and we are going to be very actively buying back stock common stock to the extent that we are trading below book value and we believe that will result in creating exceptional value for our shareholders. Like I said earlier, we are very optimistic about our future. Iâll now turn it over to Sam to talk about the performance of our franchises in this as well as some key financial highlights. Sam? Thank you, Jay, and good morning, everyone. At Customers Bank are differentiated but simple business model is built on two foundational principles. First, we are a client-centric, high-tech, high-touch organization. Second, we are committed to industry-leading credit quality. Iâd like to take a few minutes to walk you through the franchise we have created across our community, corporate and digital verticals over the past few years and recap how franchise growth has delivered outsized financial results for our shareholders. Moving to Slide 4 and starting with our community banking franchise. This is where clients are service to our single point of contact model by relationship managers who have years, if not decades of experience in their local markets. On the loan side, this is led by our regional C&I, multifamily investment CRE, and SBA products. We ended the year with about $5.9 billion in community banking loans. Our deep relationships and network in these markets lends to a lower cost sticky depositor base. We have significant market share in many of our northeast home markets and are selectively looking to expand this model nationally into higher growth markets over time, beginning first in the southeast. Now moving on to our corporate and specialty banking franchise. Teams here service sophisticated corporate clients across complementary products. This vertical ended the year with $7.2 billion in loans and the mix has increased from 25% of total loans just a few years ago to nearly half of total loans today. This growth has helped transform the organization we were just a few years ago. Importantly, we have focused our efforts on floating rate low to no credit risk verticals. The largest component, which we call our fund finance vertical includes our capital call and lender finance line businesses. The fund finance, tech and venture and financial institution group teams are leading the growth of our lower cost deposit pipelines. Moving to Slide 6, our digital banking team has organically built a franchise that has acquired over half a million profitable digital customers since 2019. We are leveraging our deep FinTech relationships and industry-leading technology capabilities to build out our FinTech banking revenues, otherwise commonly referred to as Banking-as-a-Service. In the fourth quarter, we successfully onboarded a major customer and as previously stated, we expect revenues in this business to reach a $10 million run rate this year. We are currently in discussions with new partners regarding further opportunities. Additionally, building off of the demand around our consumer installment portfolio sale in the third quarter, we are developing a held for sale origination strategy, which we will have more to report on in the next quarter or two. Finally, Iâm pleased to report that our tech-enabled deposit and transaction banking customer pipeline is strong, by merging the product innovation of a tech company with the expertise of a bank. We expect these initiatives will help our deposit mix in the latter half of 2023. Now turning to Slide 7. Iâd like to take a few minutes to reflect back on the dramatic transformation that this organization has had over the past few years. At the beginning of 2020, our balance sheet was just $11.5 billion, and as of year-end 2022, we are now just under $21 billion. Weâve gathered over $5 billion in deposits in 2021 alone. This allowed us to self-fund our PPP loans and as those loans were forgiven, we deployed that cash into securities and low risk loan growth. Following the deposit growth in 2021, we grew total loans excluding PPP by an impressive 30% while maintaining our credit discipline. In 2023, securities book cash flows and PPP forgiveness, which youâll hear from Carla in a minute will provide significant fuel for higher margin reinvestment without the need to increase the size of our balance sheet. We expect this will set us up for a strong second half of 2023 and an even stronger 2024. Moving on to Slide 8, youâll see the real cumulative power of our three franchises. While PPP was understandably viewed as one-time in nature, we focused our efforts on using the benefit of this business line to build recurring earnings power. Our net interest income excluding PPP has more than doubled from 2019 from $277 million to an impressive $565 million in 2022. And our associated recurring earnings power has dramatically increased with our EPS, excluding PPP increasing by over 2.5 times during the same time period. We achieved this growth without raising $1 of equity in diluting our shareholders. All of this came through organic growth supported by PPP revenues. Thanks, Sam, and good morning, everyone. Iâll begin by briefly summarizing our fourth quarter and full year 2022 results as shown on Slides 9 and 10. From an earnings perspective, in fourth quarter 2022, we earned $0.77 in GAAP EPS on net income of $25.6 million. For full year 2022, we earned $6.51 on net income of $218.4 million. Our fourth quarter GAAP results were negatively impacted by two items. The first after tax net losses realized from the sale of available for sale investment securities of $13.5 million or $0.41, which benefits net interest margin in the short-term and only has a one-year earn back. And the second after tax net losses on PPP loans of $6 million or $0.18, primarily caused by slower forgiveness than expected, leading to higher funding costs and one-time charge-offs of $11 million net of a $7.5 million gain recognized upon settlement with a PPP loan servicer. To provide additional perspective, PPP related income contributed a positive $0.18 in the third quarter compared to the negative $0.18 this quarter. Iâll also highlight that the $11 million of gross charge-offs are before the impact of any contractual indemnities or recoveries we may receive in future periods. After adjusting for these two items, Q4 2022 core earnings were $1.37 on $45.3 million beating internal targets and estimates adjusted for PPP. This brings our full year 2022 core earnings to $6.51. As a reminder, included in this amount was a pre-tax provision benefit of $36.8 million or $0.86 from the loan sale that Jay mentioned earlier, leaving $5.65 of sustainable core earnings for full year 2022, significantly higher than our $4.75 to $5 target and the $4.44 we made in 2021. Net interest margin excluding PPP was 2.87% for fourth quarter lower than our previously guided range of 3% for two primary reasons. First, challenges impacting the mortgage industry as a whole led to an unexpected large outflow of non-interest bearing deposits from clients in our mortgage warehouse vertical, which negatively impacted our fourth quarter margin by roughly 12 basis points. And two, higher average cash balances compressed margin by approximately 3 basis points. Turning to the balance sheet, we ended the year with $19.9 billion in core assets ex-PPP, up 22% over the prior year. Our core loan book ex-PPP grew an impressive 31% year-over-year ending 2022 at $14.8 billion. This growth was primarily in the low risk variable rate corporate and specialty banking vertical Iâll discuss in more detail later. Total deposits grew by 8% to $18.2 billion and have more than doubled over the last three years. From a profitability standpoint excluding PPP, our Q4 2022 core ROA was 93 basis points and our adjusted pre-tax pre-provision ROA was 1.67%. Turning to Slide 11 on loan growth. In fourth quarter 2022, we purposely moderated loan growth that we intend to retain on balance sheet, as we think about optimization strategies over our planning horizon. Our Q4 2022 held for investment loan growth was about 300 million of which $200 million was in our low risk variable rate, corporate and specialty banking vertical, which prices at roughly 300 basis points over SOFR. Year-over-year, this vertical increased $2.2 billion and ended 2022 at $7.2 billion. Moving on to deposits on Slide 12. Total deposits increased $1.4 billion in 2022 and ended the year at $18.2 billion, up 18% year-over-year. Notably, 57% of total deposits are sticky transaction related DDAs consistent with the challenging deposit environment industry-wide, we experienced a negative mix shift and higher funding costs in the fourth quarter, primarily from several larger institutional customers that we were previously able to hold at lower levels. Our core deposit pipelines remain robust, particularly in the verticals that Sam mentioned earlier as we continue to build out our relationship-based deposit franchise. Turning to Slide 13, we had another strong year of interest earning asset growth with interest earning assets up 22% year-over-year. Notably, we have $1.5 billion of lower yielding PPP loans and available for sales securities, which can be reinvested at roughly a 400 basis point higher yield in 2023. Moving to Slide 14. This slide shows a trend of increasing net interest income excluding PPP over the past five years, largely driven by strong organic growth in our corporate and specialty banking vertical. In 2022, we continued to experience strong growth in our NII ex-PPP, which was up 33% year-over-year. This growth outpaced the 22% annual growth rate we experienced over the past four years. The right side of that page also shows significant margin expansion since 2018 and highlights our disciplined loan pricing strategy despite the remix into lower credit risk lending verticals. Turning the Slide 15, this slide really showcases our effective and disciplined expense management. Despite significant asset and NII growth, weâve more than doubled our asset size since 2018. Our core non-interest expenses have only increased 9% annually. This has resulted in a significant decrease in our efficiency ratio down from 63% in 2018 to 43% in 2022, highlighting our positive operating leverage. Moving to capital on Slide 16, our regulatory capital levels remain within our targeted operating ranges and well above required regulatory well capitalized minimums. Our TCE ratio was down slightly during the quarter given loan growth and slightly higher AOCI losses. Our AOCI adjusted TCE ratio was 7.2% at year end. Slide 17 highlights significant tangible book value accretion over the past five years, despite $165 million of increased unrealized losses deferred in AOCI. Our tangible book value at year-end 2022 was just under $39, up approximately 5% from last year despite nearly $5 of negative impact from AOCI. This significantly outpaces our midcap peers. Without AOCI, we wouldâve ended this year at nearly $44. Thanks, Carla, and good morning everyone. As Sam and Carla referenced earlier, the bankâs organic loan growth has been in low-to-no credit risk verticals as noted on Slide 18. 70% of the bankâs total loan book and 90% of its loan growth is in verticals that have experienced low-to-no credit losses. And this remains our strategy moving forward. By continuing to lever our strong underwriting standards and remaining focused on these strong credit segments, we are confident that our performance within these verticals will remain extremely strong as evidence to date by the limited lifetime loss rates noted for our funds finance, multifamily, mortgage warehouse, and equipment finance business lines, all of which are mature and have been in existence at the bank for at least seven years. Moving to Slide 19. Credit quality remains strong as evidenced by NPLs of only $31 million or 19 basis points of total loans. NPAs to total assets of just 15 basis points and continued decline in total special mention and substandard loans in both a dollar and percentage of total loans perspective. And most importantly, as it represents some more real-time assessment of portfolio performance. Total 30 day to 89 day delinquencies were a modest 35 basis points. Looking solely at the commercial loan portfolio, which comprises over 85% of the bankâs total loan book, total 30 day to 89 day delinquencies were minimal 24 basis points. Moving to net charge-off. Net charge-off figures in the core commercial and consumer portfolios were in line with expectations. Total net commercial charge-offs were only 8 basis points. While the 2.53% net charge-off rate for the consumer portfolio was higher than that of Q3, it is well in line with our portfolio by portfolio vintage loss curves and was fully anticipated as the underlying portfolioâs naturally seasoned. Although pleased with how well our commercial consumer portfolios have performed, we remain committed to the following. First, maintaining a strong reserve position is evidenced by a robust 425% coverage of total NPLs. Second, adhering to our strong underwriting and portfolio management standards. And third, remaining committed to our low-to-no credit risk portfolio strategy I previously noted. Wrapping up based on continued strong credit metrics and a portfolio comprised predominantly of loans to no-to-low credit risk verticals, strong portfolio management with ongoing loan level stress testing, limited exposure to high risk credit segments such as investment CRE office and investment CRE retail, which standard only $132 million and $180 million in total exposure respectively and continued strategy of not lending into discretionary spending dependent verticals. We are confident that our loan portfolio is well positioned moving forward. Thanks, Andy and Carla. Now to connect some of the dots and bring it all together on Slide 20, we wanted to provide a fair amount of guidance in our 2023 outlook to assist with modeling. While much uncertainty remains in the coming year, we believe we are very well positioned to navigate the environment we see ahead. Although our lending opportunities remain strong, youâve heard we will be looking to even further moderate our overall growth and project low-to-mid single-digit loan growth in 2023. This is excluding PPP. We expect a relatively flat balance sheet overall as we will reinvest cash from PPP loans and securities runoff as they roll into higher yielding loans. On the deposit side, our growing pipelines will help us remix as we expect to shed higher cost deposits throughout the year. It is worth noting that in January we informed the material amount of our market sensitive depositors that we will be â we will not be increasing their rates any further in 2023 and so far we have not seen any related outflows. Moving to full year NIM. We see this in the 2.85% to 3.05% range. We expect our non-interest expense to decline in the year, including the effect of BMT and expect to deliver $6 to $6.25 in EPS. On our core non-interest expense excluding BMT, we would expect that to be less than 10% growth for the year. I would note that NIM and EPS are expected to be lower in the first half of the year with margin and earnings expansion expected in the second half of the year. Even with the limited growth, we expect over a 15% ROE with capital ratios in line with the industry and well above regulatory thresholds. While a share buyback is typically lowest in our waterfall of capital actions, we want to reiterate that we are committed to materially improving our valuation by moderating our growth, focusing on capital, profitability and funding cost, all while buying back stock likely aggressively. We plan to begin buying soon, as soon as our trading window opens on Monday. As a reminder, we have 1.9 million shares remaining under our previously authorized program and through our guidance you can see we have ample capital available through organic growth and retained earnings to complete the program without growing our balance sheet. We expect our tangible book value to be above $45 by year-end, which is a 15% growth rate over the next few quarters, and a CUBI [ph] valuation convergence to book value or higher due to these action implies at least a 50% valuation upside from recent trading levels. To wrap it up on Slide 21, let me summarize what weâve shared with you this morning. As youâve heard today, we are well positioned to manage the risks of the dynamic market environment. We will be moderating our growth to improve our margins, capital ratios and profitability. Credit quality, as you heard from Andy, has and will be at the center of every decision we make and our capital ratios are very much in line with our peer group. We have a formidable balance sheet with available liquidity of over $9 billion and are well positioned to support our buyback. Iâm proud to work with a very forward thinking management team that has a proven track record of driving exceptional financial performance and we are proud that we have leapfrogged the industry in tech strategy and tech capabilities. We will have an opportunity to showcase this by delivering on fee income and low cost deposit generation. Finally, as weâve said a couple of times, we have to take firm action with conviction and we will be commencing what we expect will be a significant buyback immediately. We are hopeful that this will lay the foundation for a significant share price out performance in 2023 for our investors. Yes, thank you very much Sam. And before we open it up for Q&A, Iâd also like to recognize our team members who are executing superbly and are â they are helping us build this very strong foundation for continued exceptional performance and we are delivering outstanding shareholder performance over the next couple of years. In 2022, we delivered, as you heard, another outstanding year of financial performance and with the strength of our credit profile, as you heard from Andy, the capital and liquidity position as Sam just summarized as a differentiated model that all of my colleagues talked about, we believe we are very welcome [ph]. Hi. Good morning. This is Mikeâs associate Andrew filling in. Thank you for taking my questions. I just wanted to ask for a little more color on the margin guide in 2023. Is it just the slower growth that you mentioned that as youâre feeling like you can stabilize the NIM? Or are you expecting relatively â to relatively lower your incremental funding costs near-term beyond just that core customer base that you mentioned that youâre holding at their current rate? Good morning, Andrew. I can give some background on that. First of all, when we are thinking about margin and net interest income, weâre really focused on growing net interest income based on low risk growth rather than focusing specifically on a NIM target or an ideal beta. Practically all our deposits are corporate or institutional deposits and only a very small percentage are consumer deposits that have virtually no corresponding branch expenses, which in our opinion should be factored into the total cost of deposits. To put some specificity around this, our non-interest expense to average earning assets was 50 basis points below the mid-cap bank average, highlighting that our structural cost advantages and most rate environments. With higher deposit costs in mind, weâve continued our discipline pricing strategy requiring a spread between 300 basis points and 350 basis points over the projected funding costs. As weâve referenced before, we have $1.5 billion of lower yielding PPP loans and AFS securities that can be reinvested in the coming year at 400 basis points incremental spread. Now specific to our guidance, weâre expecting the full year to be between 2.85% and 3.05% with tighter margins in the front half of the year and expansion margins in the back half of the year. Great. Thanks, Carla. And then secondly, Sam, I was wondering if you had any additional update on CBIT? Are you guys slowing down there and kind of seeing how the regulatory piece plays out or are the deposits just kind of less valuable here because you canât leverage them? Sure. Yes, so on our CBIT balances actually grew by about $400 million in the quarter. So, we ended with $2.3 billion at the end of December. And as you can probably appreciate given some of the industry dynamics, we saw significant customer interest and also that sort of translated into growth and activity on CBIT. To your question about sort of waiting and scene, our related deposits are under 15% of total deposits. We did add 90 new customers in the fourth quarter ending at 391 total customers, but importantly, weâre growing some of our, our key anchor customers there and payments activity and associated non-interest bearing deposits, will â that will translate into better deposit costs as the year progresses. Awesome. Appreciate the color there. And then just lastly from me. What would you outline at the if the priorities for the next year, given it was a pretty volatile Q4 for many fintech and digitally focused companies and the macro for 2023 kind of remains uncertain at this point? Sure. So, I think we, laid that out, pretty clearly in our outlook and our guidance and, while we see, weâre seeing sort of strength in our customer base, weâre also seeing an opportunity for very strong loan pipelines that we arenât necessarily capitalizing on, because we think itâs very important that customers banks specifically to focus on capital and profitability. In terms of our guidance, you could have seen us, grow by an extra dollar of EPS and an extra 15 basis points, 20 basis points of NIM. If we brought in, as Carla mentioned, the higher margin loan growth on top of our incremental marginal cost of deposits, but we thought it would be much more prudent for us to slow that growth, focus on profitability, build capital, support the stock, and reduce our share count from an EPS perspective. And to your question about the macroeconomic environment itâs â thereâs a lot of uncertainty that I think that we all are seen. We are hopeful that the market is right, that the market has turned a little bit in the past 30 days to 60 days in terms of looking at the data. And weâre hopeful that thereâs an opportunity that thereâs an â that there can be a soft landing, however, weâre not necessarily, planning on it, but we are hoping for it. Thank you. Iâd like to start with PPP loans if we could. Would you please discuss the $11 million charge-off and the opportunity to recover that, given that we think the PPP loans or government guaranteed. So, can you walk through the dynamics of all that please? Sure, Bill. Iâd be happy to do that. Just to begin, just wanted to level set. So, we had $10.5 billion of PPP loans in total of which $9 billion has been repaid, forgiven or guaranteed by the SBA. In the fourth quarter, there was a discreet population of $11 million of loans that really came from two PPP loan servicers that we worked with. The first we had disclosed a settlement with one of them in October, and we had $7.5 million that we were expected to cover any potential losses for one reason or another whether there would not be an SBA guarantee. And in the fourth quarter we did have roughly $8 million, so that was largely neutral. For the remaining $3 million, we still have contractual indemnities with our PPP partner that would allow us to recover any losses to the extent that the borrower did not pay those underlying loans. So, we think this is largely behind us, but thought it was prudent to take the charge-off in the fourth quarter Just to point on that, Bill just to, weâre either have had already had associated revenue against the charge-off, or we have contractual indemnification, but we are being conservative and prudently, adding the adding to provision. For the life-to-date program we made over $8 from the PPP program, increasing our risk weighted ratios, capital ratios by roughly 180 basis points. Right. Thank you. And so just to be the $11 million charge-off and the $7.5 million recovery, those two are actually related to each other and as opposed to being the independent. Thatâs right, Bill. They are related to each other, but from an accounting perspective, theyâre not netted in the same financial statement line item. So, youâll see the $8 million in provision expense and within non-interest income, youâll see a $7.5 million gain on settlement. Thank you. Thatâs really helpful. And then shifting to the CBIT, where are you at with adding additional verticals beyond the crypto industry? Thanks, Bill. Good question. So, we have and are active with customers across our commercial base. We have added new verticals that weâve previously talked about. Weâre working to explain the benefits of the 24/7, 365 payments. Itâs a bit of a longer play. However itâs a question of, when, not if, and I think itâs allowing us to attract, in some cases, customer bases and customer verticals that do not exist at Customers Bank today, which is very interesting an exciting for us. And there are no further questions at this time. Iâll turn the call back over to Jay Sidhu for some closing remarks. Thanks so much. This is Sam, Iâll wrap up. I think Jay was having some technical difficulties. Thank you so much everyone for your time and your interest in Customers Bank. Weâre very pleased with our financial results in 2022. And really excited to deliver on our outlook for 2023.
|
EarningCall_1134
|
Hi, everyone, and welcome to the Hilltop Holdings' Fourth Quarter 2022 Earnings Conference Call and Webcast. My name is Bruno, and I will be the operator of your call today. [Operator Instructions] Thank you, Bruno. Before we get started, please note that certain statements during today's presentation that are not statements of historical fact, including statements concerning such items as our outlook, business strategy, future plans, financial condition, allowance for credit losses, the impact and potential impacts of inflation, stock repurchases and dividends and impacts of interest rate changes, as well as such other items referenced in the preface of our presentation are forward-looking statements. These statements are based on management's current expectations concerning future events that, by their nature, are subject to risks and uncertainties. Our actual results, capital, liquidity, and financial condition may differ materially from these statements due to a variety of factors, including the precautionary statements referenced in our presentation and those included in our most recent annual and quarterly reports filed with the SEC. Please note that the information presented is preliminary and based upon data available at this time. Except to the extent required by law, we expressly disclaim any obligation to update earlier statements as a result of new information. Additionally, this presentation includes certain non-GAAP measures, including tangible common equity and tangible book value per share. A reconciliation of these measures to the nearest GAAP measure may be found in the appendix to this presentation, which is posted on our Web site at ir.hilltop-holdings.com. Thank you, Erik, and good morning. For the fourth quarter, Hilltop reported net income of approximately $26 million or $0.39 per diluted share. Return on average assets for the period was 0.6%, and return on average equity was 5%. Although the mortgage market remained under significant pressure, we still generated consolidated profitability, and grew our capital base due to our diversified business model, strong balance sheet, and continued focus on expense discipline across each of our companies. During the fourth quarter, PlainsCapital Bank generated $58 million in pretax income, and a strong return on average assets of 1.3%. Though pretax income is down year-over-year due to changes in provision expense from deterioration of the economic outlook, the bank's pre-tax pre-provision income grew materially from net interest income expansion and a relatively flat expense base despite the inflationary environment. Average loans held for investment at PlainsCapital Bank increased $101 million or approximately 4% annualized in the quarter as a result of both core commercial loans and an increase in retained mortgage balances. Average loan growth would have been higher if not for the approximate $116 million decline in average national warehouse lending balances versus the prior quarter, which has been impacted by the shrinking mortgage market. We are pleased with the loan growth in 2022; however we are starting to see pressure on the pipeline as a result of our heightened credit standards and declining loan demand in general due to the economy, elevated rates, and other factors. Total average deposits decreased by $270 million or 2% quarter-over-quarter as customers have migrated deposit balances towards higher-yielding assets, both inside and outside of the bank. We are pleased that we have been meaningful deposit relationships within our private bank's assets under management as customers move some money from bank deposits into treasuries and similar securities. For the full-year, the bank generated $219 million in pre-tax income and a return on average assets of 1.2%. Net interest income before purchase accounting accretion and PPP income grew by $32 million or 9% as interest rates increased throughout the year. We do expect deposit balances and costs to be under pressure in 2023 due to intense competition across Texas where many banks will inevitably drive up market pricing for deposits to maintain liquidity. We continue to monitor credit closely in anticipation that economic conditions could result in a downward migration in asset quality. That said, we currently do not show any significant signs of credit deterioration in our loan portfolio. Additionally, with elevated rates expected throughout 2023, we anticipate continuing to see borrowers putting higher amounts of equity into transactions and projects continuing to slow. Overall, we are extremely pleased with PlainsCapital Bank's results in 2022, and remain optimistic for the banking environment in 2023. We have a great group of leaders and bankers across Texas, and we'll continue to capitalize on the growth in strong economies within our start. Moving to PrimeLending, during the fourth quarter, PrimeLending experienced a loss before taxes of approximately $26 million on $2 billion of originated volume. This was driven by a 59% decline in volume and a 151 basis point reduction in gain on sale margin from the same period prior year. There were multiple factors that adversely impacted the mortgage industry in 2022, including inflation, the resulting steep rise in interest rates, limited housing inventory, and the negative residual impacts of the COVID-19 pandemic. These factors have constrained the willingness and ability of prospective home-buyers and existing home owners to conduct mortgage transactions, both in the purchase and refinancing markets. Additionally, these trends have added to already competitive mortgage pricing pressures, leading to a decline in average loan sales margins as mortgage volume declines have materially outpaced the capacity that needs to come out of the mortgage origination ecosystem. Throughout the challenging year, our team has remained resilient and undertook difficult but impactful cost reduction and optimization actions to help resize the overall business, specifically reducing non-originator headcount by approximately 515 people or 37% during the year. That said, our PrimeLending leadership team remains focused on their two primary objectives, originating profitable loans and continuing to operate the business more efficiently. During the quarter, HilltopSecurities generated pre-tax income of $19.8 million on net revenues of $107 million, an increase in revenues of $12 million or 13% compared to Q4, 2021. The revenue increase was primarily driven by fixed income services, which more than offset a slow quarter in public finance as national issuance declined by 41% compared to Q4, 2021. Increased revenues from fixed income can be attributed primarily to improvements in municipal and mortgage products. Additionally, our revenue from sweep deposits continues to improve, so we expect the growth in that revenue to moderate in 2023. For the year, HilltopSecurities generated net revenues of $394 million and a pre-tax margin of 9.6%. Financial results improved over the last three consecutive quarters following very volatile trading results in the first quarter. Moving the page forth, Hilltop maintained strong capital levels, with a common equity Tier 1 capital ratio of 18.2%, and tangible book value per share of $27.31 at year-end. During 2022, Hilltop returned $485 million to shareholders through dividends and share repurchase efforts, repurchasing approximately 19% of the shares outstanding one year ago. This week, Hilltop's Board of Directors declared a quarterly cash dividend of $0.16 per common share, a 7% increase from the prior quarter, and authorized a new stock repurchase program of $75 million, through January 2024. Overall, 2022 was a challenging year for our mortgage-related businesses though buoyed by the strength of our banking franchise. Despite challenges in certain business lines, we feel that we have positioned the organization well entering 2023. First, our financial position is solid. We have a strong balance sheet with ample liquidity, diversified and accessible funding sources, and an outsized capital base. We believe this allows us to invest in our business, stay resilient through unknown economic cycles, and take advantage of growth opportunities as they arise. Second, we have worked to enhance productivity and expense efficiency across all business and, in particular, executed on significant actions within our mortgage operations groups to better align with the current market. Through those efforts, we are expecting a more efficient expense base to help combat rising inflation costs. And we are poised to benefit from higher margins as the economy recovers. Additionally, employee engagement is high, and we feel that we are more focused and aligned as a company than ever before. In conclusion, we believe that 2023 will be a prosperous year for Hilltop. We have the solid foundation -- excuse me, we have a solid financial foundation, well-established businesses, and solid teams across our franchise. We are excited about the opportunities that lie ahead are committed to delivering value to our shareholders. Thank you, Jeremy. I'll start on page five. As Jeremy discussed for the fourth quarter of 2022, Hilltop reported consolidated income attributable to common stockholders of $26 million equating to $0.39 per diluted share. As shown on page six, for the full-year 2022, Hilltop reported consolidated income attributable to common stock holdings of $113 million or a $1.60 per diluted share. Of note, Hilltop's outstanding shares will reduce by 18% or 14.3 million shares during the year primarily as a result of the successful 10-year offer completed during May. Turning to page seven, Hilltop's allowance for credit losses increased by $3.6 million to $95.4 million as deterioration in the macroeconomic outlook drove a modest increase in the ACL. The economic impact was somewhat offset by reductions in both specific reverses and collective portfolio migration. Allowance for credit losses of $95 million yields an ACL to total loans HFI ratio of 1.18% as of yearend 2022. Of note, we continue to believe that the allowance for credit losses could be volatile and the future changes in allowance will be driven by net loan growth in the portfolio, credit migration trends, and changes to the macroeconomic outlook over time. Given the current uncertainties regarding inflation, interest rates, the future outlook for GDP growth, and unemployment changes in the ACL on a quarterly basis could be volatile. I am turning to page eight. Net interest income in the fourth quarter equated to a $123 million including $2.2 million of purchase accounting accretion. Versus the prior year quarter, net income increased by $19 million or 18% driven primarily by higher yields on loans, securities, and cash balances which was somewhat offset by higher rates on deposits and variable rate borrowings. And interest margin continued to improve versus the third quarter of '22 increasing by 4 basis points to 323 basis points. Our current outlook reflects a scenario whereby fed funds moves to between 5% and 5.25% during the first half of 2023 and remained stable for the balance of the year. If this scenario proves to be accurate, we expect NII and NIM to continue to expand modestly through the first half of the year. And then began to decline as the interest-bearing deposit rates will likely continue to move higher throughout the balance of 2023 as the competitive environment for liquidity remains very intense. Turning to page nine, in the chart we highlight the asset sensitivity of Hilltop assuming parallel and instantaneous rate shocks which represents an asset sensitive position of approximately 6% in the up 100% basis point scenario. As we evaluate asset sensitivity and the interest rate risk, we assess a number of potential scenarios. Of note, we shift the analysis from instantaneous parallel shift to a gradual increase over the course of the next 12 months, the up 100 basis point sensitivity falls through approximately 3%. Further in this scenario, each 25 basis point increase positively impacts net interest income by approximately $4 million. Moving to page 10, total non-interest income for the fourth quarter of 2022 equated to $170 million. Fourth quarter mortgage-related income and fees decreased by $121 million versus the fourth quarter of '21 driven by the evolving environment in mortgage making which remains very challenged in combination of higher interest rates, home price inflation, limited housing supply, and ongoing overcapacity in terms of mortgage originators across the United States has driven volumes materially lower and moved margins to levels we have not seen in the recent history. Further versus the prior year quarter, purchase mortgage volumes decreased by $1.7 billion or 47% and refinanced volumes decreased by $1.3 billion or 90%. During the fourth quarter of 2022, gains-on-sale margins continued what has been a multi-quarter decline with gain-on-sales margins for loans sold to third parties declining 16 basis points to 211 basis points. Our gain on sale margins have been pressured, we are continuing to see the customers are paying to buy down their interest rate. And as such, our mortgage regions are stable versus the prior-year period. We expect the gain on sale margins will continue to be pressured and trend lower throughout the first half of the year, and customers will continue to prefer to buy down their interest rate rather than probate -- rather than pay the prevailing market rate, resulting in mortgage origination fees continuing to outperform origination volume trends. Other income increased by $18 million driven primarily by improved municipal trading results, and additional favorable valuation marks across the fixed income trading books during the quarter. It is important to recognize that most of fixed income services and structured finance businesses, HilltopSecurities can be volatile from period-to-period, as they are impacted by interest rates, overall market liquidity, volatility and production trends. I'm turning to page 11. Non-interest expenses decreased from the same period in the prior-year by $69 million to $253 million. The decline in expenses versus the prior-year was driven by decreases in variable compensation of approximately $50 million at HilltopSecurities and PrimeLending, which was linked to lower fee revenue generation in the quarter compared to the prior-year period. Additionally, non-compensation variable expenses, particularly mortgage production related expenses, which are captured in other expenses in the table in the upper right of the slide, declined as production volumes declined versus the prior-year. Looking forward to 2023, we expect expenses other than variable compensation will remain relatively stable as the ongoing focused efforts relating to streamlining our operations and improving productivity, continue to support lower headcount and improve throughput across our franchise. Moving to page 12; fourth quarter average HFI loans equated to $7.8 billion in 2022 stable with the prior-year fourth quarter levels. On a period ending basis, HFI loans grew versus the third quarter of '22 by $213 million driven by improving commercial loan growth, particularly in commercial real estate, and the retention of one to four family mortgages originated by PrimeLending. During the fourth quarter of 2022, PrimeLending locked approximately $142 million of loans to be delivered to PlainsCapital over the coming months. These loans had an average yield of 617 basis points, and average FICO and LTVs of 774 and 68% respectively. Turning to page 13; in the graph in the upper right, we show the progress made in reducing NPAs throughout 2022, which continued to support a relatively low level of net charge-offs throughout the fiscal year. As is shown on the graph, the bottom right of the page, the allowance for credit loss coverage at the bank ended 2022 and 1.24%, including mortgage warehouse lending. I'm moving to page 14. Fourth quarter average total deposits are approximately $11.4 billion and declined by approximately $1 billion, or 8% versus the fourth quarter of '21. On an ending balance basis, deposits declined by $1.5 billion to $11.3 billion from the prior-year ending level, including the decline was our usage of $442 million related to the HTH tender share repurchase and $410 million of deposits that have transferred into our private bank in pursuit of higher yields and treasuries or other suite programs. While we expected deposits to decline, given the level and speed of market interest rate adjustments, coupled with our decision to manage interest bearing deposit costs was a significant lag, during the fourth quarter of 2022, we began to see customer activity shift as customers began to seek higher interest rates at an accelerated pace. Interest bearing deposit costs rose 157 basis points from 22 basis points in the prior-year period. Given the ongoing competitive intensity for liquidity by some participants in our markets, we expected deposit rates will continue to move higher throughout 2023 dropping our expected deposit date is above our previous target of 50% towards 60% through the cycle for interest bearing deposits. We remain focused on balancing our competitive position and supporting our long-term customer relationships with managing net interest income over time. Turning to page 15, as we turn the calendar to 2023, there continues to be a lot of uncertainty in the market regarding interest rates, inflation and the overall health of the economy. We're pleased with the work that our team has delivered to position our company for times like these and our teammates across our franchise remain focused on delivering great customer service to our clients, attracting new customers to our franchise, supporting the communities where we serve, maintaining a moderate risk profile, and delivering long-term shareholder value. As is noted in the table, our current outlook for 2023 reflects our current assessment of the economy and the markets where we participate. Further, as the market changes and we adjust our business to respond, we will provide updates to our outlook on our future quarterly calls. [Operator Instructions] Our first question is from Michael Rose from Raymond James. Michael, your line is now open, please go ahead. Hey, good morning, guys. Hope you're well. Thanks for taking my questions. Just wanted to talk about the Mortgage segment and I think you mentioned some of the steps you've taken to reduce the cost base. Can you just give a little bit more color on what steps you've taken to kind of right-size the business and how we should think about segment profitability, at least over the next couple quarters? Right now, it's going to be pretty challenging, but just wanted to see if we're kind of at or near an inflection point with the loss this quarter? Thanks. Hi, Michael, this is Will. Thanks for the question. I think as we have gone through 2022, a lot of work was done, as Jeremy mentioned, in the non-production area. We'll continue to make investments in our originators, trying to grow our sales staff obviously. We've got to originate profitable loans to reach the inflection point you talked about. We've done significant reductions in the middle and back office to focus on productivity targets that had been set forth previously. We continue to make strides in that area, so we're continuing to evaluate it. I'd say the realignment of that business is more of a process than a place where we just get to an endpoint. We'll continue to evaluate the business on, really, a weekly basis -- weekly and quarterly basis as we see production trends here in to the first quarter. As it relates to profitability, we are expecting that the first quarter will yield results similar to those in the fourth quarter. First quarter is seasonally a weak origination period; nothing we've seen in the first month here has changed that view. However, in the second-half of the year, we expect to start to move closer to breakeven or profitability. So, the work the team's done, I think, has positioned us to reach that inflection point. But again, we do expect a challenging first quarter. Perfect. Appreciate the color. And what -- I know you talked about pressure on the gain on sale margin, but do you have a sense for how much either downward pressure there may be from here, or maybe when you think, might be the better question, when it might actually stabilize? I know we've talked about the excess capacity coming out of the system, but still seems like you and others are still seeing pressure. When do you think we kind of hit an inflection point there? And then could we actually start to see some relief as we move into the back-half of the year? Thanks. I think it's hard to call. Obviously, we're playing with the market -- we're playing in the market we're given, so it's hard to absolutely say. Our expectation just based on that return to breakeven or profitability relies on some relief from a gain on sale perspective as well as mortgage origination fees continuing to remain strong. So, we are projecting that it will start to improve in the second-half of the year. But again, it has taken longer and moved slower from a rightsizing of the overall industry than we would have otherwise expected. So, we're going to continue to be vigilant around cost in rightsizing our franchise, and be focused on driving our businesses as best we can toward profitability. Appreciate it. And then just maybe moving to the core bank, the margin was under, I think, some -- it was flat q-on-q, but the consolidated margin up a little bit. Obviously, that the Fed seems to be at or near peak levels of Fed funds in looking at the forward curve. Can you just give us an idea for a trajectory for the margin? I would assume that you might expect maybe flat-to-up on a consolidated basis just given the impact of the rate hikes. But, obviously, there's the deposit side of the equation too. So, if you can just give us just general thoughts on near-term margin trends would be helpful? Thanks. So, from an overall margin perspective and I'll talk about consolidated, which you could see on page eight of our materials. But we are expecting, as I said in my comments, to see, with the expected Fed funds, kind of targeting at 5 to 5.25 range. We are expecting to see modest improvement -- ongoing improvement in our NII and our NIM through the first-half. Now, as I noted, we are seeing deposit betas in our business, in our markets move higher faster than we would have otherwise expected. A lot of that is related to the liquidity, competition, and the intensity there too around banks continuing to acquire deposits. So, I'd just give you an endpoint. So, the December net interest margin on a consolidated basis was 332, so that gives us a sense versus the 323, which was the average for the quarter. That gives you a sense of some positive trajectory there. But we're going to have to be vigilant around protecting our deposit base and protecting our relationship. So, again, we're expecting modest increases in NII and NIM through the first-half. We do expect that this deposit and liquidity competition will persist for the balance of the year. So, we do expect to see those improvements moderate in the second-half, and likely start to trend downward, at least slightly, through the end of '23. Perfect. And then maybe finally for me, so the buyback, you guys were obviously fairly active last year. Just given the economic uncertainty, do you expect to use the full amount of the buyback or is it just you're going to be opportunistic, if there's declines in the price, just given the uncertainty in the economic backdrop? Thanks. Sure. I mean, I think that part of our capital planning, we authorized a share repurchase, so we did that. And so, we'll evaluate it in open windows this quarter. And I think that's the best number you got to go on this year as we go forward. Can you guys maybe dig a little deeper into the broker dealer fee guidance you provided, the 0% to 5% growth in 2023, just looking for any color on the moving parts by business line there? Yes, so as we look out into 2023, obviously that the investment banking business, the trading businesses can be difficult to assess. And so, as we look forward, we expect to see improvement in our public finance services business. We had a challenging underwriting year in 2022. We think that improves modestly. From a fixed income services perspective, it's difficult necessarily to predict exactly how the year goes. We obviously saw some volatile results quarter-to-quarter, in 2022. But we do -- we don't see the environment necessarily materially changing in the first quarter from what we saw. But it is starting to heal slowly. So, we've got it improving modestly through the year. And then we expect our sweet peas that we've talked about to continue to carry forward and -- carry forward into 2023. So, a modest improvement, but not a market shift in what I would call the overall environment for HilltopSecurities. Yes, I wanted to touch on credit. I mean all the credit metrics were pretty stable quarter-over-quarter, which was good to see. Are there any loan segments in particular you are taking a closer look at at this time? Or, just how are you thinking about credit over the next six months? We are our entire loan lookout obviously as interest rates have shot higher. Different reset period for different clients. So, it's affecting different clients at different rates here. But we are evaluating the book really across. Certainly for anybody who has got a floating rates or variable rate loan, portions of the book we continue to look at, I think this has been consistent. The office book which is just under $860 million, we continue to monitor closely given work-from-home trends and the like. The hotel portfolio, which is much smaller than it used to be, but we continue to monitor that portfolio certainly for business travel. But outside of that, I think it's really wholesome look across the portfolio. Again because the biggest -- what we are seeing as the biggest challenge is higher interest rates and the speed with which those interest rates did move higher, our customers not necessarily being to push that through to that customers or pass that through. And so, it is impairing -- it's a very cash flow on the margin. So, we were watching that across the book. Okay, that's good color. And then, I wanted to touch on the deposit guidance. Your way out -- you are expecting average deposits down 4% to 8% for the year. Under this scenario, do you think the overall size of the balance sheet shrinks, or would you look for a fill the hole with short-term borrowings in this scenario? Our outlook kind of expects the balance sheet is similar in size year-on-year. So, it doesn't get materially smaller but it does likely shrink modestly. But again, we are looking to see -- we have got excess cash levels. Those cash levels will likely run down. And, we will see that reinvest in loans in the loan portfolio. Ladies and gentlemen, we currently have no further questions. And this concludes today's call. Thank you for joining. You may now disconnect your lines. Have a great day.
|
EarningCall_1135
|
Good afternoon. My name is JP, and I'll be your conference operator today. Welcome to the Knight-Swift Transportation Fourth Quarter 2022 Earnings Call. [Operator Instructions] Speakers from today's call will be Dave Jackson, President and CEO; Adam Miller, CFO. Thanks, JP, and good afternoon, everyone, and thank you for joining our fourth quarter 2022 earnings call. Today, we plan to discuss topics related to the results of the fourth quarter, provide an update on current market conditions and share our full year 2023 guidance. We have slides to accompany this call, which are posted on our investor website. Our call is scheduled to go until 5:30 PM Eastern Time. Following our commentary, we will answer questions related to these topics. [Operator Instructions] We will answer as many questions as time allows. If we're not able to get to your question due to time restrictions, you may call (602) 606-6349. To begin, I'll first refer you to the disclosure on Page 2 of the presentation and note the following. This conference call and presentation may contain forward-looking statements made by the company that involve risks, assumptions and uncertainties that are difficult to predict. Investors are directed to the information contained in Item 1A Risk Factors or Part 1 of the company's annual report on Form 10-K filed with the United States SEC for a discussion of the risks that may affect the company's future operating results. Actual results may differ. And now on to Slide 3; this chart on Slide 3 compares our consolidated fourth quarter revenue and earnings results on a year-over-year basis. Revenue excluding fuel surcharge declined by 9.5%, while our adjusted operating income declined by 39.3%. GAAP earnings per diluted share for the fourth quarter of 2022 were $0.92, and our adjusted EPS came in at $1. These results included a $15.4 million pretax charge, which negatively impacted EPS by $0.07 for an actuarial insurance adjustment related to third-party carrier risk in our iron insurance business. On a year-over-year basis, lower volumes in the absence of a holiday peak season negatively impacted earnings. Now on to the next slide; Slide 4 illustrates the revenue and adjusted operating income for the fourth quarter and year-to-date periods in each of our segments. In an unusually soft fourth quarter, our largest segments proved their ability to operate efficiently. Our Truckload segment operated in the low 80s, while LTL and Logistics stayed in the mid-80s. Our Intermodal was impacted by weaker demand as well as greater availability of truckload capacity at better service levels. Freight demand in the fourth quarter was well below typical seasonal patterns. While spot opportunities were very subdued and projects were infrequent as anticipated, general freight demand was softer than expected. We believe this was largely driven by the holiday goods pull-forward earlier in 2022, an existing inventory overhang dating back to last year where some products arrived too late for the season, and general caution around what retailers could expect from consumer demand. Weak demand pressured volumes and pricing, while ongoing inflation was a further headwind on operating income in most segments. The chart on the right highlights the percentage of revenue during the fourth quarter of 2022 from each of our 4 segments as well as the percentage of revenue from our other services, which include our rapidly growing insurance, equipment maintenance, equipment leasing and warehousing services. We are focused on improving service to our customers and reducing costs as we navigate a tough operating environment. We continue to work on diversifying our business and developing complementary services that bring strategic value to our customers and partner carriers. The next few slides will discuss each segment's operating performance, starting with Truckload on Slide 5. On a year-over-year basis, our Truckload revenue excluding fuel surcharge declined 7.2%, while our operating income declined by 36.5%, reflecting the comparison of an unusually weak fourth quarter of 2022 against perhaps the strongest fourth quarter we've ever experienced. Our Truckload business navigated the softness well and operated with an 82.7% operating ratio. Our efforts to reduce spot exposure and secure more contractual committed freight since the beginning of 2022 helped us maintain an adjusted operating ratio in the low 80s. During the quarter, revenue per tractor fell 8.6% driven by a 3.9% decrease in revenue per loaded mile and a 4.5% decrease in miles per tractor. The decline in revenue per tractor, combined with inflationary pressures across our business, caused the reduction in Truckload operating income. Most notably, we see ongoing cost pressures in equipment, maintenance and insurance. We continue to take steps to align our cost structure with the reduction in volumes. Having a diverse group of brands and services, including nearly 5,000 dedicated trucks, provides us with flexibility and strategy. For example, as over-the-road truckload volumes have softened year-over-year, our dedicated business has grown top line revenue and improved margins on a year-over-year basis. Despite the soft market, our customers still value trailer pool capacity at scale, and we see this expressed to both our Truckload and Logistics segments. We continue to invest in our already industry-leading trailer fleet, which grew sequentially to nearly 79,000 trailers. We believe our scale in trailers is a competitive advantage and provides our customers capabilities that are extremely difficult to replicate. Now on to Slide 6. Our LTL segment continues to perform well and make progress on yield and network initiatives. For the quarter, revenue excluding fuel surcharge was $204 million, and we operated at an 85.5% adjusted operating ratio. This represents a 480 basis point improvement from the fourth quarter last year and only a 100 basis point sequential degradation despite demand softening for more than a typical seasonal step down from the third to fourth quarter in LTL. Pricing remained strong as revenue excluding fuel surcharge per hundredweight increased 13.3% year-over-year. The leadership at both AAA Cooper and MME were able to complete the system integration during the fourth quarter, less than 12 months since the acquisition of MME. This creates seamless connectivity for our customers while maintaining the culture and brands of each company. We believe this positions us to provide additional services to existing customers as well as create new customer relationships. Our Knight and Swift brands have deep relationships with large shippers who in many cases deal with larger LTL providers. Creating a super-regional network in the short term and a national network in the long term will enable us to find opportunities to further support our existing truckload customers with LTL capacity. Now we'll move to Slide 7. Our Logistics segment continues to perform well with an adjusted operating ratio of 86.4%. Gross margin also expanded to 22.1% in the quarter compared to 20.7% last year. Overall, revenue was down 42.2% driven by a 28.9% decrease in revenue per load from lower spot market rates and a decrease in load count of 18.6%. Load volumes were negatively impacted by lower import volumes, particularly over the West Coast ports. Our customers continue to value the power-only services we provide, which resulted in our power-only volumes feeling less pressure than our traditional live load, live unload activity. Our vastly growing trailer network allows our customers the ability to optimize their warehouse space and labor costs. Third-party carriers prefer power-only business because it saves them hours and each load and unload location, lowers their capital investment and risk, reduces their operating costs and gives them access to freight that historically wouldn't be able to participate in. We continue to be excited about this business and have several technology initiatives ongoing that will improve the experience for our third-party carriers as well as provide more seamless information internally and to our customers that will lead to more opportunities to utilize our equipment. I'll now touch on intermodal on Slide 8 before turning the call over to Dave. Revenue decreased to 8.6% driven by a 6.3% decrease in load count and a 2.5% decrease in revenue per load. Intermodal volumes are being pressured by the general freight environment and the current competitive position of the truckload alternative. Customers are leveraging the extremely low spot rates, quicker transit times and better service in the truckload market. Labor within the rail network appears to be improving as we enter the first quarter, leading to improving transit times and more predictability for our customers. These improvements should help close the service gap between intermodal and Truckload and support future growth for this business. Thank you, Adam, and good afternoon, everyone. Slide 9 illustrates the growth in our businesses that make up the non-reportable segment, which include insurance and maintenance under the Iron Truck Services brand as well as equipment leasing and warehousing activities. For the full year of 2022, we reached $517 million in revenues, representing 69% year-over-year growth. For the quarter, we had a 32% increase in revenue year-over-year. As previously mentioned, the results of the other services were negatively impacted in the fourth quarter by an actuarial adjustment of $15.4 million pretax related to third-party carrier risk in the iron insurance business, which resulted in the $11.6 million operating loss for this segment. We are already taking steps to enhance our insurance program, which include a recent conversion to a new platform that we expect will lead to improved collections and more timely cancellations. We've applied rate increases to various lines of coverage that will bring underwriting results in line with expectations. These service offerings have found tremendous interest from small carriers, especially as we help them improve their cost structure. But later in 2022, we have observed the pressure of the weaker environment impacting these carriers as seen through their difficulties, paying insurance premiums and the practice of extending maintenance service intervals on their equipment. We expect to continue growing the revenues and income from these other services over time and believe this effort supports our ongoing diversification objective. Next on to Slide 10; this slide illustrates the progress of the intentional changing of the composition of our business into an industrial growth company. The chart on the left shows the percentage of adjusted operating income from each of our segments and our other non-reportable services since the Knight and Swift merger in 2017. We're pleased to report meaningful contributions in earnings from each area. These diversification efforts are intended to make us a less volatile company and we expect will help us mitigate the downside through truckload freight cycles. Our Truckload earnings now represent approximately 65% of consolidated earnings, which is a meaningful shift from where we were in 2017 following the merger. This reduction in the percentage of our earnings coming from Truckload has been achieved while we significantly improved our Truckload earnings from a 2017 full year combined pro forma Knight and Swift earnings of $319 million to $748 million for 2022. The chart on the right shows our annual adjusted earnings per share since the merger. Our adjusted EPS has moved from $2.16 per share in the first 4 quarters following the merger to $5.03 per share in 2022. Moving to Slide 11; strong earnings have driven increases in our free cash flow since the Knight-Swift merger, reaching $819 million in 2022. Year-to-date, we've used cash to increase our dividend to shareholders by 20%, repurchased $300 million worth of shares and paid down $395 million in long-term debt and leases. Since the 2017 merger, we've invested $1.6 billion in acquisitions. Making acquisitions remains a high priority, and our strong cash flow generation and leverage ratio of less than 1.0 provide us with ample capacity for M&A opportunities. Our balance sheet is strong and we're well positioned to invest in organic growth, pursue acquisitions, purchase more shares, increase dividends and/or pay down debt. We are constantly evaluating market conditions to maximize our use of cash to create value for our shareholders. On Slide 12, we demonstrate the return on net tangible assets, which remains a key measurement for us. In 2022, we achieved a 19.0% return on net tangible assets. Our goal is to improve this measurement by focusing on 3 key areas: growing our less asset-intensive businesses; two, acquiring and improving businesses; and three, expanding margins in our existing operations. We've achieved synergies and improvement in every business we have acquired, be they warehousing asset-based truckload, less than truckload or truckload brokerage. We believe our focus in these 3 key objectives will leverage our core competencies in areas of opportunity that are unique to us and will allow us to continue to generate significant returns to our shareholders in the long run. On Slide 13, we provide an outlook for market conditions as we begin 2023. We expect the current softness will persist through the first half of 2023 based on indications from shippers that are working through their inventory overhang. This soft environment combined with ongoing inflation in equipment, maintenance and insurance and rising interest rates will increase the pressure on carriers, especially smaller and less well-capitalized carriers. These factors will most likely accelerate capacity attrition in the coming quarters. Thanks, Dave. On to our last slide here, Slide 14. For the full year 2023, we expect adjusted EPS to be in the range of $4.05 to $4.25. Last year, we expected the first half to be strong and then cool off in the second half, which is largely what happened. In 2023, we expect the opposite: more challenging environments in the first half before we start to see a recovery to a more typical freight demand, leading up to an improving Q4 peak season. Over-the-road truckload contract rates will be pressured with few noncontract opportunities until the latter half of the year. We expect these noncontract opportunities, combined with some return of peak season volume, to result in rates inflecting positive year-over-year in Q4. Overall Truckload revenue per mile should be down mid- to high single digits in Q1 and trending to be positive by low single digits in Q4. Dedicated rates should increase in the low single digits for the year. Truck count should remain sequentially stable throughout the year with miles per tractor reflecting positive year-over-year by the middle of the year. Our LTL segment is expected to see slight improvement in revenue with relatively stable margins. Sequentially, Logistics revenue per load should drop in the first quarter before increasing sequentially throughout the year. We expect volumes to follow a similar trend. Gross margin will compress as the freight market picks up, pushing logistics OR to climb into the high 80s to low 90s. Intermodal revenue per load in margin will deteriorate in the first half before improving again in the back half. For the full year, we expect the operating ratio to be in the mid-90s. Revenue and op income in our other services will increase driven primarily by improvement in rates and new customer growth in our insurance business and increased volumes in warehousing. Inflationary pressure will decelerate as labor loosens and equipment availability improves. Gains are expected to be in the range of $10 million to $15 million per quarter, and our CapEx is expected to be in the range of $640 million to $690 million, and our tax rate is expected to be around 25%. Interest expense is also projected to increase from where we were in the fourth quarter as rates continue to climb. So I guess maybe a two-parter here. But Dave, I'd be curious if you could maybe comment a bit on the fourth quarter to first quarter seasonality given that the fourth quarter of 2022, to your point, was anything but peak. How would you sort of think about that trending sequentially? If you could kind of help us set our expectations there. And then, I guess, just to kind of follow up on your comment about what your customers are telling you about the trends and trajectory of their businesses. Well, I guess, what's giving you the confidence to think that we're going to see a trough in sort of freight fundamentals in the first half of the year and that we can kind of build back in the second half? If you could just expand on those two items, I'd appreciate it. Okay. Thank you, Jack. Yes, I would say that from fourth to first, this is one where the step down is significantly lower than what we're used to. And I would say that the freight market continues to show signs of life here as we get -- as we go through January. And so typically, you would see quite a bit of seasonality in the fourth quarter, which then changes with the holiday in the rearview mirror moving into the first. We do expect first to be seasonably softer than the fourth, they always are. But there's a good chance that after we complete the first quarter, we'll look back, and this might have been the most benign change sequentially from the fourth to a first. I would say that some of what gives us some indications of how this will play out maybe from customers would be the fact that in the fourth quarter, so much of their holiday inventory had already arrived. Some of it has already arrived 10 or 11 months before. It kind of sat around. It just barely missed the holidays. So it seemed that by the time October started, the fourth quarter freight was already -- had already arrived and was largely in position. So that explanation made sense to us. And so naturally, our next question is, well, how long are you going to continue to have this inventory overhang. And the general consensus, almost unanimous from customers that have given us this kind of -- or given us feedback about their inventories, has been that by the time they get through the spring, things are caught up. And that makes sense. I mean it was -- freight was flowing rather normally by the time we got to summer of 2022. So throughout the summer, there wasn't the traditional delays on imports. And so the import volumes definitely support the idea that this freight has already been here and came early. So what we expect is that through the first two quarters of this year, we'll see this softness as a result of freight that's already moved, and then we start to move back into a more normal cycle. And consumers are hanging in there. And everybody has been trying to figure that out. It's pretty remarkable that we've had the kind of performance as an industry. Certainly for our company, it seems remarkable to have that kind of a performance in the fourth quarter that really didn't have the seasonal uplift. I think it tells us really -- or it's evidence of the lack of oversupply that came rushing in has normally happened in previous cycles. We just didn't see that in '21 and in '22 or '20 either because most of '20 was really good. So in '20, '21 and the first half of '22 when we had still a very healthy environment, we just didn't see the oversupply. And so I think that's partly why you see our asset-based Truckload business put up an 82.7% operating ratio in a fourth quarter that is a year past peak. I mean the peak was fourth quarter of 2021. And so certainly, that wasn't because of demand, but I think it tells us how tight supply really is. So when you fast forward that, Jack, and you think that we're going to burn off this inventory, we'll be back to a normal goods flow -- our flow of goods come, call it, summer through the back half of the year without the expectation that there's incremental supply at it. In fact, we believe supply is leaving, has been leaving and will continue to leave over the next two quarters. That gives us confidence that we'll see a much different environment in the back half of 2023. Yes. And just to add to that, Jack, I mean just looking at historical data of how cycles have typically trended, it's unusual for rates to be down year-over-year for more than 4 quarters. I think that's what gives us confidence in looking at fourth quarter of this year where rates could inflect positive. I think we've had a lot of dialogue with many of our customers. Many of those are the largest retailers in the nation, a lot of the largest CPG shippers in the nation. And independent conversations would support just their buying habits and how they change pretty dramatically in the fourth quarter and even into the first quarter. But in all those conversations, the expectation is for those ordering patterns to begin to normalize and to see those volumes really begin to pick up into that June and July mark. So I think -- so it's not only just our view of the market looking at historic data and then our own information but also through the discussions with our customers. Dave, you talked a bit about this in your response to the first question, but just really on the cycle and how you see it playing out. I guess another kind of angle on that topic, do you think there are reasons why shippers may behave differently in the current freight downturn compared to other downturns? And I mean truckloads are highly fragmented. It's kind of hard to get my arms around the industry behaving differently, but maybe like the largest trailer pool players behave differently. I'm just trying to get a sense of if there's not a bigger downturn on rates or what could be partly shipper behavior is different or even large carrier behavior is a bit different. So yes, that's the question. Thanks for the question, Tom. So I would say one thing that stands out that's a different behavior than what we've seen maybe historically from previous cycles is how well contractual rates have hung in there and what the demand for trailer pools has been. I think that where you see that showing up in our business is how well we've held on to our rate per mile. Now of course, we try to anticipate the market many months, many quarters in advance. Ideally, we're somewhere between 6 and 12 months ahead of schedule all the time in how we anticipate and plan. And so this time last year, we were clearly increasing our commitments and moving away from the spot market. And that, of course, has served us well as you see in the results. But when you look at our Logistics business, for example, one that had an 86.4% operating ratio despite the fact that load volumes were down almost 19%. And you got to remember, when you have a Logistics business, but you also have such a large asset-based business, there's going to be probably a little support -- normally, the loads would flow the other way, but there might be a little bit more support that business. But you look at our power-only volumes, and those were down 14%. But our gross margin continued to be very strong, 22.1%. So there's some value that's been created there. There's customers giving us opportunities when, I would say, other logistics firms are struggling to break even. We've been able to enjoy nice margin, hold on to volumes, and I think that's because we create more value with the trailer pool. So I think those are connected. I think we see that in our logistics. We clearly see that on the asset-based side of things. And so I do think that that's a little bit of a different -- that's a different behavior in the past. I mean, if we go back to pre-ELDs, the playbook for this kind of environment was very predictable. You would see shippers would move towards very large non-asset-based brokers who would come in offer, in many cases, double-digit rate declines. They would win massive volumes, and then they would execute. They would go find anybody and any carrier that could haul those, and there were people that were willing to do that at discounted prices given the difficulty in the market. And in many cases, it appears that some of those smaller carriers that maybe didn't have ELDs would figure out how to run more miles to stay alive in difficult times. Well, we have ELDs today, which regulate and are effective in enforcement of the hours of service rules. So you can't just go extend the day. You can't run more miles to make up for the fact that maybe you're not making as much. And likewise, our shippers, they can't just rely on that flexible group to wait around to be live loaded and live unloaded when a truck and a trailer and a driver show up. And they have to -- and the warehouse has to figure out how to stop what they're doing and unload it as opposed to for us can drop the trailer, and they can get to it hopefully within a day or 2. And so in this ELD world where you can't extend the day, if you will, they have to be paid if they're detained. And if you're detained more than two hours, even the smallest of carriers have to be compensated for that. And so that changes the economics tremendously. So I think from -- those are just a couple of reasons why we think it creates so much value, and we're definitely seeing that pull through. I think that if you look at the last 12 months of contract rates, not just for us but based on some of the industry data, what you'll find is those rates are not down much, somewhere mid-single-digit rates, generally speaking. And that's over a very broad group of a very fragmented industry, whereas spot rates declined every single month for 12 consecutive months in 2022. That's never happened to have such a steep decline in spot rates. And so those rates now are showing signs of a bit of a debt cap bounce, if you will. I mean they're just kind of bouncing maybe along the bottom. So we're at or near the bottom on spot rates. And now the question becomes, Tom, when do those rates start to crest up and when do we see the inflection point. If you look at the last couple of cycles, in 2017, it was in July or August of 2017 that spot rates came through the inflection point from the bottom and came through contract rates. And then they spiked and they hit their peak by August of 2018, and then they were back down. Whereas in a post ELD world, we saw this happen in the June, July of 2020 is when spot rates came off the bottom, and they intersected contract rates that were higher at the time. And then those rates continued to move forward up until January of 2022, which is when spot rates officially peaked before they started to decline for the 12 consecutive months, as I mentioned. And so I think now we find ourselves where those spot rates have come off, contract rates have really held in there, probably due in large part to the value of trailer pools. And now those spot rates are poised and if not have started to make their way back up to an intersection point. And what we know is once they intersect, we begin to enter a period of positive rates, not only in spot rates but start to see positive contractual rates. And then the question becomes, how long do you go until that peaks again? And that has everything to do with broader economic demand and to what degree do carriers oversupply their fleets by buying too many trucks and trailers, which I will tell you for the, I don't know, third consecutive year, purchasing new equipment still is on allocation. So it is not a free-for-all. And the cost is much higher to say nothing for the impact of interest rates. So Tom, probably a 10-pound answer for a five-pound question, but that was some feedback. Maybe just to pick up -- and Adam, I think you touched on this on the first question. Dave, you touched on this a little bit to Tom's response. But thinking about your commentary on revenue per mile and the high single-digit declines to start the year and then an inflecting positive, how do you have that parsed out between contract and spot? And what are you seeing right now on kind of the contract renewal pricing side? How is that working through the numbers as we move through the revenue for model assumptions for the year? Yes. I think -- so Tom, there's -- or Todd, sorry, there's very little spot opportunity in our expectation in the first half of this year. So most of that decline will be a result of contract renewals. And it's still early on in the bid season, and so we haven't had too many final awards. So those are still more -- those declines are more anticipated than what we actually have received. And so we're still in the early phases of that and having good dialogue with our customers. And then our expectation is in the back half of the year, some of the improvements in rate will come from contract renewals, but more or less the spot rate improving and then some of the projects that we typically participate in, in the fourth quarter. And Adam, just a follow-up on that comment. So on the contract side, what is a reasonable expectation for contracts this year, I mean, just given the spread right now between spot and contract? Yes. Again, we're still kind of filling it out to the bid. So I don't want to put a number on that right now. We're still kind of understanding -- it really depends, Todd, on when we renewed the contract with that customer. I think the early parts of the bid season, that number will be larger. The higher single digits will be lower double digit. And as the bid season progresses, that number gets reduced. Yes. Todd, it's hard for us to just generalize the whole thing because we have pieces of business that still need to be increased in rates because of how it works and how it fits into our network and the fact that we continue to see inflation. We do have other parts where sometimes we have an opportunity to maybe make a concession, help a customer who's trying to hit a budget target or goal if things are working in a super-efficient way and perhaps, to Adam's point, the time in the cycle when that rate was renewed. But this is not an across-the-board answer that the rates are automatically down. That's just not the case. Yes. Because I think we mentioned that some of our dedicated business, I think that's what David's alluded to, we'll have to increase because of how it's performing. And I think -- that's, I think, a typical hedge and an environment that we're faced with when you have OTR and dedicated, they perform differently in these type of environments. Yes. Understood. No, it's helpful context. Just really trying to think about that expectation for that positive inflection in the fourth quarter, which certainly would seem to be positive? So I think, Dave, you said, I think it was about a year ago now, that you think trough EPS has a $4 on it, and clearly, your guidance for the year implies that you're comfortably above that level. But if I were to kind of just like take a step back and listen to what you've been saying on this call so far, kind of talking about the cycle actually not being as bad as prior cycles and a midyear inflection and everything else, it doesn't really sound that bad. And in that context, kind of the guide seems kind of punitive at this point, especially given that you have a really easy fourth quarter comp in '23. So I'm just thinking of like are there any puts and takes in some of the non-TL segments that we need to keep in mind? Or kind of what are some of the kind of the moving parts and maybe the bull case or the bear case that can get you to a higher number than what you've guided to or a lower number at the cycle turned out to be much worse than you expected? Yes. Well, I mean, the full Truckload still represents 2/3 of our earnings. So the full Truckload is by far the piece that gets -- that moves the needle the most. So when we look at what we would expect for them to earn in the first half of the year, that's going to be less than 50% of what our annual guidance would be. So I don't know if it's 45-55, 45% in the front half of the year, 55% in the back half of the year. But it's not like we're looking at a back half that's a total hail Mary in order to get over $4 a share. But I will tell you that for us to achieve more than $4 a share would be a tremendous accomplishment, recognizing that here in 2022, we just earned $5 -- just over $5 a share with such a tremendous environment. And for us to adapt and yet have a stock that trades based on being a pure cyclical, well, a cyclical would not react that way. That would be -- we would be countercyclical to earn more than $4 a share. So it isn't going to be easy, but our model guides us there or we wouldn't put it there. I think one factor that we have working for us is the LTL portion of our earnings. Boy, we just couldn't -- we couldn't be more happy with that group. I mean that's a group that -- yes, LTL is feeling -- as an industry is feeling a little bit of pressure, but it's nothing like the volatility that you see and what happens with rates on the full Truckload side. And so -- and it's a business that, for us, we just continue to make incremental progress. And so that's a bit of a factor that's out there that, hey, we're new into it, and we want to be a little bit cautious. But in this fourth quarter, in addition to performing with an 85.5% OR, that's almost 500 bps better than the 90.3% a year ago, that's a business where we were able to take the MME brand and business that's a 100-year-old company. And our leaders at AAA Cooper were able to successfully integrate a new back-end system that really touches and affects 100% of the business. And so it was tremendous modernization to do while still running and working the business. And that took effect in October and has continued to be modified, and there will continue to be synergies that will roll out. I mean this -- we didn't use dimensioners, as an example, at MME before the acquisition. And so those investments that have been made, that will continue to take effect. And so -- and I guess I at least should note, Ravi, that, that business revenue was up almost 15% with adjusted operating income up over 70% on a year-over-year basis. And so that's diversification. That's why we're in LTL. That's why we like it. And we continue to find ways that we can bring synergies between TL and into LTL. And of course, we're still working to fill out the country and geographically to have a nationwide offering. And so that will continue to help us. But there's a lot of people, I think, Ravi, that aren't sure we can earn $4, just if I look at what's some of the guidance and how this -- I mean the stock seems to be tied to us earning a lot less than that. So -- but hey, we're just -- we've done our homework in terms of where we feel like our guidance is going to be best on -- or based on the best information we have available now to try and predict the future, and that's the range we came up with. Yes. And Ravi, I think last quarter, I went into greater detail of how each segment would need to perform to achieve that $4 mark. And I think as we look at our guidance, we're not going to that detail in our guidance today. But fairly aligned there. I think maybe the one outlier is the intermodal. We talked about that being a mid-90s operating ratio. We've just seen some challenges there on volume, especially with the better availability of truckload capacity and the service that, that performs at versus intermodal. And so that would be one area that would be maybe off from what we would have called out last quarter. But generally speaking, our segments will perform as I laid out. And we'll still have to see how everything plays out in this bid season, but we just have a tremendous amount of confidence based on how these cycles have developed historically and the communication we're having with our customers. If I can just kind of maybe follow up on that $4 floor and the stress test there, just maybe talk a little bit about the Truckload side moving back into the -- does that go to mid -- upper 80s in your thought? And I guess, specifically, confidence in the gains, you've got $10 million to $15 million. It seems to have $10 million to $15 million sense to the targets, which would -- could put some pressure alone, I guess, on that floor. And then on the -- I guess, on the intermodal side, any comments on the now transition of Schneider over to Union Pacific? Obviously, they had some service issues, how your service has been. And is that -- I know you mentioned kind of the mid-90s that -- can you see deterioration if they start getting maybe better access to the yards or thoughts on intermodal? Sure. So I'll start on your truckload question. Last quarter, I talked about in a difficult environment, the Truckload segment as a whole, which would include our over the road and our dedicated business operating in the mid-80s. And that would be our expectation for the full year with that being a little more challenged in the first half of the year and then improving into the back half, particularly into second quarter -- or sorry, the fourth quarter. As it relates to your intermodal question, thus far, there hasn't been much impact with the conversion from Schneider from the BN to the UP. I think we watch our service closely. I mean there's certain areas where we certainly can improve the service. And I don't know that it's related to the Schneider conversion. I think just kind of the challenges that we've been dealing with, with some of our rail partners across the board. But it does seem like the rail fluidity is improving, rail labor is more readily available, and we have confidence that will continue to improve. And I think our customers have seen that. I think we've improved service dramatically with certain customers where we expect to receive large awards this year. And so we're confident to be able to build that low count into the back half of the year. But I think the first half is still going to be a bit of a challenge kind of given the environment we're currently in. And Adam, can you just wrap up on the gains on sale, right? Because that's such a big, I guess, swing factor in that range. Yes. We had the gains coming off meaningfully from where they were last year. And we have a good purview into the used equipment market. And even in the first quarter when spot market has been as slow as it has been, which would typically mean that you've got small carriers not buying equipment, we're still seeing activity. And I think that's a result of just very lean inventories because the OEMs have still been challenged to fill everyone's orders. And I think most of the large carriers have continued to age their fleet out. And so that's just limited the inventory of used equipment. And so what we are selling is still at healthy margins. And we don't see that changing dramatically throughout the year. Dave, if I look at Slide 14, I don't want to belabor the point, but I think it's obvious thinking about your $4-plus earnings guidance, that implies about 100% earnings power expansion, which is obviously a tremendous feat. And so I think people are trying to get their arms around that. If I look at Slide 14 in those guidance assumptions, where would you say the greatest uncertainty is in your mind as you go through them? Yes. I mean it's tough to say. I mean, I know -- look, the guidance is kind of our best guess based on what we know in the market today. I don't want to say it's aggressive. I don't want to say it's conservative, and this is what we feel is kind of down the fairway with the knowledge that we have today for -- so it'd be tough to point out one of the data points as being more uncertain than another. Well, if Washington somehow messes with tax rates, that would be the biggest. So we'll start there, if we can't stay at close to 25% tax rate. Does that help you, Bert? Realistically, Bert, rate per mile -- if rate per mile -- weird, weird things happen with rate per mile. Obviously, that's a big lever to move. But we're not sitting here looking at a market that's about to slow. Spot rates peaked 13 months ago. And so I mean -- so we already are well into this. And so if you can predict what's going to happen with rates, you can predict a lot of things. And so nobody knows exactly how that's going to go. But we've seen significant resiliency in our rate per mile through this year as a result of the way we've built the business and the way we do things, but also the relative value that we create compared to other folks. And so you'd be hard-pressed to go back and find any other cycle where you went peak to trough in longer than 18 months. It's just -- you just don't find it. I mean often, it's -- you don't see the double digit -- or you don't see the declines in over 12 consecutive months. But you'd be hard-pressed to find peak to trough in greater than 18 months. And this -- we're already over 12 months into this, and this one was not was not precipitated by an oversupply of equipment coming into it like every other cycle was. And so that gives us a little bit of little bit of a glimpse into what we can expect both in contract rates as well as spot rates that we think will rebound in the back half of the year. So -- but that would be -- I mean that would arguably be the biggest lever in the guidance. Maybe just put another way, Logistics, the manner in which you operate it is certainly different from several years ago. And LTL is a new business altogether for Knight-Swift. I guess my question is maybe how do you get comfortable with those assumptions because Logistics OR, you're implying sort of low double-digit to high single-digit margins, which would be fantastic, particularly in a bad year. In LTL, somewhere in this sort of mid-low teens range on margins, both would be really good and haven't really played those out through a down cycle, at least in their current form. So I know you've talked about your models consistent. I'm just curious, are those not -- there's not a ton of uncertainty there for you? It's more on sort of how contract rates play out? No. I would say there's less uncertainty in the LTL world. I mean they just perform -- it performs just so much more consistent than full Truckload does. And then we have a bit of a secular story on top of what's going on in the industry. And that's -- the secular story just has to do with the kind of synergies and opportunities we have and what can come from a super-regional that could connect large portions of the country and allow us to compete in some of the national arena already. And the other side of that, I would tell you, is wages continue to go up. LTL industry wages are on pace for probably about a 5% increase to the wage of those drivers. Now that's different than LTL or different in full Truckload. And so I think you're going to continue to see LTL rates have to go up because their largest expense continues to be inflationary. On Logistics, Logistics is going to be volatile. But the reality is our Logistics business, if I look at just this most recent quarter, it produced $23.5 million of operating income, of the which we're grateful for all of it. But in terms of moving the needle on our entire nearly $8 billion parent company, that isn't the one that -- that isn't the biggest lever. Yes. And I'd add on the Logistics front, Bert, I mean we do have that moving up from the mid-80s, which we accomplished in 2022. And we note here in the guidance, high 80s, low 90s shift. If you look at the absolute performance for 2023, it would be very good compared to really anybody else in the market. It's just we're coming from such a strong position in 2022. So we do expect to give up something there. Now I mean, as you know, in Logistics, your largest cost is purchase trends. That's going to be variable and move with rates. And generally speaking, when you're doing power-only loads that -- those rates are less volatile too, typically hold in stronger because there's less competition in the brokerage market, yet you're buying capacity in the open market. So the gross margins there are a lot more resilient than your pure live load, live unload opportunities. I guess I just had a couple of quick ones. One, Dave, how likely is it do you think for Knight to do another acquisition this year, kind of like a meaningful acquisition like AAA that can really move the needle in terms of earnings contribution? And then, Adam, if we look at the fourth quarter results, I want to go back to maybe Jack's question around the first quarter. Because in the fourth quarter, we didn't really see crack in yield on a loaded-mile basis. It was down by 1% sequentially. And it's probably going to be down by 10% sequentially in the first quarter. So I'm trying to reconcile that dynamic with Dave's comments initially, saying that you should see like not much of a seasonal -- a very counter-seasonal move 4Q to 1Q? Because if I look at 4Q, we just didn't see the crack in yield that we may be expecting in the first quarter. So it would be just helpful, Adam, I think if you could help us frame like what is the actual decline you expect in Truckload profits from 4Q to 1Q just given that dynamic on yield. So Amit, from an M&A perspective, we sit here right now at about 0.97 leverage ratio. So we're well positioned to act. Our number one priority clearly is LTL. Those take time and you have to have the right timing in some cases for that to work out. And so in between those, we look at a variety of companies. And as we alluded to in our last quarterly call, truckload carriers are attractive to us and -- because we had so much comfort. We have, we think, an enviable track record with that and we know it, we love it, and we wouldn't be afraid to do truckload deals as well. So we think we have the bandwidth to be able to do both. And so we remain very interested, and I would say, very active in the M&A world. And on the -- your second question, Amit. when I look at 2021 versus 2022, I mean the fourth quarter there was unbelievable in 2021 led to a big step down, I think almost $0.25 $0.26 a share into Q1, which Q1 was still strong. Q4 this year, we are hauling freight in just normal course. We didn't have projects, we didn't have spot opportunities. And so as you transition from Q4 into Q1, you don't have a lot changing in that freight dynamic. Now you have bids that you're working through. But many of those bids aren't effective until you go into probably early second quarter, some will be later in the second quarter. And then as the bid season progresses, you're probably complete by probably mid-third quarter. So is rate going to be pressured Q4 to Q1? Probably. I don't know is to the extent that you quoted. But -- so I don't see the normal step down you would see from the Q4 where you have project business, you have robust spot market and then you move into Q1 where you're just, again, moving freight in the normal course. The dynamic hasn't changed that dramatically. So -- but adjusted profits in truck cracking went down 18% 4Q '21 to 1Q '22. Are you basically saying that it's going to be down significantly less than that as you move from 4Q '22 to 1Q '23? I would say overall for the business, I wouldn't see the same step down in profit from -- the same percentage step down in profit from Q4 to Q1. Yes. Thanks, Amit. Well, JP, we appreciate your help as our operator. Everyone, thanks for joining our call today. we apologize to a little more than a half dozen who were in the queue to ask questions that we didn't get to. Welcome to reach out to us directly and hope everyone has a great evening.
|
EarningCall_1136
|
Greetings, and welcome to the Alliance Resource Partners, L.P. Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Brian Cantrell, Senior Vice President and Chief Financial Officer. Thank you, sir. Please go ahead. Thank you, Donna, and welcome, everyone. Earlier this morning, Alliance Resource Partners released its fourth quarter and full year 2022 financial and operating results, and we'll now discuss those results as well as our perspective on current market conditions and outlook for 2023. Following our prepared remarks, we'll open the call to answer your questions. Before beginning, a reminder that some of our remarks today may include forward-looking statements, subject to a variety of risks, uncertainties and assumptions contained in our filings from time to time with the Securities and Exchange Commission and are also reflected in this morning's press release. While these forward-looking statements are based on information currently available to us, more of these risks or uncertainties materialize or if our underlying assumptions prove incorrect, actual results may vary materially from those we projected or expected. And in providing these remarks, the partnership has no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law to do so. And finally, we'll also be discussing certain non-GAAP financial measures today. Definitions and reconciliations of the differences between these non-GAAP financial measures and the most directly comparable GAAP financial measures, are contained at the end of ARLP's press release, which has been posted on our website and furnished to the SEC on Form 8-K. Now with the required preliminaries out of the way, I'll begin with a review of our record results for '22 fourth quarter and full year, and then turn the call over to Joe Craft, our Chairman, President and Chief Executive Officer, for his comments. While 2022 was certainly an interesting year with supply chain difficulties, transportation challenges and inflationary pressures driving operating costs significantly higher, while Russia's invasion of Ukraine impacting global commodity flows, post-pandemic demand increases, and global governmental policies led commodity prices to historically high levels. The Alliance team responded to this turbulent market exceptionally well, achieving record full year 2022 revenues, net income and EBITDA. And ending the year our results for the 2022 quarter were also strong as ARLP delivered record coal sales and oil and gas royalty revenues and significantly higher net income and EBITDA compared to the 2021 quarter. Looking more closely at the 2022 quarter compared to the 2021 quarter, coal sales volumes increased 2.3%, while royalty volumes for oil and gas minerals increased 42.6% as production on ARLP's legacy properties outperformed our expectations and combined with the new volumes from the previously announced minerals acquisitions in September and October of 2022. Coal production declined 3.5% from the 2021 quarter primarily due to an unplanned outage at our Hamilton longwall mine that I will discuss in more detail in a moment. As a result, our coal royalty tons fell 8.5%. We saw higher commodity prices during the 2022 quarter with coal sales price per ton increasing 50.1%, oil and gas prices climbing 7.2% per BOE and coal royalty revenue up 1.5% per ton, all as compared to the 2021 quarter. For the 2022 quarter, segment adjusted EBITDA expense per ton sold was $40.71, up 20.2% versus the 2021 quarter and on a full year basis was [$36.73] per ton, up 21.5% versus 2021. Our increased operating expenses in the 2022 quarter reflected a number of factors including higher sales-related expenses as a result of higher price realizations and coal sales volumes, inflationary pressures, particularly on wages, raw materials, petroleum-related supplies such as resins and lubricants, higher freight costs passed on to us from our suppliers as well as $6.5 million of noncash accruals for various long-term liabilities such as workers' compensation and asset retirement obligations at our non-operating mines. Also specific to the 2022 quarter, the thermal event at our Hamilton Mine resulted in an unexpected outage that lasted approximately four weeks. The responses by our mine rescue team members and our miners were exceptional. Our personnel were kept safe with no injuries occurring, no equipment was damaged and we work closely with federal and state regulators, mining operations allowed to return to normal production levels in December 2022. However, we did incur approximately $5.8 million of third-party expenses directly related to the event and we lost approximately 500,000 tons of production during the quarter. Absent certain noncash accruals and third-party expenses associated with the Hamilton event, Illinois Basin segment adjusted EBITDA expense per ton for the 2022 quarter would have been more in line with the percentage increase we experienced in the Appalachia region for the 2022 quarter. Our net income and EBITDA rose sharply in the 2022 quarter, increasing 313.8% and 125.7% respectively, over the 2021 quarter. These increases reflect higher sales volumes and price realizations, which more than offset the inflationary pressures and other impacts on costs that I previously described. 2022 full year results were also significantly higher compared to 2021. Coal sales and production volumes increased 3.3 million tons, up 10.3% and 10.2%, respectively, driving year-over-year coal sales revenues higher by $715.3 million or 51.6%. Higher coal sales revenues, combined with a $63.4 million increase in oil and gas royalty revenue drove ARLP's 2022 total revenues up by 53.3% to a record $2.4 billion. During 2022, Alliance generated $604.2 million of free cash flow before growth investments, returned $196.3 million to unitholders through quarterly cash distributions while reporting coverage of 3.45x for the year, and we reduced debt and financing leases by $16.9 million. Exiting 2022, our balance sheet remained strong. ARLP's total leverage ratio improved to 4.5x trailing adjusted EBITDA and with $296 million of cash and cash equivalents, our net leverage decreased to an all-time low of 0.14x. Our liquidity also increased to $762.8 million at year-end. As we disclosed earlier this month, we successfully closed our new revolving credit facility and term loan A financing. This transaction was very well received in the market with oversubscribed demand, reflecting the positive fundamentals of our business and the strength of our balance sheet. Our new $425 million revolving credit facility positions us well to manage ARLP's day-to-day operations, while the $75 million term loan proceeds allow us to term out the capital associated with infrastructure projects as we expand into new reserve areas at our River View and Tunnel Ridge operations. The capacity we obtained with this new financing enables us to use cash generated from operations to support our capital allocation plans, including increased unitholder distributions, potential repurchase of our common units and senior notes and positioning to capitalize on growth opportunities in the future. To that point, we announced today that the Board authorized an increase to our existing unit repurchase program. The program was previously established in May 2018 and had $6.5 million of remaining available capacity at year-end. The expanded program authorizes ARLP to repurchase up to $100 million of its outstanding limited partner common units, further increasing our flexibility in returning cash to unitholders. Future unit repurchases will be subject to ongoing board review and will be based on a number of factors, including ARLP's financial and operating performance and other capital requirements as well as future economic, business and market conditions. The unit repurchase program has no time limit and ARLP may repurchase units from time to time in the open market or in privately negotiated transactions. The unit repurchase program authorization does not obligate our ARLP to repurchase any dollar amount or number of its units and repurchases may be commenced or suspended from time to time without prior notice. Now turning to our initial guidance detailed in this morning's release. 2023 is shaping up to be another strong year at ARLP. We anticipate our overall coal sales volumes in 2023 to be in the range of 36 million tons to 38 million tons, an increase at the midpoint of 4% over 2022. Supported by our highly committed and priced coal contract book, we are currently anticipating 2023 coal price realizations in the range of $67 per ton to $69 per ton, an increase of 13% to 17% compared to 2022. Currently, 34.7 million tons are already priced and committed for '23 and ARLP has secured commitments and pricing for another 23.7 million tons in 2024. With these commitments, we continue to believe that ARLP should benefit from increased coal sales volumes and pricing over the next several years. On the cost side, while we have recently begun to see some moderation in the inflationary factors we experienced in 2022, we currently anticipate labor pressures and higher sales-related expenses will continue to add to our costs in 2023. From a comparative standpoint, recall that inflation in 2022 built dramatically during the first half of the year before peaking in the third quarter. And as a result, we expect segment adjusted EBITDA expense per ton to be higher during the first half of '23 compared to 2022 levels before moderating in the back half of the year. For the 2023 full year, segment adjusted EBITDA expense is anticipated to increase by approximately 10% to 15% over 2022 full year levels to a range of $40.25 to $42.25 per ton sold. One other item I would highlight is our anticipated capital expenditures in 2023. Not surprisingly, inflationary pressures are expected to impact maintenance capital this year, as we have previously discussed. And CapEx this year and next is expected to be higher as we move into a new reserve area at our River View mine. Reflecting these impacts, we currently anticipate capital expenditures to be in a range of $400 million to $450 million from $286 million in 2022. This includes maintenance capital ranging between $350 million to $390 million. Additionally, as we announced earlier this morning, 2023 guidance includes the benefits of our acquisition of an additional 2,682 net oil and gas royalty acres in the Permian Delaware Basin. The cash purchase price of $72.3 million for this acquisition will be funded with available cash and is expected to close within the next 30 days with an effective date of January 1, 2023. Since this acquisition involves an entity owned by Mr. Craft, terms of the transaction were approved by the Board and its Conflicts Committee, which is comprised entirely of independent directors. This acquisition not only further enhances our existing high-quality Permian royalty portfolio, but is expected to add approximately 250,000 total barrel of oil equivalent in 2023, weighted 67% towards oil and NGLs and will be immediately accretive to cash flow. Before I turn the call over to Joe, let me take just a moment to comment on my upcoming retirement that we announced last March. I'm extremely proud to have been a part of this incredible organization that Joe started 26 years ago and of what ARLP has grown to become. As you know, our Vice President of Corporate Finance and Treasurer, Cary Marshall, will be assuming the CFO role effective April 1, and I can't think of anyone more capable and prepared than Carry. It has been an honor and a pleasure working with my colleagues at Alliance, our investors, bankers and analysts. The future at ARLP is bright, and I look forward to following closely as a loyal interested investor for many years in the future. Thank you, Brian, and good morning, everyone. Now Brian, please let me express my heartfelt appreciation to you for your service and commitment to ARLP for the nearly two decades you have been with us. I appreciate everything you've done for me and our partnership and wish you continued success and happiness in the next chapter of your life. I also want to echo your observations that we have the best possible replacement for him, for you in, Cary Marshall. Cary has been a critical contributor to ARLP's success from the beginning. Having been closely by my side since 1994, when he joined the coal group as a Manager of Financial Planning. Thank you, Brian, and congratulations, Cary. I want to begin my comments this morning by thanking the entire Alliance organization for their hard work and dedication since the pandemic began in 2020. The challenges have been unprecedented and their resilience and determination to not only persevere, but to thrive need to be recognized. Through their efforts, ARLP delivered record financial results in 2022. I'm extremely proud of all that has been accomplished and thankful for the unwavering focus of our teams on creating long-term value for all of our stakeholders. Now let me share some thoughts on the state of the industry and our strategy for growth and value creation going forward. As Brian mentioned in his opening remarks, 2022 was a historic year for ARLP, but it was also a year that emphasized the importance of keeping coal-fired generation and the mix for years to come, providing a reminder for the need to value energy security and resilience for our nation and nations around the world. During the quarter, the U.S. experienced another major event with the arrival of Winter Storm Elliott that put an exclamation point on this fact, consistent with what we have talked about on all of our earnings calls this year. Winter Storm Elliott brought severe cold across much of the continental U.S., straining the grid in a way that has become all too common in recent years. During the storm, electricity demand soared as natural gas wells froze, pipeline deliveries were constrained and renewable sources were unable to respond with significance, resulting in severe price spikes for consumers in many states. As tragic as the storm's impact was, let me repeat, it was merely the latest highlight of need for a diverse mix of energy sources and in particular, the vital role coal plays. This was evidenced by the fact that the U.S. coal-fired generation in December was at a three-year high despite the retirement of almost 28 gigawatts of coal-fired generating capacity nationwide over that same three-year period. As you have heard repeated over the years, it is still true today, coal keeps the lights on, especially at times when we need it most. Policy decisions continue to challenge our industry. But events like Winter Storm Elliott in the not-too-distant Winter Storm Uri, which devastated many lives and homes in Texas reinforce the urgency and need for an all-of-the-above strategy, embracing energy security, reliability and affordable electricity. The past forced retirements of a significant portion of the country's coal-fired generation has exposed the grid especially in the regions that comprise our primary market, where many utilities recently have reported delaying previously announced coal plant retirements for several years. As the nation continues to embark on its transition of energy and related infrastructure, we believe ARLP can play a vital role in the conversation and any changes to the U.S. power grid will create opportunities for ARLP to leverage long-standing relationships with the electric utilities, regulators and other customers to create additional avenues for growth. While at the same time, having the opportunity to rely on the coal plants we serve until we can responsibly get there. Again, we do not view our country's future energy needs as an either-or solution, but an and solution, which we will continue to advocate and support as we continue to highlight the reality of the situation. Now turning to the current market and commodity pricing environment. U.S. natural gas prices continued their decline heading into the new year with the Henry Hub spot price down sharply this month, a warmer than usual January builds in underground storage of natural gas and the Freeport LNG export terminal remaining offline are all factors contributing to the weakness in near-term pricing, falling natural gas prices in the middle of winter tend to increase the risk of lower-than-expected coal burn, which could cause coal stockpiles to grow faster than anticipated. However, Eastern U.S. coal pricing has not been meaningfully impacted so far since we, along with most of our competitors, are either fully committed or have very little inventory available. This is evidenced by our year-end coal inventory of 500,000 tons, of which 200,000 tons were staged for export in early 2023. Our planned January shipments are on schedule, keeping our inventories at relatively low levels. Internationally, a number of factors are impacting global energy trade routes and in our view, will continue to drive higher demand and pricing in the back half of 2023 and for several years to come, if not permanently. Our primary trading partners for thermal coal in Europe are faced with the consequences of losing roughly 40 million tons per year of Russian coal imports for power generation, which resulted in skyrocketing prices in 2022. And while mild weather so far this winter in Europe has resulted in API2 prices easing from recent peaks during the last year, we expect them to rebound sometime in midyear 2023. Meanwhile, China's ban on imports of Australian coal is slowly being relaxed, putting additional pressure on European supply. The Chinese power generators and a steelmaker were recently cleared by their regulators to buy Australian coal, it is believed easing of the band will continue to broaden, allowing other Chinese entities to pursue Australian thermal and metallurgical coal. As Europe continues to replace Russian supply and Australian supply becomes more competitive as China's economy reopens, we believe coal demand will grow as European stockpiles will need to be replenished ahead of next winter and extend further into 2024. Again, we expect this increase in demand will lift oil, gas and coal prices during this year. Turning to our own book and guidance. 94% of our coal sales are priced and committed in 2023, which includes 3.3 million tons for export markets, giving us strong visibility and certainty into our 2023 guidance. Of our roughly 2.3 million tons of unsold coal this year, assuming production of 37 million tons, which is at the midpoint of our guidance, we expect at least 1/2 will be sold into the export market with the balance to either go to the export or domestic market as pricing dictates. Even though we are guiding for higher cost, as Brian mentioned, we expect favorable market forces and our current coal sales commitments will drive top line growth that should more than offset these inflationary pressures as margins are expected to expand to record levels in 2023. Now turning to our capital allocation priorities. Our primary focus is to provide well-covered distributions and attractive returns to our unitholders over the long term. Last week, we announced that our Board approved a 40% increase in our quarterly distribution, equating to an annualized rate of $2.80 per unit. We elected to declare a quarterly distribution increase to a level that we expect to maintain throughout the year as opposed to smaller increments each quarter. This was based on our confidence and high visibility in 2023 and 2024, expected cash flows, committed tons and strong financial position. After distributions, we will continue to support our co-operations, funding appropriate maintenance capital requirements and investing in high-return efficiency projects with near-term paybacks that maintain our low-cost competitive advantage. Thereafter, Alliance's robust cash flow generation uniquely positions us to pursue attractive investments that meet the evolving energy needs of tomorrow and are consistent with our proven track record to date, including investments in oil and gas royalties as evidenced by the Permian Basin acquisition announced today. We took the next step in our diversification strategy in early 2022 with three energy transition investments totaling $87 million in outstanding commitments. In September, we hired a dedicated team of leaders to join our new ventures group to continue these efforts of identifying, evaluating and executing commercial opportunities beyond coal and oil and gas royalties. The team is focused on highly strategic investments that allow ARLP to leverage its core competencies and relationships with the electric utilities, industrial customers and federal and state governments. As we embark on this new journey, we will maintain a disciplined and process-oriented approach to allocating capital. Absent available opportunities to invest in these businesses, we will continue to maintain flexibility evaluating other high-return uses of cash, which as Brian noted, may include redeeming a portion of our senior notes outstanding unit buybacks as well as providing well-covered cash distributions. In closing, I am very proud of ARLP's 2022 record levels of revenues, net income and EBITDA; at the same time, equally excited about the opportunities in front of us. Our operations are running well. Our coal contract book is heavily committed at very attractive levels and our financial position has never been stronger. Looking forward, we believe ARLP is well positioned to deliver solid growth and attractive cash returns to our unitholders in 2023 and beyond. I was just wondering if you could contrast the overall market and pricing dynamics for your coal produced in the Illinois Basin versus Appalachia and whether you think the outlook for Illinois Basin looks a little stronger moving forward? And then also, did you get the other unit at the Hamilton Mine added? So the other unit was for the Gibson mine. And so we have added the unit and it is staffed for one shift. We've got the second shift yet to be deployed, and that's anticipated to come online sometime in the second quarter of this year. So back to the Illinois Basin versus the Appalachia, in most of our Appalachia production is targeted for the export market that we have that's unsold. And I'd say of the unsold position, about half is the Illinois Basin and half of it is for Appalachia. And so we do have the flexibility in Illinois Basin to either sell that tonnage either domestically or the export market depending on what the market pricing will be. Currently, there's really not much activity in the market, we are seeing more inbound opportunities from the export market than we are domestically given the warm weather and the inventory build that the utilities did for coal in the fourth quarter. So it's hard to answer specifically your question at the moment. I mean, we believe that in the back half of the year, most of our customers still have an open position, and there will be requests for additional tons, weather dependent, more likely for the rest of the winter as well as the summer. So again, most of our book is pretty much sold for the first half, and our open position is really opening up in the second half when we do see favorable markets compared to what we're seeing at the current moment in time. Okay. I just had one more question and then I'll get back in the queue. With respect to the acquisition, Brian talked about the barrels of oil equivalent, but like the last acquisition, can you provide some additional information in terms of like the number of producing wells to be completed in a number of permitted locations? Hey, Mark, I'll give you some aggregate statistics. At the end of 2022 we had 12,833 producing wells on our acreage, which was an increase from the year-end 2021 level, about 2,661 wells. We currently have 67 wells or at the end of the year we had 67 wells running on our acreage, an increase of 35 over year-end 2021 levels. And permitted locations, we currently have -- or at the end of the year, we had 779 total permitted locations on our acreage with 923 wells being drilled and 8,130 being completed. Great to see significant quarter-over-quarter increase in the distribution. I heard those comments about how you just -- it sounds like you knocked out in one big chunk, maybe you kind of see that flattish throughout the year. I had a question related to the target. I think in the past, you guys have mentioned around a 30% target payout. Is that still the case? Any conversations going on with the Board about adjusting that level and then any thoughts on the target distribution coverage ratio as we look ahead? Or should we still just think about this more as a targeted payout that would fluctuate depending on cash generation? I'd say that we have moderated that view from that cash generation point to more of a coverage ratio perspective, given the strong growth in cash flows that we have seen over the year and what we've locked in with contracts going forward. So we believe at the levels we are today that we can pay out a distribution at this coverage ratio that will be anywhere from 2.2x to 2.5x coverage and still have sufficient cash flow to be able to participate in trying to grow the company. Great. Appreciate that update, Joe. As you guys talked about some notable weakness in the gas and thermal coal markets to start the year, again, 94% committed and priced for '23 to midpoint of guidance. I mean what portion of those tons are susceptible to price fluctuations in either the domestic or export market, is that variability largely incorporated into your realized price per ton guidance? So the committed tons are all fixed price. I mean they're all prices committed, so we know what the price is. They have been factored into our guidance. Our UI production, the tons we have opened to the market. Again, we projected what we believe the market is. We think that, again, based on our view of where the market is going to be in 2023, that we can definitely achieve those levels. And right now, they're sort of priced at the midpoint of the guidance we gave you when you factor in both the committed and our UI price situation. I think the volume is dependent on the economy. I believe and most people believe that China's reopening has not been factored into the market. I believe it's going to happen. And I think that gives us the confidence that the second half of the year is going to -- is going to be very supportive of the export market that will sort of set the standard of where the pricing is going to be when we start making decisions to sell our own so coal. Yes. And Nate, as Joe mentioned during his opening comments, we're anticipating pricing to firm up in the back half of the year. And as you look at our commitments for 2023, most of our open times are in the back half of this year. So as Joe has just articulated, we feel pretty confident about the price levels that we're projecting for this year. So Brian, by firm up in the back half of the year? Are you thinking pricing increases kind of as we move throughout the year from the first half and the second half, what you're saying or am I misunderstanding that. Okay. Perfect. And then, I mean, also just kind of thinking about the cadence throughout the year, any way to think about it from a shipment standpoint, any longwall moves to keep in mind? And I think, Brian, you also said just to confirm that first half expenses likely higher than second half expenses. On shipping, we obviously have the normal seasonal impacts of miners' vacation, holidays, et cetera. We do have more longwall moves scheduled for 2023. Last year, we had a total of six. This year, we have a total of eight. I believe we have a longwall move scheduled in the first quarter at both Hamilton and Tunnel Ridge -- I'm sorry, two at Tunnel Ridge in the first half of the -- in the first quarter of this year. So after that, it will be spread out over the balance of the year. I would believe that our deliveries are going to be fairly consistent in the first and second quarters. And then as we look up the rest of our open position, the back half of the year should remain strong as well. Yes. So as Gibson -- as the second unit comes on in the second quarter, you'll see that bump up for the third and fourth quarters. And you see that when you look at the sequential quarter fourth quarter, you can -- you know we had the impact at Hamilton of about 0.5 million tons. So as you think about the first couple of quarters, it should be similar to the sequential quarter in the first half -- the first half of the year and then the second half slightly higher for that second unit at Gibson. Okay, Joe. So basically, you get that 0.5 million tons back, it sounds like in 1Q versus 4Q with Hamilton seemingly behind the event that occurred. And then first quarter, second quarter flattish and then Gibson second shift comes on, we should see a bump up? Yes. There may -- you may not get the full amount back into the second quarter due to the number of longwall moves we got in the first quarter, but it's pretty close. Got it. Really appreciate that color. And then just finally on CapEx guide, and I'll get back in the queue. A little bit higher than expected, it looks like '22 CapEx came in a little lower than your updated guidance. Many items that kind of carry forward, incorporated within '23 full year guidance? And then it looks like growth in maintenance grew about $100 million -- excuse me, maintenance grew roughly $100 million year-over-year. Assuming again, that's the main driver of the year-over-year guidance increase. But could you give a little bit more color maybe what's included in the growth piece as well. On the growth piece, as we mentioned last quarter and in our opening remarks, we are moving into new reserve areas at River View and the main portion of the capital expenditures related to that will be incurred in this year and next. Other factors impacting maintenance capital, we're obviously projecting increased volumes, which by definition, you'll have higher maintenance capital costs associated with that, the inflationary impacts on our supplies, maintenance, equipment, et cetera, is also reflective. And then Nate as you know, maintenance capital year-over-year can be pretty heavily influenced by just the timing of rebuild schedules, et cetera. And 2023, we have an occurrence of more rebuilds during this particular point in time than we've seen recently. Just wondering if you could give a little more color as to what you're seeing on transportation expenses as inflation starts to turn a corner and specifically just outside of any seasonal moves? On the transportation expenses, we are seeing better performance. Expenses are still elevated as we run into -- going into the year. Some of that does tie to pricing in the export market. So there could be some softening of that. Again, there's not been much activity because of our sold-out position. So we'll have to wait and see how that goes for the back half of the year. So I'm not sure I understood your second part of your question. Except for export, that's correct. So it really has an influence on decisions we make around where can we achieve the highest netback at our operations? Is that in the domestic market or the export market? That's perfect. Thank you. And then on those export constative movement, how sticky do you view that just going into 2024 with the 40 million ton gap that Russia laps? We believe that, that will continue to be there. There's a lot depends on several decisions that they make. We do think that as you move towards the end of '24, end to '25, there may be opportunity for them to get more LNG. But then into their country, they're trying to move to renewables, but they've opened up their own coal facilities. They've opened up coal plants. So if you look at in addition to the Russian supply, we think there's like 8 million to 10 million tons of added demand in 2023 for coal plants that they've opened to meet their energy needs. How long those stay online? It is hard to know. But based on our 4.4 million tons or so that we're going to sell in the export market, we believe that there is more than plenty of opportunities for that to sustain itself if not grow. If you go back before the pandemic, we were shipping at a 12 million-ton rate. So I think not sure we'll get back to that level, but there is opportunity for us to grow just with the demand that we've seen over the last six years or so. And so we don't need a lot of growth. We just need stability and we believe that with our low-cost operations, we can compete in that global economy in the 4.5 million, to say, 7.5 million to 8 million tons over the next three to four years if there's not alternatives in the domestic market. Congratulations on the quarter. Also, Brian, congrats on the retirement and Cary, congrats on the promotion. So just quickly one housekeeping question. Brian, are you going to be staying on through the 10-K filing. And do you have kind of a targeted date in mind when you'll get the K filed? We should be filing the K toward the end of February. And yes, I will be here through that. My targeted date is March 31, and Cary steps in on April 1. Got it. Got it. And then just -- I was intrigued by the acquisition activity and the comments regarding another one. I was wondering if you guys could perhaps kind of highlight some of your high-level criteria. I'm very encouraged by the fact that it sounds like you're going to be cash flow accretive immediately on this one that you just closed. And I just wanted to know if you could give us a little bit more color on your criteria when evaluating acquisitions? We have certain underwriting standards not only for oil and gas, but then we are very focused on having results that will give us risk-adjusted returns that will be more longer term in nature for our unitholders. So, our return thresholds for this particular acquisition, probably - obviously, have been consistent with the past. We've committed to the oil and gas group, royalty segment that we will allow them to reinvest whatever cash flow they generate on an EBITDA basis the prior year. So they have capacity for another 50 million or so beyond the investment we made that we announced today. I'm hoping that some people will want to sell their gas at what current prices are. So that could give us some opportunities there. I don't know if people will. So, I think that we're very focused on those products or services and solutions that are needed for the long-term. And that's what we're looking for and then are -- right now, a challenging part of acquisition is just where it is the cost of capital. Interest rates are moving and all kinds of mixed signals as to whether the Fed is going to be right or the market is going to be right on where interest rates are going to be or where they are. So, I think that obviously, in order to have those attractive long-term investments, you have to have a significant level of return above your cost of capital and our cost of capital is probably moving right now that could make 2023 evaluations maybe a little bit more conservative than what they would have otherwise been had we not been in a higher cost environment. In other words, we're going to make sure that we get a nice return above our cost of capital, and we may hedge a little bit on a higher cost of capital in '23 than what possibly it will turn out to be. Those higher interest rates will obviously be impacting the seller's perspective. And so that just depends on what will be in the market from an acquisition standpoint as they look at their needs for cash and/or their strategic options that they're looking at. That makes a lot of sense. I guess the acquisitions announced so far really are more oil and gas. So is there anything on the coal side where things could potentially become compelling? There's -- as far as opportunities, there haven't been many in the coal space. I think from a strategic standpoint, the only thing that could potentially be an opportunity, is met coal potentially that we've had on our list, which we've been able to get from our Mettiki operation. And so that's an area that I could see is possible, but it's not highly probable. It's probably the best way I'd put it. So most of our focus is outside the coal sector on acquisitions front. In other words, there's nothing going on right now. Just a couple of questions on the balance sheet. So, I'm sure you're aware fixed income markets are beginning to fall a little. We have seen some other coal companies take up some notes early. And then in your capital allocation discussion, you did mention you could potentially redeem a portion of your bonds which I'm sure you know your bonds, the call price kind of steps down to par this May 1. Maybe kind of more holistically, what are you thinking about your capital structure and even more specifically about your bonds? Yes. With respect to the bonds, we needed to wait until we completed our bank financing to make sure that we have the flexibility that we wanted to see should we choose to go out and begin taking the bonds down. We did achieve that flexibility. And with the strong cash flow that we're generating, we do have the opportunity to potentially opportunistically repurchase in the open market if conditions warrant. And then beyond that, you're correct, our bond call goes to par in May of this year. We'll evaluate market conditions and whether it's right -- when the right time is to completely potentially take those bonds down before they mature in May of '25. Clearly, we've got plenty of time to manage that, and we'll be watching markets very, very closely to try to pick up some of those positions at attractive levels. Yes. I mean, obviously, managing our balance sheet is one of our core capital allocation priorities, returning cash to unitholders is as well. The distribution we announced today -- or on Friday, I'm sorry, as Joe mentioned, we intend to currently intend to maintain that level through the year. So that's fairly well defined. And with the flexibility we've been given with our bank refinancing. Should conditions warrant, we could return additional cash to unitholders through a repurchase program that the Board elected to top off last week. And then just two quick housekeeping. It was good to see your credit agreement was extended. I think it also -- within that note, it included a $75 million term loan, just maybe uses. And also, is that currently undrawn? No. The term loan is drawn at closing. So that cash is now on our balance sheet. In our prepared comments, we noted that we do have these activities going on at the River View and we acquired some additional coal reserves at Tunnel Ridge. So we're using that $75 million to effectively turn those activities out for a more extended period of time primarily. Just on the guidance, when you talk about the stronger second half -- and I'd agree with those observations. But -- so coal prices in Illinois Basin in the fourth quarter was $57.47 a ton and an Appalachia at about $89 a ton. I was just wondering how much of a leap you have to make in terms of on those open or unpriced tonnage to meet your guidance? Not much. I mean I think if you look at fourth quarter and then you look at our guidance, I mean, like you said, our fourth quarter averaged $67.84. And so our guidance is what? $69. So you can see we're right on with what we have committed. And so anything that we have open, it's going to be helpful to those numbers. So I think that that's where you get to the midpoint or the higher end of the range. But if -- so I think we've got flexibility there within that range that we're in. I would say -- yes, the pricing is conservative that's in our guidance for the year... And then I was just curious on -- has the new ventures team -- what kind of progress have you seen there in terms of have they come up with some pretty good ideas? Or what are your expectations there? Primarily, we -- they have established a process and we established internal resources as well as external resources to help us as we go through the many, many, many opportunities that are out there. We're trying to take those multitude of opportunities and trying to narrow those into preferred areas so that we can be efficient with our time and our resources, our people resources. So that we're focused on the right targets. So they made significant progress in a short period of time. I think we've got a clear vision on how we want to approach inbound opportunities that come to us. We also have an approach that's very much proactive that we are, again, using some outside sources to help us go target certain areas that will fit with what we believe to be our core competencies and give us those long-term risk-adjusted returns. Most of the things that we're looking at are more in the mid- to late stage of the growth process of a lot of these what have been in the transition world, we're trying to not limit ourselves on just a transition-type investments. So we're looking at other type things that are a little bit more mature that have cash flow that can be financed. But I would say our progress has been good. At the same time, there's just a lot of things we can look at that we're having to prioritize and it's going to take a little time. One thing I've always appreciated is the strength and the longevity of Alliance's management team. So congratulations to both Brian and Cary and to the whole team for an excellent -- for the excellent results. Just wanted to go back to your comment about the royalty team having like 50 million or whatever, they can use their free cash to keep expanding their business. So when they come to you with a deal, does it feel [technical difficulty] Okay. When the royalty guys come here with the deal and you compare the packaging in the common stock repurchase. Is there a critical mass in royalty that's important to achieve and you're willing to reach a little bit relative to the comment to get to a certain level? How do you think about the size of that business standalone? Again, you were cutting out a little bit. But the way we think about our Minerals segment is we do believe it has -- we have a proven track record now that we have been successful in our underwriting approach. We believe that oil and gas is going to be here for decades and decades. And so I think that it can compete with sustainable cash flow and it meets our strategic objectives again, to try to give them some guidance so they have certainty in developing deal flow. We've given them the latitude to know how much capital that they know they have available to them. It's not a cap. I think if they bring other opportunities that come to us that we can evaluate those and look at those, but we do not look at thinking in terms of re-examining on a quarterly basis, whether or not we want to allocate that capital to that segment. We believe that it needs to grow and so if we can put $100 million to $120 million to whatever their growth is on an annual basis, we will get to a meaningful number. That has proven to be the case so far, since we've been in the business since 2014, late 2014. We're committed to that business. We believe that it's an attractive business. We believe we have a proven track record of understanding how to value those opportunities and as a long-term investment we continue to have confidence and faith that it's a good place for us to allocate capital. Thank you, Donna, and to everyone on the call. We sincerely appreciate your time this morning as well as your continued support and interest in Alliance. Our next call to discuss our first quarter 2023 financial and operating results is currently expected to occur in late April, and we hope everyone will enjoy will join us again at that time. This concludes our call for the day. Thank you very much. Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines or log off the webcast at this time, and enjoy the rest of your day.
|
EarningCall_1137
|
Good afternoon, and thank you for standing by. Welcome to Flex's Fiscal Third Quarter 2023 Earnings Conference Call. Presently, all participants are in a listen-only mode. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded. With me today is our Chief Executive Officer, Revathi Advaithi; and our Chief Financial Officer, Paul Lundstrom. Both will give brief remarks followed by Q&A. Slides for today's call as well as a copy of the earnings press release and summary financials are available in the Investor Relations section at flex.com. This call is being recorded and will be available for replay on our corporate website. As a reminder, today's call contains forward-looking statements, which are based on our current expectations and assumptions. These statements involve risks and uncertainties that could cause actual results to differ materially. For a full discussion of these risks and uncertainties, please see the cautionary statements in our presentation, press release or in our most recent filings with the SEC. Note, this information is subject to change and we undertake no obligation to update these forward-looking statements. Unless otherwise specified, we'll refer to non-GAAP metrics on the call. The full non-GAAP to GAAP reconciliations can be found in the appendix slides of today's presentation as well as in the summary financials posted in the Investor Relations website. On January 13 of this year, we publicly filed a registration statement on Form S-1 with the U.S. Securities and Exchange Commission relating to Nextracker's proposed initial public offering. In connection with the proposed offering, Nextracker intends to list under the ticker symbol NXT. The timing, number of shares to be offered and the price range for the proposed offering have not yet been determined. This offering is determined -- excuse me, this offering is subject to market and other conditions. For more information, please refer to the S-1 filing. Following SEC regulation remain in a quiet period, and we'll not make any further statements or answer additional questions on the Nextracker filing at this time. So, by now, you've all probably seen the S-1 public filing for the Nextracker IPO. As I said, from the very beginning of this process, the first step in creating value for our shareholders and to unlock the full long-term potential of Nextracker is for it to operate as a standalone company. This process was, of course, delayed by the supply chain crisis brought on by the pandemic. Despite all of the challenges during this time, we have maintained discipline and achieved multiple quarters of improving growth and margins. Along the way, we partnered with TPG Rise Climate, a team who's making a real difference in the renewable energy transition. So, now we're moving forward. That said, renewable energy is one of the most important global technology transitions ever. It also represents a robust long-term growth opportunity for a number of technologies, including solar trackers, and Flex will continue to be involved to help drive this critical sector. Moving to our results, please turn to Slide 4. Overall, fiscal Q3 was another fantastic quarter for Flex, and another validation in the resiliency of our diverse portfolio. Revenue grew 17% year-over-year, with adjusted operating margin at 4.8%. And the strong performance overall drove solid results of adjusted EPS at $0.62, up 24% year-over-year. Turning to Slide 5. Many of the positive dynamics in fiscal Q2 continued through the quarter, but with a few ongoing challenges that I'll touch on in a minute. We see strong growth driven by secular trends with technology transitions in EV and ADAS, in renewables, in factory automation, along with cloud expansion and strong automotive backlog. We're also seeing demand in communications, network security and many of the industrial applications we touch. Consumer end markets remained weak, which shouldn't be a surprise and we expect that weakness to continue in the current environment. Similar to last quarter, the overall supply chain and logistic situation continues to improve on a global level. However, shortages in the large node semiconductors remain a challenge, particularly within higher liability applications such as automotive, industrial and some healthcare products. We have talked before about how this causes inefficiencies and their absorption of costs, and this golden screw effect is also the primary driver of higher working capital requirements. We remain very bullish on the long-term growth opportunities in Reliability, so have made additional near-term operational investments to support this growth, including increases in higher skilled labor. The net result this quarter was additional pressure on Reliability operating margins. However, these investments will benefit our longer-term market positioning, and is worth the focus as Reliability has and will be the bigger driver of our long-term growth story. The Agility team had great execution, meeting strong demand in CEC and delivered another quarter of growth in lifestyle, but also demonstrated very effective cost management given the broader consumer turndown. We continue to recognize the benefits of both the operational improvements and portfolio changes we have made over the last several years. It is important to highlight the power of a well-diversified and balanced portfolio. We remain in a challenging macro environment and yet delivered growth in five of six core business units and accelerated growth at Nextracker. Now looking to Slide 6. Paul will discuss our guidance in a minute, but assuming Q4 revenue comes in as expected, we remain on track to deliver 16% year-over-year growth in fiscal 2023. As you can see in the chart on the left, this also means, we will have beat our previous revenue high watermark before we pruned a substantial amount of lower-quality business. Adding in our operational initiatives, you can see a steady and consistent path of margin expansion, and all of this reflects the improvements we have made as a company. With the evolving macroeconomic uncertainty, it's still a highly dynamic environment out there. However, I want to share an early view into what we're seeing as we look to our fiscal 2024. At this point, demand indicators are holding up for many of the multiyear trends we've been talking about, including renewables, next-gen mobility, cloud and healthcare. We believe these are strong enough to offset headwinds like consumer-related weaknesses and slowing enterprise IT spending. So, at this point, we thought it was important to state we expect to grow next year, in fiscal 2024. We will discuss our full fiscal 2024 guidance on next quarter's call. Turning to Slide 7. Lastly, taking a step back. As I look at the fiscal 2025 financial framework we gave you in our Investor Day last year, we said high single-digit revenue CAGR, which will lead to 5%-plus adjusting operating margin in core Flex, which is without Nextracker, with mid-teens adjusted EPS growth getting us to $2.65 for core Flex, and 80% adjusted free cash flow conversion. It is a combination of strong multiyear drivers coupled with our focus on the right growth areas and our execution that will get us to these targets. I'll begin on Slide 9 with a review of our third quarter results. Please note, all results provided will be non-GAAP and all growth metrics will be on a year-over-year basis, unless stated otherwise. The GAAP reconciliations can be found in the appendix of the earnings presentation. Revenue growth was strong, up 17% at $7.8 billion. Gross profit totaled $595 million and gross margin improved to 7.7%. Operating profit was $372 million, with operating margins at 4.8%, improving 30 basis points year-over-year. Lastly, earnings per share came in at $0.62 for the quarter, an increase of 24%. GAAP EPS came in at $0.50, up 4% year-over-year. But if you recall, in Q3 of last year, we had a number of small non-operating gains that we non-GAAP-ed out, creating the difficult comp. Overall, we're pleased with our performance this quarter. The strong growth is a result of the resiliency of our diverse portfolio and the compelling value proposition that Flex brings to the markets we serve. Turning to our third quarter segment results on the next slide. Reliability revenue increased 19% to $3.2 billion. Operating income was $143 million, up 6%, and operating margin for the segment was 4.4%, impacted by persisting semi shortages and some increased operational investments made to support future growth. In Agility, revenue was $4 billion, up 13%. Operating income was $181 million, up 11%, with an operating margin of 4.5%. Finally, Nextracker revenue came in at $516 million, up a very impressive 53% year-over-year. Operating income at Nextracker was $60 million, up 225%, with operating margins now at 11.7%. That's over 2.5 points of sequential improvement and three sequential quarters of significant margin expansion. In Reliability, despite macro concerns, auto inventory is still low and customer backlog is stable. However, semi shortages impacted efficiency and contributed to increased expedite costs, tempering profitability. Industrial demand was solid with notable strength in renewables, automation and other specialty programs. Demand in the healthcare space remains steady and we continue to invest for future growth. Looking at Agility, our lifestyle business was up slightly in the quarter despite the ongoing consumer-related weakness. We've now seen multiple quarters of this outperformance driven by significant share gains. As expected, consumer device -- consumer devices was down similar to what we saw last quarter with continued soft end markets. And finally, CEC again showed excellent overall performance, driven by strong execution and a continuation of trends in cloud and network infrastructure. Moving to cash flow on Slide 11. Q3 net CapEx totaled $157 million, on target at approximately 2% of revenue. Free cash flow was $202 million in the quarter. With the golden screw situation continuing to the degree it has, and given our visibility today, we expect free cash flow in the fourth quarter to be on par with what we delivered in Q3, which would put us below our previous target of $550 million for the full year. We are, however, beginning to see trends inflect. Inventory net of working capital advances decreased 3% sequentially, and we flattened the curve on gross inventory up only 1% sequentially. So, it's nice to see that we are starting to see some progress on inventory. Lastly, we returned $40 million to shareholders this quarter through share repurchases. For Reliability Solutions, we often talk about the longer-term secular tailwinds, but they are also playing out in the near term. Industrial continues to benefit from regionalization opportunities and trends in factory automation. And while the industry awaits further clarity on the IRA, the overall renewable energy transition is a positive driver. Health solutions remain strong, with outsourcing trends providing more opportunities to grow and we continue making progress on program ramps. And in auto, the EV and ADAS transition remains a dominant theme. Collectively, these trends should contribute to overall growth with Reliability revenue up high single digits to mid-teens. For Agility Solutions, revenue will be relatively flat. CEC is expected to grow based on healthy underlying fundamentals, particularly within cloud and communications. But we expect both consumer devices and lifestyle to be down, driven by the weakness in consumer product end markets. On to Slide 13 for our quarterly guidance. We expect revenue in the range of $7 billion to $7.4 billion, with adjusted operating income between $315 million and $345 million. Interest and other is estimated to be around $60 million. We expect the tax rate to be around 14% this quarter and we expect adjusted EPS between $0.48 and $0.54 based on approximately 460 million weighted shares outstanding. Now let's go over our full year guidance on the following slide. We increased our fiscal '23 revenue expectations to $29.9 billion to $30.3 billion, which would result in mid-teens growth year-over-year. We expect adjusted operating margins to be around 4.7%, consistent with what we've told you before. And adjusted EPS is up from last quarter's guidance and is now between $2.27 and $2.33 a share. Before we begin Q&A, I want to just echo Revathi's thoughts that I remain excited about the opportunities ahead of us. As our results demonstrate, we are able to slow -- to continue to deliver growth despite facing macro pressures and industry-wide challenges. The resiliency of our portfolio has been strengthened by our diversification, strategic investments in key growth areas and operational excellence. There are a number of external factors still at play, but our team is executing against our strategy and we remain focused on meeting our long-term targets and delivering value for all Flex stakeholders. We will now begin the question-and-answer portion of today's call. [Operator Instructions] The first question comes from the line of Steven Fox from Fox Advisors. You may ask your question. Okay. Thank you. First of all, I was wondering if you can provide a little more color on the margin pressures on Reliability Solutions. Can you quantify the hit from sort of investing for the future and also the semiconductor area, and talk about what kind of path you see going forward for the margins for that segment? And then, I had a follow-up. Yes, Steven, I'll start and then Paul can weigh in if he feels like. I'd say first is, Reliability is seeing tremendous growth, as you're aware. We're very pleased with our growth around 19% and with growth comes all kinds of challenges. I'd say first is, the supply chain issues and under absorption continues in pretty much all three segments of the Reliability business. And because to support the growth we have this year and then what we continue to see moving forward, driven by all the macro trends we have talked about, regionalization, et cetera, we decided to continue to make some operational investments that supports multiyear program growth and also try to pull forward some program ramps we could and put in some front-end costs when we can afford to do it, right? And like I said in my opening remarks, the diversity of our portfolio and how the company is performing gives us the room to make those decisions. And then, there's nuances also, of course, for liability that you know well, Steven, is that the skilled labor market is tight. And so, we have to continuously find ways to keep that labor available and hire the right kind of labor in different regions of the world that provides some pressure. But we feel very good about kind of the trajectory of how Reliability margins comes out of this. I think these are decisions we choose to make because of how bullish we are about the long-term sector growth itself. We feel like overall, the longer-term growth driver of margin expansion and all of that has -- and the longer-cycle program ramps hasn't changed. So, the strategy is intact. But we had room to make some decisions and invest extra that we chose to do. But I feel very good about the commitments I've made for a liability longer-term. Great. That's helpful. And then, just as a follow-up, I was wondering if there's anything you would highlight, say, over the last 90 days or so related to that regionalization theme. There's been a lot of headlines good and bad in China, India, related to electrification, et cetera. Is anything you call out that's either playing more or less on that theme than you would have thought versus a quarter ago? Thank you very much. Yes. Steven, I would say, if anything, this only continues to accelerate. I would say, it doesn't matter the ups and downs of the conversation on China, whether it is regionalization or whether the country is opening up now, or what you're hearing going on in India. We are just supporting quite a significant amount of programs right now that is driven by that -- regionalization trend, which is driven by reducing resiliency -- increasing resiliency in the supply chain, particularly in Mexico, in U.S., are kind of our two biggest growth areas, and then, some in Southeast Asia. So, haven't seen the trajectory change. If anything, it's accelerated, where we're trying to kind of absorb this [beat] (ph) and really figure out how much more we can do moving forward. So, the pressure is on from customers to do more and do it quickly is what we're seeing. Thank you very much. Can you talk a bit about cash flow? And what I'm wondering, I mean, you're holding to 80% of cash conversion over a longer period of time. But what are you doing internally to, I don't know, maybe improve your visibility, manage inventory better, because it's -- I know some of what's gone on obviously has been the golden screw. I'm guessing some of it has been working capital related to just the growth that you've had. So, I'm just wondering as you look at how the business has changed over the last couple of years, how you're going about managing this, so that you can get back to the 80%, because I think that's one of the few knocks on your stock right now is your cash conversion. Yes. I would say, first, let's start with, Shannon, that I really feel good about kind of the trajectory change that we're starting to see overall with working capital and how we're managing our customers. And I'm happy with the things we're seeing. I'd say, overall, inventory is flattening out. And while we still have this whole incomplete kit issue, I would say, because we have a part missing here and there, particularly in Reliability, I feel good about the general underlying trends that we track to see the right direction in inventory. So, we do think that slips, and you're seeing that kind of the start of this quarter in terms of our overall cash flow and we think that continues to improve. That is the reason why we've feel comfortable with sticking with kind of our cash flow conversion target, because obviously coming out of this, this business is going to generate cash. I'd say in terms of longer-term, Shannon, my view is, we have -- the thing about Flex that we have done really well the last four years is we have taken every burning platform and become more disciplined with it. So, underlying theme across the company is we have become more in planning. We're helping our customers get more disciplined with it. And that will have longer-term implications in terms of how supply chains are managed, not for us, but all the customers that we touch, right? This is near and dear to my heart, supply chain and planning. And we think that this will really make us a better company and my aspiration will be to be better than 85% at some point in time. But I think we're seeing good inflection points here, and that makes us comfortable with sticking to these targets. Okay. Thank you. And then, just again on cash, can you talk a bit about cash utilization? You have Nextracker out there, I understand you're not going to talk about it necessarily, but just in terms of cash generation assuming you move back, you'll have excess cash. So, maybe can you talk a bit about what the landscape looks like in terms of potential acquisitions? Obviously, you've been buying back stock, but just in general your approach to returning cash to shareholders? Thank you. No problem, Shannon. So, first, I'll just say, I think if you look at our performance over the last few years, you've seen us to be disciplined and judicious when it comes to capital allocation. Specific to M&A, we have a robust process and a robust pipeline. But in terms of prioritization, when it comes to capital allocation, I would say, number one priority right now is supporting very strong organic growth, whether that's with some working capital or if it's internal investments or CapEx, very high priority, because we have a very clear path ahead of us for solid top-line growth over the next several years, and we want to make sure that we've funded the business for that. So that's one. Stock buyback has been a priority for us the last couple of years. I think we've been pretty vocal about our views on valuation and we've leaned into that. And so, I guess I would put M&A last. Although again, we remain disciplined, we're going to be opportunistic, we have a pipeline, but at the moment, that's probably our lowest allocation priority. Yes, good afternoon. Thanks very much for taking the question. In the CEC segment, the company, if I heard correctly, was guiding for growth there. I think a number of companies have been reporting pretty broad-based weakness in the comms infrastructure market. So, maybe elaborate a little bit more on what Flex has seen in the comms infrastructure markets? And perhaps is there share gain or something else that's a tailwind for Flex that other companies perhaps are not benefiting from? Yes. No, I'd say first, there's two things that are happening, right? If you think about the three segments in CEC, cloud, communications and enterprise, we're still seeing growth in all three segments of it, while you are seeing a lot of noise about enterprise segment and how that is performing. But for us, a couple of things happening. In cloud, we've clearly, while people have talked about the rate of growth changing, it is still pretty significant growth. And that's important. And along with that and market share gains, it has helped us show continued growth for cloud, and we see that playing forward. I would say in the communications space, similarly, we have seen share gain that has happened with specific customers and we're supporting that growth. But we're also seeing there's enough backlog being cleared in that business that is also supporting underlying growth. So, overall, I'd say CEC, the story of share gain is a big story there, particularly in communications and cloud. So -- and we feel like if the rate of change of growth switches a little bit, overall, it's still a very positive growth story for us. Thanks, Revathi. And my second question was on the China market. I was hoping you could elaborate a bit more on what Flex has been seeing operationally in China, given the unfortunate COVID dynamics in recent months. And also, when you talk to your customers, are they expecting demand to pick up this coming year, given the potential reopening that's occurring in China? Thanks. No problem, Mark. So, the way we thought about this a couple of months ago was we -- as things started to open up, we expected there to be sort of a big COVID spike in the November-December timeframe. And then, post Chinese New Year, our thought was we'd see another one. I'll just kind of tell you how that played out. COVID cases were very high as we move through December, particularly the back half of December. That probably had a little bit of effect on us, but I think we were able to manage it. But absenteeism was quite high in December. Too early to call on what's going to happen here post Chinese New Year, but we track this stuff every day. And I'm pleased to say that people returning to work has been very, very high, higher than what we had originally anticipated coming back from Chinese New Year. And I think by the end of this week, we're going to be at 100%. So that's good news. Yes, thanks. Good afternoon. I wanted to ask another question on the Reliability segment where you've got good growth, and it sounds like you're confident in most of those subsegments in terms of growth and program ramps. We are hearing about some incremental weakness in some of those broader industrial markets, particularly semi cap. I know you have some exposure, but not as much as of some of your peers. So, could you talk about those end markets demand versus program ramps and any pockets of concern there? Yes. So, Matt, across Reliability, we have really good strong demand, driven by the underlying fundamentals of the end markets we're in, but also kind of continued market share gains. We have very little in semi caps, so that's a good thing. And so, we don't see the fluctuations of the up and down in that, and that doesn't affect our overall portfolio. In industrial, we're seeing very strong growth in renewables and we have a lot of opportunities to continue to grow in renewables. We're seeing really good growth in areas like automation. So, industrial between renewables, the basic power business there and automation, the fundamentals are very strong, and we don't have much exposure to semi cap equipment. And then, in auto, EV and ADAS is -- EV particularly is very, very strong, because we have a lot of new program ramps going on there. And even while dealer lot inventory maybe getting filled up a little bit more, we see a very strong path forward in terms of year-over-year growth for automation. So, we really are on the other side of this equation, we have a lot of growth in Reliability. We just have to execute to that. Okay. Thanks for that. And then, on the margins within that business, which I know have been under pressure for the reasons that you explained. How do we get to that? You're talking about a 5%-plus margin for the whole company, which would imply nice margin expansion within Reliability, because I assume that the Agility business is going to be sort of in that range. So, what's the timing there? And in terms of these investments playing off or these other issues like logistics and supply issues, when do we start to see those margins move up? Yes, it's a good question, Matt. I look back to the February-March timeframe when we're putting together the framework that we ultimately shared with you with our Investor Day. In a spreadsheet, we always plan for a nice gradual acceleration of margins, nice even smooth line, but I don't think any of us anticipated going into this year that inflation would be as sticky and persistent -- as large and sticky as it has been, nor did we anticipate the semiconductor shortages persisting as long as it has. And so, both of those have put pressure on the business, including Reliability, of course. And I would say more so with Reliability, because what we've talked about before, the stops and starts on that larger node technology where you have resources idled, waiting for components definitely puts pressure on margins. And so, I look at both the inflation effect and the component shortage effect and ultimately how that impacts factories as sort of being one-time items. All else equal, I think you would have seen better margin performance out of the core Flex business. And I think as we look ahead, we'll slowly start to see those things abate and we'll see the margins accelerate. And Matt, I think all the more reason to feel bullish about our long-term target, right? Because if we are at core Flex target where we are today performing with Reliability margins under pressure, the upside is clear from that. So, long-term targets remain intact. If anything, we feel really good about it. Hi, thanks for taking my questions. Revathi, I wanted to ask you about how you're thinking about risk management. When you look out into the next 12 months, what is it that gives you the most concern? And you just reiterated the long-term -- or the medium-term target of high single-digit revenue growth. Can you talk about what are some of the things that are giving you confidence in that, assuming if we have a recession this year, if the consumer-facing end markets are weaker than what you would think? Can you maybe talk about like some of the levers you have that if one part of the business, the Agility part, is weaker, I mean, do you think that the other part can offset that? So, tell us here like what is giving you the most concern and what is giving you confidence in the medium-term on revenues? And then, I have a follow-up on margins. Yes. Ruplu, I'd say first is, our portfolio has changed significantly if you look from history to where we are today. We have in a very smart and planful way, we have looked at our portfolio and moved it forward in terms of being in the longer and more resilient cycles of the overall economy. And so that itself, and we have shared those numbers with you, right, in terms of how the overall Flex portfolio looks, says that we are in the end markets that have good long-term trajectory and the macro is in our favor, right? Whether it is regionalization or continued technology transitions, all of those are really in our favor. And that's why when we look forward, we are really focused on that we need to have reliability growth continue to be supported, because that's going to be the long-term trajectory. Agility, the way the portfolio is, we'll always have some ups and downs, but we have really minimized that pretty significantly, right? We've already -- as you can see the last few months, we took the comms on consumer markets and still grew. So, the diversity of our portfolio really makes it the real story of why we feel very strong about kind of committing to this longer-term growth. And we have delivered on that. If you look about the last four years, Ruplu, doesn't matter if it was trade crisis and exiting large portfolios or whether it is COVID or supply chain crises, we've really executed on being able to get to this growth trajectory with how we've built up this business. So, the diversity of the portfolio is what I really tell you is the big reason why we're very comfortable with making this commitment. Okay, thanks for the details there, Revathi. If I can ask a follow-up on margins. So, I think you just talked about the Reliability segment being 4.4% and Agility 4.5%. So, you're pretty much at the mid-4%-s, right? And if we take out inflation pass-through, I mean, those margins are likely like 10 basis points to 20 basis points higher already. So, when I look at the long-term target of 5% for fiscal year '25, I mean, that seems a little bit conservative. I mean, if you look over the past two years, you've done like a 40 basis points of margin improvement. This would be more like 20 basis points. So, maybe can you talk about some of the levers that you have for the margin improvement over the next two years? Is it getting harder to get the margin improvement? Or how -- where is that margin improvement going to come from? And what -- why wouldn't it be higher than 5% is what I'm trying to get at. Yes, I think, Ruplu, a little bit of this I answered in the last question about -- and you hit the nail on the head, right, that even with kind of Reliability margins, we were able to make decisions on investment for the longer-term of the business, because we could afford to make those investments, right? And so, obviously, as we try to -- as we taper those off, we expect that the longer-term margin commitment is one that we can definitely commit to. In terms of what is the next upside to that 5%, I think you have to wait and see in the next Investor Day. I think it's too early to commit. But I see lots of room for what we can continue to drive. I'd say manufacturing productivity is big for us. There's tons more to do. I see all kinds of opportunities there. I'd say driving efficiency around program growth and how we do that, there's lots of room for efficiency there. The mix-up story continues to be important for us. That hasn't changed, right? We're continuing to drive that in all the six business units. And of course, like you said, if you take inflation out, the 10 basis points to 20 basis points of upside on that does help. So, I have to agree with your thesis. I just don't want to make any commitment. I would say, we are sticking with the long-term commitment we're giving you. Okay. Thank you for that. If I can -- since you mentioned efficiency, I can sneak one more in. If we talk about manufacturing efficiency, I'm just looking over the past four years, right, your revenues have grown $4 billion, but your total manufacturing square foot has not increased that much. So, I mean, technically the revenue per square foot is looking much better. So, I mean, you've had -- ever since you've come in, you've driven a lot of efficiency in the factories. Can you talk about, like, as you think about the fiscal '25 -- fiscal year '25 target, how much more -- how should we think about CapEx? How much more revenue can the existing infrastructure support? And can you talk about any manufacturing efficiencies? Are there more efficiencies to be add, and where do they come from? Sure. Well, first of all, thank you, Ruplu. Do more with less, that's the goal. A couple of things. Will there be incremental PP&E expenditures? Absolutely. We're going to have to facilitize for growth. Revathi talked about the regionalization trends, significant growth in the U.S., significant growth in Mexico, significant growth in Malaysia this year. You'll see it in the K in another few months. But those regions are going to be growing probably 2x the overall Flex growth rate. So, there will be some pressure to invest, but that's a high-class problem. And again, we remained laser-focused on factory productivity and high, high asset utilization. Hi. Thanks for taking my question. So, just on Anord Mardix, so you've had this acquisition for about a year. Can you talk about how that business has performed kind of on revenues and margins and would have been some of the benefits of cross-sell? And how material has the acquisition been to kind of winning other deals in the space? And as we think about future complementary kind of acquisitions, where are you looking to find incremental value and which specific verticals should we be thinking about that can kind of see the same playbook from an Anord Mardix? Yes. I'd say, Paul, the acquisition has gone very well. If you recall, the strategy was we wanted to get bigger in the power space and we particularly wanted to focus on data centers, both colo and hyperscale, and expand our portfolio in that, because we felt it's a long-term macro for us that was important. And Anord Mardix has -- in terms of revenue growth, has done really well and they have a strong backlog. We're more focused on expanding their footprint and really helping them grow their business faster. And in terms of how it has helped us win overall business, I would say, in hyperscale and in colo, where the focus is really on schedule and delivery of schedule, it really helps to have a more comprehensive portfolio to be able to offer to our customers. And we see that as a differentiator that nobody else has in our space. And so, the conversation has definitely changed with data center space in terms of how we're focused on power and on the IT sector, whether it is racks and enclosures and servers and storage. So, we're seeing the effect of it. It's playing out exactly how we thought it would, and you see that in our cloud expansion and our overall growth there. So, really good asset, I would say, for us. The growth story has been fantastic. Okay, great. And then, just a follow-up on cash flow. Which end markets are you having kind of the most issues with golden screws? And how do we think about some of the timing of conversion there on cash? And are you taking advantage of more customer deposits to kind of partially offset as well? And then, I know it's early, but can we see more meaningful conversion in '24 and get close to that 80% mark in your view? Thank you. Sure. So, I think three questions in there. First on the end markets, the older technology or the larger node technology have been the biggest headwind of late. Things have gotten a little bit easier and so the more the commoditized, more consumer end markets. But automotive and industrial, to an extent, health solutions have continued to face pressure from those shortages and that has not been helpful. You see it manifesting itself in the P&L as we talked about earlier today. But you're absolutely right, Paul, that also has an effect on -- that also has an effect on inventory and ultimately cash flow. I think the second part of that was, what are things that we can do to offset that. Well, working capital advances and support from our partnerships we have with our customers has definitely been helpful. And you probably heard in our prepared remarks, I was very pleased to see that for the first time in a long time, we saw the trends of net inventory, and I say net as in gross inventory less advances from customers, actually came down sequentially. So that was a source of cash and great to see. Is there light at the end of the tunnel? I don't know. But certainly, I'd like to see that trend. So, we are getting some support from the customers. I think Shannon asked a question before about the last couple of years what's changed, well, that would be one change. I think better partnership with our customers in supporting a very voracious appetite for inventory. And then, the third, looking ahead to 2024, it's a little premature to guide on that. Long-term, I think everybody understands that this is a timing issue and ultimately, yes, I mean inventory should come down as all these shortages start to abate. But I would balance that with a comment on organic growth. Look, Flex is probably going to grow 16% this year. That definitely puts some pressure on working capital, but it's our job to manage that. So, a little early to target on '24, but I think overall this is -- it's really just timing. Thank you very much. This is more of a strategic bigger picture question. Revathi, as you load more onshoring facilities, whether it be Guadalajara or North America or South America or Europe [ones] (ph) facilities, and you build on a cost-plus model, now that those factories are better utilized, plus the labor rate is a little bit higher, which you passed to the end customer, doesn't this also help out your long-term operating margin goals to be accretive also? I just wanted to make sure or maybe it doesn't work that way. I would say, first, Jim, that I think the areas you've picked out are all the right ones, that we have said Mexico, parts of the U.S., are definitely our biggest growth trajectories, some in Malaysia, Southeast Asia. So, those are all the right areas that we're growing. The way I think about it, I mean, you see this in the liability now, right, when we start to execute these programs, there's always some challenges with it, because they are big complex programs. And what you see particularly in Mexico and U.S. is very few people can execute these type of complex programs and we are choosing to take those on. So, you see that execution pressure, which challenges some of our Reliability margins as you see now. But as you say, as those programs mature, and we get to a more efficient model, I won't call it just a cost-plus model, but a more efficient model that we work within our customers, we do expect that to be tailwind for margins. And that's why I keep answering the question of the 5% as it's something that we feel good about, right? There's a lot of different ways this industry is monetizing and expanding margins, and that is definitely one of them. So, I agree with you. Okay. So, thank you, everyone. I just want to close by saying that on behalf of the Flex leadership team, a sincere thanks to our customers and to all our shareholders for their support, and, of course, to the Flex team across the world. Your hard work makes this possible. We wouldn't be here today without you all.
|
EarningCall_1138
|
Hello, and welcome to the Eastern Bankshares, Inc. Fourth Quarter 2022 Earnings Conference Call. Today's call will include forward-looking statements, including statements about Eastern's future financial and operating results, outlook, business strategies and plans, as well as other opportunities and potential risks that management foresees. Such forward-looking statements reflect management's current estimates or beliefs and are subject to known and unknown risks and uncertainties that may cause actual results or the timing of events to differ materially from those expressed or implied in such forward-looking statements. Listeners are referred to the disclosures set forth under the caption forward-looking statements in the earnings press release as well as the risk factors and other disclosures contained in the company's recent filings with the Securities and Exchange Commission for more information about such risks and uncertainties. Any forward-looking statements made during this call represent management's views and estimates only as of today. While the company may elect to update forward-looking statements at some point in the future, the company specifically disclaims any obligation to do so, even if management's views or estimates change, and you should not rely on such statements as representing management's views as of any date subsequent to today. During the call, the company will also discuss certain non-GAAP financial measures. For a reconciliation of such non-GAAP financial measures to the comparable GAAP figures, please refer to the company's earnings press release, which can be found at investor.easternbank.com. Please note that this event is being recorded. All lines have been placed on mute to prevent any background noise. After the speakerâs remarks there will a question-and-answer session. [Operator Instructions]. I would now like to turn the call over to Bob Rivers, Chair and CEO. Please go ahead. Thank you, Joanna. Good morning, everyone and thank you for joining our fourth quarter earnings call. With me today is Jim Fitzgerald, our Chief Administrative Officer and Chief Financial Officer. We hope your new year is off to a good start, and I'd like to start this morning's call by thanking my 2,100 colleagues at Eastern for all of their good work in making 2022 such a successful year. Together, we posted record net income for 2022 of $199.8 million, 29% higher than our previous record in 2021. As always, this bottom line result is the product of a number of significant achievements, including the completion of the integration of Century Bank, record commercial loan and home equity originations, outstanding asset quality, the acquisition of two insurance agencies, the continued upgrade of our technology platforms as well as many other notable accomplishments. For example, Eastern was once again recognized by the Small Business Administration as The Top Small Business Lender in Massachusetts for the 14th consecutive year and was ranked among the top 10 most charitable companies in our region by the Boston Business Journal for the tenth time. All of this, along with the strength of our underlying franchise is a testament to their hard work and tremendous commitment. In a moment, I'll turn it over to Jim for an in-depth financial review, but I wanted to first provide some high-level comments on our results for the fourth quarter and our near-term outlook. The fourth quarter of 2022 proved to be a more difficult environment than earlier in the year. Like the industry, we experienced deposit outflows and an upward repricing of deposits that quickly increased our cost of funds due to an aggregate 425 basis points of rate hikes by the Federal Reserve through 2022. It's been important for us to keep close to and respond to the needs of our customers with competitive pricing to attract and retain long-term customer relationships. We are watching our funding trends very carefully, but do not expect a reprieve from the more difficult competitive landscape over the near term. We saw a six basis point decline in our net interest margin in the fourth quarter, and we expect the margin to continue to contract. Given the current environment, as we look into 2023, we are prioritizing profitability over growth. We expect higher market interest rates and an overall softening in the economy to reduce loan demand. Coupled with our higher marginal cost of funds and taking into consideration our required returns, we expect the commercial loan growth rate in 2023 to be in the low single digits following an extremely successful year in 2022. We are proud of our diversified loan portfolio and the many commercial customer relationships we have built at Eastern over the years. We are carefully watching for any signs of credit deterioration, but remain very pleased with all of our credit metrics in Q4. Our reserves and capital levels are very healthy. We are taking many steps to realign and adjust to what we expect will be a more challenging year in 2023. As Jim will cover in more detail, we have significantly reduced our expense guidance. With the change in the environment and our growth outlook, we have pulled back across the board and reduced our expense budgets accordingly. We will continue to evaluate expenses as the next few months and quarters unfold. We have navigated our way through challenging times before and have successfully worked our way to the other side. I am very confident, we will manage our way through this environment as well as the fundamentals of our company and our strong market position in Boston keep us poised for long-term success. And now I'll turn it over to Jim. Great. Thank you, Bob, and good morning all. As Bob mentioned, our Q4 results reflect solid operating results, but also a very challenging and competitive environment. Net income was $42.3 million or $0.26 per diluted share, and operating earnings were $49.9 million or $0.31 per diluted share. As previously disclosed, we were required to use settlement accounting for our pension plan in Q4 and incurred a nonrecurring pretax expense of $12 million due to the unusually high number of lump sum payout levels in 2022. This expense is primarily responsible for the difference between our GAAP and operating results. Our operating net income of $49.9 million and $0.31 per share compares with $55.7 million and $0.34 per share in Q3. Net interest income was $150 million in Q4, down $2.2 million from Q3 or a decline of 1%. The net interest margin on a fully tax equivalent basis was 2.81% in Q4 compared with 2.87% in Q3. The cost of interest-bearing liabilities increased from 18 basis points to 77 basis points in the quarter, which exceeded the increase in our interest-earning asset yield of 29 basis points. We experienced loan growth in all of our major portfolios in the quarter. Commercial loan growth was $313 million in the quarter or 13% on an annualized basis. Mortgage loan growth was $342 million, including $289 million from our Embrace relationship and annualized consumer loan growth was 4.8%, which was primarily in home equities. Asset quality continued to be very sound with net charge-offs of one basis point and nonperforming loans at a very low 28 basis points of total loans, both of which are consistent with Q3 levels. Our Board approved a dividend of $0.10 per share payable on March 15th to shareholders of record of March 3, 2023. We repurchased 1.5 million shares under our share repurchase program in the fourth quarter, most of these share repurchases were early in the quarter. I'll now make some comments on the balance sheet. Assets were $600 million higher in Q4 than Q3, and we ended the quarter with $22.6 billion of assets. Total loans ended the quarter at $13.6 billion, increasing $672 million from the $12.9 billion at the end of Q3. Total deposits increased $241 million in the quarter, which included an increase in brokered deposits of $929 million and outflows of approximately $700 million of customer deposits. Borrowings increased $318 million in the quarter and totaled $741 million at the end of the quarter. The increases in broker deposits and wholesale borrowings were used to fund the deposit outflows and the increases in loans. The securities portfolio was down $160 million as reductions from cash flows and sales were $210 million and offset by market appreciation of $50 million. Shareholders' equity increased $56 million in the quarter due to retained earnings and improved AOCI, offset by the share repurchases. Moving to the earnings review, as I mentioned, GAAP net income was $42.3 million or $0.26 per diluted share and operating earnings were $49.9 million or $0.31 per diluted share. Net interest income of $150 million was $2.2 million or 1% lower than Q3. The net interest margin was 2.81%, down six basis points as funding costs increased more quickly than asset yields. The cost of interest-bearing liabilities increased 59 basis points to 77 basis points due to deposit rate increases geared towards core customer retention as well as the use of FHLB borrowings during the quarter. The overall cost of total deposits, including demand deposits, was 37 basis points, up 27 basis points from the prior quarter. The graph on Page 12 of the presentation shows monthly detail on the rise of total interest-bearing liability costs and how the beta is evolving over the cycle. We've added some new tables on net interest income and net interest margin on Page 7 of the presentation that provide more detail on these changes as well. The provision for loan losses was $10.9 million in the quarter compared to $6.5 million in Q3. Similar to Q3, loan growth was the driver, attributing $7 million of the $11 million provision. The allowance as a percentage of loans increased a modest three basis points in the quarter. Noninterest income on an operating basis was $42 million in Q4. Insurance revenues were $22 million in the quarter, up 5% from the same quarter of 2021 and down $1.7 million from Q3. Other operating noninterest income line items were generally in line with either the prior quarter or the prior year quarter. As we disclosed in Appendix A and B in the presentation, there was a reduction in non-operating losses from the rabbi trust assets and security sales in Q4 compared to Q3. Including the pension settlement costs, noninterest expense was $132.8 million in Q4 compared to $116.8 million in Q3. On an operating basis, noninterest expense was $119.6 million compared to $117.4 million in Q3. Salaries and benefits, occupancy, professional services, and loan expenses were all down in the quarter from Q3, while data processing and marketing were higher. Other expense was higher due to the previously mentioned pension expense and an increase in the provision for credit losses on off-balance sheet credit exposures. I'll include some comments on our outlook for expenses later in the presentation. The tax rate in the quarter was 17% due primarily to some timing items, and the tax rate for all of 2022 was 22.1%. Asset quality continues to be very sound. Through the end of the fourth quarter, net charge-offs were very close to zero. NPLs are at very low levels, and our reserve coverage to NPLs is over 360%. We continue to carefully monitor all of our portfolios. We have several early warning signals as part of our credit review process, and based on those early warning signals, we don't see any significant items of concern at this point. As Bob mentioned earlier, we expect the economy to soften, and we will continue our credit and portfolio review processes diligently. I wanted to review our outlook page and make some additional comments. As mentioned, there's greater uncertainty in the environment, specifically related to expectations for liquidity in the net interest margin. We expect the challenging liquidity conditions to continue over the next few quarters, and this uncertainty makes our outlook subject to a wider margin of error than prior quarters. We are expecting commercial loan growth to be in the low single digits for 2023 due to the impact of higher rates on new originations. We would expect mortgage and consumer loan growth in a similar range. We experienced a net interest margin decline of six basis points in Q4 and expect further declines until the funding environment stabilizes. We added some new tables on Page 12, showing the increase in deposit costs and interest-bearing deposit costs as well as the total, including wholesale funding. We expect our noninterest income for 2023 to be between $170 million and $180 million. We expect reductions in deposit service charges due to changes in our overdraft practices, which you might recall us discussing in prior calls, as well as pressures on mortgage and interest rate swap fees due to market conditions and interest rate levels. We are lowering our operating noninterest expense guidance for 2023 and expect it to be in a range of $465 million to $475 million. This is a reduction of $30 million from the Q3 guidance of $495 million to $505 million. Given the uncertain environment, we're very cautious about adding expenses at this time and have undertaken actions to reduce all of our budgets. We'll continue to assess expense levels as we move forward. Most economic forecasts expect a softening economy that will likely turn into a modest recession, and we will continue to monitor all of our asset quality accordingly. The projected slowdown in loan growth is expected to have an impact on loan loss provision levels. As I mentioned earlier, $7 million of the $11 million provision in Q4 was due to loan growth. Share repurchase activity will depend on market conditions, capital, and liquidity levels. In particular, we'll be looking for liquidity conditions to improve before considering share repurchases at the pace we had earlier in 2022. In closing, we continue to focus on our core deposit customers and expect to find the appropriate balance between deposit retention and our short-term net interest margin. Over a long period of time, those relationships have been a great source of value for Eastern, and we're very confident they will continue to be in the future. Thanks. And Joanna, we're ready for questions. I know there's a lot of uncertainty, it's hard to forecast, but I just want to get more color on your deposit cost. I think in the second quarter, you said you were modeling 150% higher than the prior cycle level of 20% for the interest-bearing deposit data. So I think that gets around 30%. Do you have any updated view on that due to cycle interest-bearing deposit beta? So Janet, I think two things. First of all, it's nice to talk with you and welcome back, and congratulations. I think a few things to respond to that. One thing that we've learned over -- in particular, the fourth quarter, but parts of the third quarter as well is that the history this cycle is different and the history that we all researched and tried to learn from wasn't all that applicable to this cycle, but velocity of change was faster. It's a little harsher -- and so I don't think that we're looking at prior betas and extrapolating to this environment. What we did do was provide the information through the end of the year on the couple of pages that we added to show you what we've experienced. And as we've articulated here, we think it's going to continue to be a challenge and that's what we would say to that at this point. Okay. So I mean, yes, I totally understand, totally on the same page that the cycle is very, very different from the prior cycle. But last cycle, you did better than your peer in terms of managing deposit costs lower than the industry, but in terms of your preference or planning lives, is it your plan to pay up on your deposits much closer to market rates and retain the deposits or stop that deposit outflows or are you still like trying to like manage your NIM and keep your deposit costs stay below peers in terms of your preference as you look out into the next few quarters? Sure, it's a balancing act. It's -- first of all, it's a difficult question. It's difficult to answer, but it's a balancing act, right. We have many, many customers that we've had for a very long time, and we value those relationships. Those relationships are very important to our future and rates are much higher, and we're looking -- we have repriced many of those and continue to reprice them. And as I said, very much appreciate the long-term nature of the relationship and the value of that deposit. We obviously are watching our margin as well, and it's a balancing act between those two things as to how we price deposits. It's just a balancing act that we're going through, very similar to the way we've gone through it before. So in terms of everyone is seeing -- I mean, basically, everyone is seeing noninterest-bearing deposit outflows. But in your case, if I -- if we back out the broker deposits, I think the deposits outflows was a little bit more pronounced. Is this just a function of your customers like leaving in search of like higher yields, like where -- like in what part of your customer base are you seeing like the most deposit outflows and are you planning to use the brokered CDs going forward to plug the hole, is that the plan that you're going to continue considering in the next few quarters? So I think -- let me answer a couple of -- there are a couple of questions in there. Let me unpack it a little bit. So we have seen outflows from most of our customer segments; municipal and commercial in particular. On the consumer side, deposits are a little bit steadier there, but we've seen a shift from lower cost deposits to higher cost deposits. Again, to retain customers, we've got higher promotional rates than we've had in the past, and that's helped keep deposits a little more stable than they would otherwise be, but obviously has a cost impact. I think, going forward, we're just monitoring. We're carefully watching it, making pricing decisions as we go. As I said, it's a balancing act between the short-term net interest margin considerations, which are very important, but also the long-term customer relationships. Okay. I might give this a shot, but in terms of 2023, is there any range of guidance you can provide on the NII growth, I know you guys have pulled that off from the slide, is there any rough range that you can give us as well as sort of the goal in terms of your deposit growth or deposits decline for 2023? I think what we put in the materials that you have is our outlook, Janet, which is that we do expect further contraction in the margin. As we said a number of times, it was six basis points in the third quarter, and we've given you, I think, pretty good information on the deposit costs in Q4 and throughout the year as well. So that's all part of our outlook and that's what we've provided. Good. Jim, just a follow-up to try to get at that margin question a little bit differently. Where does your modeling show the margin bottoming out, assuming the Fed kind of falls the forward curve? Yes. So Mark, it's -- as we've tried to say a couple of times, we're in -- it's a very competitive market, it's challenging. We think things get a little bit more -- we think things continue to be difficult. Beyond that, it's very hard to give you any more information. We've provided you the information through the end of the year. That's what we see. And as I said, we're not expecting that to get any easier over the next couple of quarters. Okay. And then secondly, when we see rallies in the bond market, are you guys selling or trying to reduce the size of the AFS book and is there any plans contemplated to take losses and shrink that book down? No. Mark, thanks. It's a good question. I think it's a very fluid environment. We're assessing things all the time and reacting as we see changes. The only way I can answer is that when we have decisions, we'll talk -- we'll communicate. But at this point, we're just watching very carefully assessing things. And in this environment, it's difficult. So many things are -- we're certainly open to things -- all things being under consideration, but no plans at this time. Okay. And then just a couple of questions around M&A, it's been pretty quiet on the insurance M&A front. Any particular reason for that? And also, given sort of the dearth in bank M&A targets in Eastern Mass, are you guys getting a little more open-minded to extending your geographies a bit, if a deal made financial sense? Sure, Mark. As you know, we've focused within our current footprint or immediate adjacencies for bank acquisitions and insurance acquisitions. That continues. Certainly, if other opportunities fall outside of that geography and they come along, we have -- we'll continue to take a look. We have in the past, we tend to be less interested in those for a number of reasons, but certainly, we will consider those. In terms of the pace of insurance acquisitions, it's really just a matter of pricing. We always have a very extensive pipeline of potential deals. Oftentimes, the pricing is very challenging relative to our return requirements, but it's something we continue to take a look at. Yeah, hi Bob and Jim. Good morning. Maybe just stick where Janet and Mark were, back on the margin, certainly, your core deposit franchise is very, very strong seeing the move in the money markets and the CDs, and the broker deposits obviously jumped to 5%. Can you help us think about how high you take those broker deposits and then maybe asking the margin question another way, can you refresh us maybe on where your December spot margin was? Sure, Laurie. Good morning. So I think the broker deposit question, it's a challenging environment as we've said many times. Historically, we haven't used broker deposits, and we've had limited wholesale borrowings. In this environment, we've used them. So we continue to make decisions based on cost and balance sheet structure, etcetera. The margin at December was in the low 270s on an FTE basis. Okay, that's helpful. And so nothing that you want to quantify in terms of how much to pull down of broker deposits? Just in terms of thinking about how big broker deposits could become, right, broker deposits are now 5% of your deposit base. Is there any thinking you cap it at 10% or how should we think about that? Yes, I would answer the question this way, our preference is to use customer -- our own customer deposits much, much more so than broker deposits. It's been a challenging market. We've repriced and continue to look at pricing alternatives with all of our customers. Our preference would be to grow those and replace the brokered deposits. The velocity of changes in the fourth quarter was what it was, and we did use the brokers as you mentioned and we've disclosed. But our preference is to continue to look at pricing strategies and structures with our existing deposits for our existing customers and grow that as our primary source of growth going forward. Got it. Got it. Okay. And then on expenses, your expense outlook is a dramatic change from where you were last quarter. So the $30 million reduction is substantial, can you take us through a very high level where that might come from, is that branch closures, or how are you thinking about that? Sure. And you're right, Laurie, it's a pretty sharp reduction. 2022 is a very strong year for the company. We were on a very good growth path. The environment changed. So the reduction is coming from basically everywhere. Some of it's in pulling back on growth plans that we had. Some of it's on looking at things that we're doing and deciding we didn't -- they weren't as important to us at this time. General belt tightening. We are looking at all the things you would expect branches to some extent, other real estate in many cases and other opportunities. But the initial reduction was really pulling back, and as I said, we saw a big change in the environment in the fourth quarter, and we knew that we needed to reassess our expense go forward in the light of that new environment. Right, I think good question. And I would say what we've got -- at the end of the third quarter, we're guiding 22% to 23% and I think that would be my updated guidance for you. Okay. And then a question here in fee income, you had a drop in insurance revenue linked quarter. Maybe any thoughts around that and then I know March is typically your strongest month or strongest quarter rather for insurance, are we still thinking that we would see maybe a $4 million to $5 million build to increase or can you help us think a little bit about that? Sure. What I would suggest and what we do internally Laurie is, I wouldn't look at a linked quarter -- I wouldn't look at the insurance revenues linked quarter because of the seasonal -- seasonality changes. I would look at the prior year, and you're absolutely right, there was a big increase in the first two quarters, but in particular, the first quarter. That's when many of -- used to be called profit sharing. It's -- that's not quite the technical term now. But a lot of that is realized, and there's a very -- there's a noticeable increase. So I would look at the prior year and look at the growth rates that you've seen this year and use that rather than linked quarter because of that seasonality. Got you, okay. And I guess, any thoughts about the drop in the December quarter, I'm just looking again at a linked quarter, but any thoughts on that? No. I think it was very much in line with our expectations, and it was 5% ahead of the prior year, which, again, I think is the appropriate benchmark. Got it, got it, okay. And then just last question on loan loss provisioning. Was there anything that was a specific reserve set aside in that $11 million, I realize $7 million was growth, you had no charge-offs, anything specific the rest of it? No, I would consider -- I would describe it as sort of modest changes in our ACL factors that the provision itself as a percentage of loans were up three basis points. So very modest. I know there were no specific items or no specific problems in the quarter. Great, kind of sticking on the margin topic because it's been pretty popular this morning. I wanted to comment a little bit differently. Could you provide a little color on the asset yield side of things, earning assets had only gone up 33 basis points with loans going up about 32 basis points, why wasn't there more lift in the loan yield this quarter? So I think, Damon, that's interesting because we looked at -- our view is the loan yields were up 32 basis points when we think about the rate moves in the quarter itself. We thought that was in line with our expectations. Obviously, the securities portfolio is fixed rate and that didn't move. That's why the interest-earning assets are below the loan yields. But when we look at the -- and we provide information on the fixed variable and the amount of the variable that has been hedged, we thought that 29 basis points was sort of in line with our expectations. Okay. And then could you just give us an update on the Embrace Home loan relationship, are you still active with that, or is that -- was this quarter just like a onetime? Yes. So just as a quick history, right, we -- at the end of the second quarter, we described what we were trying to do. The goal at that time was about $400 million of residential mortgages. At the end of the third quarter, really for a few reasons, but in particular, because of the changing liquidity landscape we didn't severe it, but we stopped -- discontinued it. The pipeline had built up, and that's what we closed primarily in the fourth quarter. There was a little bit of a straggler into early Q1 here, but the relation -- there's no origination and the growth will be very, very modest in Q1. Got it. Okay. And then just lastly, can you just provide an update as to what your exposure is with regard to office space and commercial real estate in the greater Boston area? Sure. So in total -- and we -- this is consistent with, I think, prior calls on this question. If you look at our total office portfolio and strip out the things that have either owner occupied for commercial customers and/or have a retail component to it, which I think the risks are different, portfolio is a little bit less than $700 million. There is a little bit of exposure, but not much in Boston itself. Most of it is outside of the city. We're obviously watching the portfolio very carefully, but as I said in some of my remarks, all of our early warning signals don't cause us to see any significant issues at this point. Thank you. There are no further questions at this time. I will now turn the call back over to Bob Rivers for closing remarks. Great. Well, thank you for your interest and your questions this morning. We look forward to talking with you again at the end of April when we'll report our first quarter results.
|
EarningCall_1139
|
Good morning, and welcome to Swedbank's 2022 Full Year and Fourth Quarter Results Presentation. My name is Annie Ho from Investor Relations. And also on the line is our CEO, CFO and CRO, Jens Henriksson, Anders Karlsson, and Rolf Marquardt. As this is also the full year report, we will have a slightly longer presentation than usual before we open up for questions. Thank you, Annie, and a warm welcome, everybody, to this presentation of Swedbank's result for 2022. It's a year marked by the pandemic, war and inflation. And in these turbulent times, we are a reliable and stable partner. We listen and use our expertise to support and help our customers with advice and financing, and contribute to financial stability for society at large. The fourth quarter was characterized by a weaker macroeconomic outlook. Increased prices and higher rates reduced demand as our home markets enters into recession. Inflation rates are forecasted to subdue, and policy rates will peak during the first half of 2023. Swedbank is a low risk bank, and our four home markets, Sweden, Estonia, Latvia and Lithuania, are characterized by strong public finances, well-managed firms and resilient households. And in this situation with high energy prices, increased cost of living and a continued global uncertainty, there is a need for stable, sustainable and thus, profitable banks. And in these turbulent times, I am proud to present a strong result for the full year of 2022. We have, for a long time, positioned the bank to benefit from a normalized rate environment. As a result, net interest income was up SEK 6 billion. During the year, margins on mortgages are down while they're up on deposits. The turbulence in the markets and falling asset prices affected net commission income that was down 4%. Other income was up 6% mainly from insurance-related income, and we control our costs. More than two years ago, in a low inflation environment, we announced a nominal cost cap. And apart from the cost related to the closing of the Danish branch and the winter allowance to employees in the Baltics, we delivered spot on target. Weaker macroeconomic outlook drives impairments, and they were up SEK 1.3 billion compared to 2021, all according to IFRS 9. For individual assessments, recoveries were larger than the provisions. During 2022, we made other impairments for IT systems and goodwill of around SEK 1 billion, and the bank tax landed at the same size, SEK 1 billion. And if the tax were to be removed, this would fully benefit our customers. In total, net profit was up 5% compared to 2021. Our cost-to-income ratio was down to 0.40, return on equity was 13.3% and earnings per share is SEK 19.43 of them [ph]. A sustainable bank is a profitable bank. The returns we generate do benefit our owners, our customers, our employees and society at large. During the quarter, we have delivered in accordance with the plan we presented at our Investor Day, with improved availability and based on our proven business model and pricing strategy, and we report a profit of SEK 6.8 billion in the last quarter of 2022. Return on equity was 15.8%. Our cost-to-income ratio was 0.36. And as you see, net interest income developed well. Deposits margin were up while the mortgage margins continued to be under pressure, down a couple of basis points. Net commission and other income were down compared to the previous quarter and cost increased in accordance with our plan. We have a strong and stable position. Our credit quality is good, and our proven business model with a thorough and conservative credit origination process delivers. During the quarter, we had credit impairments of SEK 680 million connected to the weaker macroeconomic outlook. Provisions on individual engagements were only SEK 30 million. Since the beginning of the pandemic, we have held an expert portfolio adjustment above what the model shows. It increased somewhat during the quarter and is now SEK 1.7 billion. Our exposure to everything property related is in line with the bank's strategy and risk appetite. In line with what we communicated at our Investor Day, we have proactively added on to our risk exposure amount while waiting for the dialogue with the Swedish Financial Supervisory Authority to be finalized. This is prudent, and this is transparent. Our liquidity and capital position is strong, and we now have a buffer of 3.4 percentage points relative to the capital requirement. Geopolitical tensions are high and the debate on threats and cyber attacks continue and we continue to invest in security. We are stable and well prepared. Our dividend policy is to distribute half of the profit. That is a dividend that contributes to society through savings banks, pension funds, insurance companies, retail and other investors and foundations, which in turn donate to local sports and cultural activities to help their communities grow. The Board of Directors proposes a dividend of SEK 9.75 per share. The remainder of the profit is used to grow our business in line with the strategy. In Swedbank, we have for the last three years focused on our fundamentals and this has produced results. I am proud of the plan we presented at the end of last year, Swedbank 15/25, where we will grow business and reach a sustainable return on equity of 15% by 2025. We set out four business priorities in Sweden, Estonia, Latvia and Lithuania, in line with our core business. First, we are leveraging our proven business model and pricing strategy. Secondly, we are growing our share of wallet for existing customers. Thirdly, we are growing the business in prioritized segments and fourth, we're improving our availability and operational excellence. And these are priorities that will grow our income 3 percentage points more than cost on average. And we will not hold more capital than necessary and maintain our focus on credit quality, and that is how we reach our goal of 15/25. The Sweden house - the Swedish housing market has stalled. Falling home prices and lower turnover increased competition. And we maintain our long-term pricing strategy. We are not the most expensive, nor the cheapest, but we have the best full service offering. In Estonia, Latvia, Lithuania, there is a structural underlying demand for mortgage loans from younger generations looking to buy their first home, and this is driving volume. Swedbank has the best full service offering. And our many savings options give customer an opportunity to choose what suits them best. We have raised interest rates on our savings account in both kroner and euro as we empower our customers to save for better future with a good return. In Sweden, savings in fixed income funds increased, while it decreased for equity funds during the quarter. At the same time, we see steady interest and growth in fund savings in Estonia, Latvia and Lithuania. In Sweden, corporate lending decreased slightly compared to previous quarter. Activity in the capital market rose and Swedbank assisted customers to raise capital in the bond markets. A continued focus on our four home markets is an important part of the Swedbank 15/25 plan, and we have thus decided to close our branch office in Denmark. Corporate customers will be served going forward through a strategic partnership with Danish Swedbank, and it's a similar solution to the one we have with SR Bank in Norway. And as we pointed out on our Investor Day, we want to grow among midsized corporates. In January, I recruited Bo Bengtsson to be the new head of LC&I. And he has a long experience working with these types of customers and he will deliver on our corporate strategy and grow our market share in the segment. Swedbank stands in the middle of the digital transformation in society. And for us, it is always our customers who take priority as we develop the bank. And increased availability is also a key part of Swedbank 15/25. In Latvia, as a first step, we have rolled out a cloud-based omni-channel communication platform that makes the next generation of customer meetings possible. New technology now integrates services via branches, telephone, the Internet bank and the app. The platform will be gradually launched in our other home markets. We have a 200 year history of innovation. And during the quarter, we made it possible for customers to use facial recognition or biometrics for identification by mobile phone when customers order their bank ID. And we've also been awarded with two European prizes that recognizes customer value delivered through our virtual assistant. Swedbank has for several years focused on reducing our own carbon footprint through less travel, less postal mail and more energy efficient offices. In the quarter, we took a new and important step as we adopted science-based targets for our credit portfolio. And the targets cover five sectors, mortgages, commercial real estate, power generation, oil and gas and steel. To contribute to climate neutral world, our finance carbon emissions will be reduced as you see on the slide by between 29% and 59% by 2030. These sectors have been chosen based on their impact on the climate, the bank's portfolio exposure and available data. Now Anders, I will turn off the - turn over the microphone to you. I know you would do a deep dive into results. What an introduction. Thank you, Jens. I'm pleased to dive into the financials in more detail. As I go through the results, I will mention a couple of one-offs. But overall, it has been a really good quarter and full year. Let's start with lending and deposits. The total loan portfolio was stable. Swedish mortgage lending volumes were broadly unchanged. The trends in the housing market, which we saw already last quarter continued, both house prices and the number of transactions decreased while extra amortizations increased as a reaction to the economic outlook. Corporate lending decreased by SEK 4 billion, excluding FX of SEK 2 billion. Lending in LC&I decreased by SEK 2 billion despite a good amount of activity. During the start of the quarter, we increased lending by SEK 10 billion through higher RCF utilization and lending to the manufacturing sector. This was offset by repayments to both RCFs and term loans across several sectors in December. Baltic Banking increased lending by SEK 2 billion each in both private and corporate segments. Customer deposits increased by SEK 14 billion excluding a positive FX impact of SEK 7 billion. Deposit volumes were lower in Swedish Banking, driven by a decrease of SEK 6 billion in private transaction deposits. We also saw a movement of around SEK 15 billion from on-demand savings accounts to term savings account. Baltic Banking contributed with an increase of SEK 25 billion, excluding FX, mostly in on-demand deposits and mainly due to seasonality of salary bonus payments and distribution of government funds. LC&I had stable volumes. Now looking at the revenue lines. Starting off with net interest income, which increased by 31% quarter-on-quarter. The strong development was driven by an expansion of net interest margin, particularly in Baltic Banking and Swedish Banking. In addition, there was a positive adjustment of the Swedish deposit guarantee fee that decreased by SEK 130 million. In terms of outlook, the view of our macro research team is that during the first half of 2023, both the Riksbank and ECB will raise rates further. But let me reiterate our belief that the higher policy rates go, the narrower the expected positive differential in pass-through on lending and deposits will become. These market dynamics were already apparent during the latter part of Q4. We will continue our pricing strategy and aim to strike an optimal balance between volumes and margins, subject to changes in risk, market rates, market growth and competition. Over to net commission income, where card commissions were seasonally lower. There was also a negative effect of SEK 80 million from adjustments relating to MasterCard. Asset management was broadly stable. We saw a shift from equity to fixed income funds, which negatively impacted income. In terms of Swedish mutual fund flows, we saw net inflows totaling SEK 28 billion, mainly institutional while retail flows were stable. Corporate Finance & Securities increased by SEK 20 million, thanks to the annual market maker fees. Turning to net gains and losses, which was once again strong. Client trading performed well, especially in FX within LC&I. Result in treasury was positively impacted by FX swaps and covered bond buybacks, which more than offset negative effects in hedge accounting and derivatives valuation. And valuations in the liquidity portfolio improved due to narrowing credit spreads. Other income decreased by SEK 90 million due to lower profit in net insurance and Entercard, while the savings banks continue to perform well. Regarding expenses, we exercised strict cost discipline throughout 2022. Full year underlying expenses were in line with the cost cap of SEK 20.5 billion set two years ago. Total underlying expenses ended at SEK 20.65 billion, a deviation of 0.7%. The deviation can be explained by the SEK 60 million of winter allowance to colleagues in the Baltic countries and a one-off of SEK 80 million relating to the closure of our Danish branch in Q4. For the full year, AML investigation costs totaled SEK 443 million. And the FX effect was SEK 320 million, reminding you that the FX effect is positive for net profit. As part of our Investor Day in December, we stated that we would use a cost income ratio of 0.4 to support our ambition to reach a sustainable 15% return on equity in 2025. This is there for a long-term, supporting KPI that looks through the annual cycle. Going forward, we will continue to exercise strict cost discipline. Moving to other impairments. As part of the annual impairment test, we have recognized impairments of SEK 681 million relating to PayEx regarding goodwill, internally developed software and brand. As we mentioned at our Investor Day, the card acquiring business in the Nordics has been facing challenges to reach profitability in a market with increased competition and rapid technological development. While it continues to add value from a total customer offering point of view, we intend to implement measures to improve profitability going forward. The Baltic part of the business is in contrast profitable, operating within a market where cash to card conversion is still occurring. In addition, the Baltic merchant payment operations is an integrated part of overall business banking. And so we will continue to develop the Baltic merchant payment business. Thank you, Anders. The macro development continued to deteriorate and the updated macro forecasts were downward adjusted for Sweden and the Baltic countries. Interest rates, energy costs and inflation impacted households are becoming challenging for some households with limited margins. The number of bankruptcies increased and retail sales slowed down. Swedbank's credit quality, on the other hand, was strong in the quarter and with only limited negative signs in credit risk indicators. This reflects that our customers generally are well equipped to manage the changing conditions. Going forward, we expect to see more credit migrations due to the weakened macro situation. This tendency also are the background to the very low level of individual provisions and increased provisions for expected credit losses. In the fourth quarter, past due loans to corporate customers were stable, both in Sweden and in the Baltic countries. For private customers, past due loans were stable in the Baltic countries. In Sweden, they increased slightly but remained at a very low level. The amount of exposures in forbearance were unchanged. Now turning to the numbers. Credit impairments ended at SEK 679 million in the fourth quarter. The updated macro forecast increased provisions by SEK 207 million. Credit migrations added SEK 343 million. And out of this, Swedish Banking accounted for SEK 198 million, which was mainly related to property management and the retail sector. In Baltic Banking, credit migrations added SEK 180 million, mainly explained by the manufacturing and transportation sectors and in large corporate and institutions, we had SEK 27 million of effect. Export portfolio adjustments increased by SEK 34 million to SEK 1,738 million. Reductions were made by SEK 115 million for oil and offshore exposures, while provisions increased by SEK 160 million for property management and SEK 70 million for retail. Individual assessments were limited and ended at SEK 32 million. When we summarize 2022, we can conclude that provisions of SEK 1.5 billion are almost exclusively explained by the updated macro forecasts and credit migrations. Regarding individual assessments, we saw net releases. Expert portfolio adjustments were largely unchanged, but releases have been made for oil and offshore exposures while increases have been made primarily for property management, manufacturing and agriculture. Now turning to property management. The foundation here is our origination standards based on strong cash flows and collateral. But it is not only about formal criteria. A key element is to be close to customers to have a continuous dialogue and to support good customers, but also to detect problems at an early stage and to be able to respond quickly, and this we do. We also take note of the fact that these companies have shored up liquidity to manage maturities in most cases, for the coming 18 months or longer and the structural changes are ongoing in the sector, which reduced risks. Against this background, we assess that the bank is well positioned also under most stressed conditions. Thank you, Rolf. Turning to risk exposure amount and capital. Last quarter, we implemented a new definition of default as a part of IRB overhaul. This quarter, ECB required a recalibration of Baltic models due to the new definition, which added SEK 11 billion of risk exposure amount. At our Investor Day, we gave an estimate of our latest view of the CET1 buffer impact from the IRB overhaul exercise. While the discussions with the regulators are still ongoing, we have decided to be prudent and proactive by recognizing this estimate already now. Therefore, the risk exposure amount increased by SEK 36 billion via an additional Article 3 add-on. The IRB model's application process is expected to last into 2024 and Basel IV Stage 1 effects are due to be implemented in 2025 according to legislative proposals. Subsequently, our CET1 capital ratio stands at 17.8% with a buffer above the minimum regulatory requirements at around 340 basis points. Regarding expected future capital requirements, the countercyclical buffer in Sweden will be raised by a further 100 basis points in the second quarter this year. The capital target range of 100 to 300 basis points remains and our capital position continues to be strong. Thank you. 2022 was a difficult year characterized by pandemic, war and inflation. In this situation, Swedbank stands strong. We've been there for our customers. And together, we delivered a strong result that is characterized by a strong cost control, a strong liquidity and capital position, a strong credit quality, leading to a return on equity of 13.3%. For the benefit of our owners, customers, employees and society at large, a result that enable us to propose a dividend of SEK 9.75 to our owners, a result that also makes it possible to continue to educate the young in personal finance. And during 2022, Swedbank and the savings banks together educated a total of 400,000 children and youngsters in Estonia, Latvia, Lithuania and Sweden. A sustainable bank is a profitable bank. And in 2023, we would take Swedbank forward in the strategic direction towards Swedbank 15/25 with a focus on our customers' future. Annie? Yes, good morning. First, on deposits. Anders, you mentioned there that the decline in Sweden was partly due to amortization. Could you tell us a bit about the competitive situation on the process in Sweden, if you're also losing anything to competition or what share is amortization of that decline? And related also to deposits, just of your Baltic deposits. If you could tell us on what share you had zero interest rates in Q4 and whether that has changed in Q1? And the second one, just on lending. I note that on your Swedish CRE book, you have the lowest quarterly growth rate now since Q3 '21, if there is any deliberate decision behind this or if it's just by coincidence? Thank you. Well, should I start before I give the floor to you, Anders? When it comes to property management exposure, we have an exposure of SEK 293 billion, and that is the lowest among the three large Swedish banks. That exposure is in line with our strategy and also in line with our risk appetite. Looking forward, we have a cautious mindset, but we are ready to support our core customers further if it's in line with our strategy, our risk appetite and leads to well-balanced growth. Anders? Thank you, Magnus. If we start with the deposit situation in Swedish banking, I think what you see in this quarter is a combination of things. It's paying higher electricity bills and higher living costs. It's extra amortizations. It's a certain migration from transaction and savings accounts to term savings accounts in Swedbank, but we also see some outflows to niche players, that's for sure. It's not something where the volumes are concerning us, but we are following it closely. On the Baltic side, out of SEK 380 billion of deposits, SEK 330 billion is transaction deposits. We see small signs of migration to some of the savings accounts where we're paying interest, but it's very limited. Yes, good morning. And thank you. A follow-up on Magnus' question here, and you discussed the pass-through on rates. Could you share some details on how large was the impact on pass-through in Q4 in terms of - I mean, obviously, NII was extremely strong. But how large part or did that impact the P&L in Q4, if you could shed some light on that? And then PayEx, how should we think about that? Obviously, you stated that it is an important part of the business, but could we expect further adjustments related to PayEx going forward? Yes, that's it for me. Thanks. Thank you, Maths. I will not go into the details on pass-through, but what you can see quite clearly is that the uptick in NII is coming on the back of NIM expansion, in particular on the deposit side. And to give you some flavor, half of the delta is explained by the Baltic balance sheet and the other half is explained by the Swedish balance sheet. So to conclude, we have successfully applied our pricing strategy during the second half of 2022, which is evident. But I've also been quite clear saying that it will become more difficult in the future to maintain that differential in pass-through on lending and deposits. On PayEx, we have written down everything that was above book value. We will do impairment tests as a regular part of our quarterly reports. But that, I think, is an important information for you. Morning, everyone. Sorry, I'm going to have to go back to the NII. I guess that's the most important driver at the moment. So I mean, Anders, you're saying that it's become more difficult, which we understand, of course. But considering you have SEK 330 billion that - in the Baltics that you pay nothing, and we expect ECB rates to move up 100 bps at least from here. You have the equity in Sweden that's placed on the short end. So those are two quite powerful drivers that should materialize this year. Then if you look at the Swedish deposit base, if we assume that all future rate hikes will be passed on to clients, which isn't a given and then you have competition, of course. Do you see any reason why we shouldn't take the Q4 NII as a very good starting point and grow that in terms of NII for 2023? Thank you, Andreas. I think it has been a shift in NII. So I would recommend you to start off with Q4 as a starting point. And I agree with you that there are some automatic effects coming from equity. When it comes to the deposit side in Baltic Banking, we have no intention, as we speak, to change rates, but I expect competition to pick up there as well. But in the Baltic, could you tell us, I don't really know. But in Sweden, we know that there are niche players that are after deposits, of course. But in the Baltics, given that both you and SEB and you're basically the banking system, you have enormous amount of excess deposits. Is it anyone or who would it be that would pay up for deposits? And aren't they so small so you can actually afford to lose a bit or what's the dynamics there? It's mainly local players, who do not have access to the capital markets funding that might be - where it might be attractive. But then you need to find healthy growth in the lending space, and I think that has been fairly subdued compared to history. So you're correct. And we are running with a loan-to-deposit ratio close to 60%. So from that perspective, it's not so that we will act in an irrational way when it comes to potential volume outflows. Thanks. And then on costs, Anders, you were making a specific point of the 40% cost-to-income target being a long-term target over the cycle, however. Does that mean that you could actually go a bit below or quite a bit below in a couple of years now when rates are as high as yours because your long-term 15% ROE target, remind us, is that based on 2% interest rates? It's based on the assumptions that I gave you on the Investor Day when it comes to the rate cycle. I don't have that exactly on the top of my head, Andreas, but we - Annie is helping me out. And the assumption is that the policy rate from the Riksbank will be 2.25 during this year and 2 [ph] next year, and ECB will have a slightly different one. But I - let me give you the details afterwards. When it comes to the cost income ratio, you are correct. We have, for two consecutive quarters, been below 0.4 already in 2022. That's why I think it is important to have that as a long-term indication of how an efficient retail bank should perform from a cost-to-income perspective. So you can expect us to have some quarters to be below 40% and maybe some quarters to be above. But the long-term target is 40%. The next question comes from the line of Rickard Strand with Nordea. Please go ahead. Mr. Strand, your line is open. You may ask your question. Sorry for that. So first, a question on costs. If you could you give an updated view on what you expect in terms of salary inflation in Sweden and the Baltics for 2023? And also in terms of IT spending, if you expect that to more or less grow in line with the general cost growth for '23 or if you expect a pickup or a decline from the current level? Okay. Thank you. What we said in the Investor Day was that we will have a headwind of around SEK 1 billion to SEK 1.2 billion this year coming primarily from salary increases. We are, as you know, not finalized the negotiations in Sweden and in the Baltics, it will come at a later stage. And the second important factor is that we see that some of the external providers, the contracts will increase in price, which is primarily IT maintenance related. When it comes to investments into IT development, we will most likely be at the same level as we have been for a couple of years and that is more about our capacity to deliver rather than our capacity to invest. Thank you. And then over to asset quality, just looked at the Stage 2 provisions for Property Management was up SEK 175 million Q-on-Q. Just want to hear if you could share some color on, if this is primarily due to the - as you talked about the macro assumptions that changed or if it's something more specific for the sector? Hi, Rickard, so that is a combination. So it's mostly explained by downgrading of some customers, and that's part of the normal credit risk assessment process. So it's - and then, as a consequence, we have seen migrations to Stage 2. And then there is also an element of the combined effect of macro adjustments we have done this quarter and also in the past that sort of pushed - could also push customers over that edge and move into Stage 2, but that's a smaller part of it. Yes, hello. Thank you for the presentation. Couple of questions. First of all, on the capital impact and IRB overhaul, if you could provide a little bit clarity. We've seen 1.2% hit this quarter. And I believe that previously, you guided for 2.1 CET1 impact, and that was related both to IRB and Basel IV before the Pillar 2 offset. Just wanted to check how much we're going to see of additional impact from here, if you can have a bit more clarity of IRB versus expected Basel IV impact in 2025? Okay. Thank you, Maria. I will start, and then I will hand over to Rolf. What we said in conjunction with the Investor Day is that our best estimate when it comes to future capital requirements from IRB overhaul and Basel IV combined was 130 basis points. And what you see this quarter is only IRB overhaul related estimates from us, so 130 versus 120. When it comes to impact from Basel IV, it's quite early to say, but there will be a number of moving parts as we go along. You will see most likely changes in Pillar 2 add-ons, and you will see some additional impact from Basel IV. But I would say in light of the 120 that we took this quarter, it's a very limited impact. Maybe Rolf, you can fill in. About the Article 3 add-on this quarter, so this should be understood and it's our best assessment today of the full impact on IRB overhaul on the risk exposure amount. So that's what you have on the table. And just to clarify this collaboration in the Baltics, that was expected, right? That was part of your guided overall impact. Understood. And then on the margin and strong impact in the fourth quarter, I appreciate your comments. But maybe more - a couple of things if you could shed some light. First of all, if there is any lag effect on the loan portfolio of already announced pricing, but that hasn't filtered through yet? And then you mentioned there is a shift from savings to term deposits in Sweden. Could you disclose what proportion is on term deposits and on households in Sweden? Yes, there is always. As you know, if we start with Baltic Banking, the liability side is immediately re-priced if there are any changes to that. And on the asset side, most of the loans are linked to six month Euribor, which means that they will gradually roll in. And then you have the place - the liquidity excess, which is placed with ECB, which is obviously re-pricing more faster. On the Swedish side, there is always an element of rolling in when we change primarily mortgage prices. We have - on the three month side, it's rolling in with one third approximately every month. And then you have the fixed part of the book, which is rolling in gradually over the years to come. When it comes to your second question, it was SEK 15 billion in the quarter, and I think that the term deposit volumes in Sweden, today, in Swedish Banking, is around SEK 45 billion to SEK 50 billion out of a quite substantial deposit base, which is - I don't know the numbers on the top of my head, but it's, I would say, SEK 400 billion, SEK 500 billion. So it's still limited. And you - but you clearly see that people are - when they have excess liquidity, they place it on the term. More specifically, the three months has been the most popular one. Yeah, hi. Here its Sofie from JPMorgan. So just going back to taking of NII, you guide that the rate sensitivities got lower here going forward most likely just given the pass-through will narrow. But if I - because your fact book, the rate sensitivity guidance is broadly unchanged. So I was just wondering like how should I think about NII growth for 2023? If I annualize the fourth quarter level, I get to over 30% NII growth in 2023. But how much more do you think you can kind of re-price upward that, your mortgage rate, it sounds like there is a little bit more deposit pressure. But how should one think about the NII kind of progression throughout 2023? Has NII peaked or is it fair to assume that there is still more NII growth to come? That would be my first question. Thank you, Sofie. Yes, the sensitivity that we provide you with the underlying assumptions are broadly unchanged quarter-over-quarter. What I also said is that the higher the policy rates go, the more difficult it will be to widen the differential between lending and deposits when it comes to pass-through. We have been very transparent to you, both in the Investor Day and in the fact book, so I will not guide you further on that one. You have - you can easily see on our website what we are paying on our deposit accounts. You can see the average rates on mortgages and the list prices on mortgages. So now it's really for you, Sofie, to - with that information, make your best estimate. But do you think it's fair to assume that when it comes to net interest income, the best is behind us or kind of should we expect net interest income to grow further? Sofie, I don't think you should expect a delta of 31% going forward. What I said when Andreas was asking the question is that a good starting point for you would be the Q4 level. Okay. I'll work with that. And then my second question would be around the potential kind of - it does mean that you're almost low-balling [ph] your capital position in the fourth quarter. You did a goodwill write-down, you did a software write-down, you have much more macro â or credit migration adjustment compared to your peers that have reported so far. You did quite big IRB overhaul that one of your peers said will have a limited impact, your - particularly Baltics that your peers didn't take anything. So kind of should we take this as a sign that the AML issue started to come to an end and potentially for the U.S. regulator, you want to kind of have a levered capital position or are these items totally unrelated? Well, I think you answered it lately. This is totally unrelated. We do our best judgment, the whole time of where we are in the business cycle. We do the provisions that the model tell us and we've done an extra because we are careful and we follow the rules, that's important. Now moving over to the different subject, namely that of U.S. authorities. And you know I've been telling you that when I was a new CEO, I call around and flew around to meet the European colleagues that have been in a similar situation. And they told me that the process like this usually take three to five years. And we have talked to the U.S. authorities now about our historical shortcomings for a little bit more than three years. So that means that, that side of the window is open. Can I then promise that it will be closed within two years? No, of course, not. It's in the hands of the U.S. authorities. We fully cooperate and we answer all incoming questions, and the investigations are in different phases. And as we always communicate, we cannot estimate whether we will get any fine. And if we do get the fine, we cannot estimate any size of that potential fine. Thanks. So first, a question on loan growth outlook, please. So loan growth in Sweden is coming down quite sharply in particular in the household segment. So your assumption of 3% to 4% annual growth for households that you communicated in the CMD, is that still about an assumption in your view? And related to that, if loan growth stays low, like it has in recent months, at least, do you target to grow your market share in that type of scenario, so you still kind of achieve some loan growth? Or would you be content with keeping your loan book flat if that's the market development? Thank you, Nicolas. I think that it's very difficult for me to give you a forecast on the development of loans. We - as you correctly said, we had an assumption on the Investor Day. That was built upon the assumption that the economy's - inflation will come down, you will see that the price drops in houses in Sweden will level out, and there will be a more sort of more clarity, and then we will see people coming back. So I still think it is valid, but I don't have a crystal ball on that one. When it comes to fighting for market share, in particular in the Swedish mortgage space, with very low transaction volumes, we are prioritizing price discipline over gaining market share. But having said that, we are also actively working with our prioritized customers to ensure that they stay with the bank. Thanks. That's clear. And then a question, please, on - related to your profitability targets and your - and yeah, I guess, also coming back to the cost income target. I think the performance you have now in Q4, I think, adjusting for the one-offs, your ROE was around 17% and cost income clearly below 40%. So that gives you kind of a luxury [ph] problem, how you can drive improvements from here. So could you say something about how you think that your business plan that you communicated at the Investor Day is going to drive improved financial performance over the next three years to 2025? Or is this basically as good as it gets from a financial performance point of view? How do you think about that? Well, I think the key point is, let's not focus on one quarter. We want to reach a sustainable 15% return on equity. And the way we do that, we were very clear in the Investor Day when we talked about how we will grow our income by working with our customers to increase the share of wallet, use with prioritized customers, to have a full - the best full service offering and then keep control, of course, making sure that we have low credit losses and not keep more capital necessary. And that is something that I said - at the end of the investor call I said that we will get back roughly a year from we had it in December, roughly a year later, and we will report on that. But now we're executing on that strategy. And that is what you saw during the quarter. Thanks for taking my questions. Just one clarification - couple of clarifications. Do I understand correctly that in the Baltics on the transaction account, which I - if I understand you correctly, it's about SEK 330 billion, you paid nothing in the quarter. Just want to be sure I understood it correctly. And if this is the case, do you still pay nothing on transaction accounts in Sweden, if that is the case? That's a clarification. The question I have is, when I look at your fact book in, and you provide the breakdown of NII, I note there is around SEK 600 million contribution from derivatives in the liability side in the quarter. I was wondering whether that is somehow a one-off sustainable or what's driving that? And the other clarification I wanted to have, if I may, is the Article 3, the SEK 36 billion. I understand correctly when I say that this should absorb the impact of the IRB model's overall currently under the scrutiny of the Swedish FSA. Do I get it right? Thanks. Thank you, Riccardo. When it comes to your first question, we are paying zero on transaction accounts in the Baltics and in Sweden currently. On your second question, I don't have that on the top of my hand, Riccardo, so I need to get back on that specific one. Maybe Annie has something. Otherwise, I will hand over to Rolf to answer your IRB overhaul question. Operator, could we do one more question because I was - we were a bit lengthy, especially me. So let's do one more and then we'll wrap this thing up. Good morning, everybody. Congratulations on a good set of numbers. I just had a couple of questions also on net interest income trends. I thought it was quite interesting that Swedbank's NII trends are up 31% Q-on-Q, significantly [Technical Difficulty] 9% Q-on-Q. And I wonder whether you can comment and whether you think your particular business and income - customer cohorts mix was benefiting you more than peers in the current environment? And I wonder whether that is the case in terms of households versus corporates, but also specifically how you think your customer cohort exposures and household might allow you to extract more deposit margin than peers? And on a related question, your peer also commented last week that the idea that interest rates won't go up on, transaction accounts can't be taken for granted anymore. Would you agree with that? Or do you think that given your particular business mix, that dynamic could stay favorable for some time? Thank you. Thank you, Omar. You have probably to remind me if I forget some of your questions. But if we start with your first one, if you look at our balance sheet, and then that was the point that I was trying to make during the Investor Day. We have very little relatively - when it comes to deposit SEK 300 billion out of SEK 1,300 billion is market rate connected, which is typically with larger corporations, and the other are transaction deposits or savings deposits. If you look at the Baltic banking balance sheet, it is even more dynamic than the Swedish since you have an automatic re-pricing on the asset side, while we are still setting the price on the liability side. I think that if you look at the balance sheet composition of Swedbank and compare that to the competitor that you are relating to, you will find the answer to your question. On the second one, we have said that we have no plans at this point to pay on transaction accounts. But what I also said is that when we're looking forward, it becomes increasingly difficult for us to keep up the differential between - in pass-through between lending and deposits. So one should never say never, but at this point, we do not have a plan to pay up on that. And did you have a third question? I don't remember that one, so then you need to repeat it. No, those were great answers. Thank you very much. I think the last element was even after accounting for mix differences in terms of the corporate deposit pricing, for example, that you highlighted. I think even if we look at the household saving rates in Sweden, it looks like - on a like-for-like product mix versus SEB. And I was wondering whether that - what were the drivers of that? Do you think your particular customer cohorts within the retail bank either have different behavior, for example, than your peers? That was a difficult one. I wouldn't go that far. There might be differences in our customer base. But I think, again, that when you look at the delta in Q4, half of the delta is related to the Baltic balance sheet where we have the largest balance sheet of all banks in that region. Thank you, Anders, and thank you, everybody, for listening to this call, and thank you all for being shareholders in Swedbank, we are extremely proud of that. And as you can see on the slide, I think we've under - we've really underlined that a sustainable bank is a profitable bank. And in 2023, we will take Swedbank forward in the strategic direction towards Swedbank 15/25. Looking forward to speaking with you in conjunction with the quarterly reports and other times. Thank you all. Bye-bye.
|
EarningCall_1140
|
Ladies and gentlemen, good morning. Thank you for standing by, and welcome to the Teledyne Fourth Quarter Earnings Call. At this time, all lines are in a listen-only mode. Later, there will be an opportunity for your questions and instructions will be given at that time. [Operator Instructions]. And as a reminder, today's conference is being recorded. Thank you, Tom, and good morning, everyone. This is Jason VanWees, Vice Chairman of Teledyne, and I'd like to welcome everyone to Teledyne's Fourth Quarter and Full Year 2022 Earnings Release Conference Call. We released our earnings earlier this morning before the market opened. Joining me today are Teledyne's Chairman, President and CEO, Robert Mehrabian; Senior Vice President and CFO, Sue Main; Senior Vice President, General Counsel, Chief Compliance Officer and Secretary, Melanie Cibik. Also joining today is Edwin Roks, EVP of Teledyne. After remarks by Robert and Sue, we will ask for your questions. Of course though, before we get started, attorneys have reminded me to tell you that all forward-looking statements made this morning are subject to various, risks, assumptions and caveats as noted in the earnings release and our periodic SEC filings and of course, actual results may differ materially. In order to avoid potential selective disclosures, this call is simultaneously being webcast and a replay both via webcast and dial-in will be available for approximately one month. Here is Robert. Thank you, Jason. Good morning, and thank you for joining our earnings call. 2022 ended up being an excellent year. We concluded it with all-time record quarterly and full year sales and earnings per share. During 2022, Teledyne, as with many other companies, found itself faced with external forces beyond our control. These were inflation, strong dollar and part shortages. Nevertheless, with continued â we continued our long history of navigating difficult market environment and will ultimately deliver earnings in excess of our own expectations. Excluding foreign currency headwinds, which negatively impacted fourth quarter sales growth by approximately 2.6%, growth in local currency would have been 5.7%. Excluding ETM acquisition, core growth in local currency would have been approximately 5%. GAAP operating margin of 19.3% was an all-time record and non-GAAP operating margin of 22.4%, increased 95 basis points from last year. GAAP and non-GAAP earnings of $4.74 and $4.94, respectively, were also records for Teledyne. Fourth quarter free cash flow was reasonably healthy, but included interest payments of approximately $30 million, which last year were made in the third quarter of 2021. While we completed the acquisition of ETM, our leverage ratio continued to decline from 3.8 times in May of 2021 when we acquired FLIR to 2.4 times at the end of 2022. Finally, our acquisition pipeline remains healthy as evidenced by the recent addition of ChartWorld, whose maritime navigation software and hardware tools bridge a product and technology gap between our Teledyne Marine and Raymarine businesses. Turning to our 2023 full year outlook. While still very early in 2023 and with many unknowns, including projections of a recession, we're inclined to offer an initial revenue and earnings outlook in line with consensus expectations. On revenue, we see total 2023 sales growth of approximately 5%, including incremental sales from recent bolt-on acquisitions. For our backlog-driven long-cycle businesses, we expect growth to be higher than average. For the majority of our short-cycle commercial businesses, foreign currency headwinds will impact the first quarter of 2023 where comparisons are tough and economic uncertainty and export regulations remain fluid. We continue to see overall growth, not contraction in these businesses, but expect that growth will be less than the total company average. On the other hand, supply chain constraints are improving, albeit modestly. There are a few minors other non puts and takes such as increased scope on our NASA contract at Engineered Systems equally offset by the 2022 completion of our OneWeb contract in the Aerospace and Electronics segments, but no other significant items to highlight this early in the year. Our earnings outlook approximately 50 basis points of margin improvement in 2023 and we currently think instrumentation and digital imaging will be above-average contributors to this, while margins at Aerospace and Defense Electronics may be flat or declined slightly, given especially tough comps as a greater mix in 2023 of Defense Electronics relative to commercial aerospace aftermarket sales. I will now further comment on the performance of our four segments. In our Digital Imaging segment, fourth quarter sales were relatively flat despite currency translation headwind of approximately 3.5%. Sales increased year-over-year for our industrial and scientific vision systems, as well as our low-dose high-resolution digital x-ray detectors. Sales of commercial infrared imaging cameras and components also increased and were at record levels since closing the FLIR acquisition in May of 2021. While total FLIR-related sales increased sequentially from the third quarter, sales of some surveillance and unmanned gun systems declined from last year on especially tough comparison. On the other hand, sales of unmanned air systems increased considerably year-over-year. GAAP segment operating margin was 18.8% and adjusted for intangible asset amortization only, segment margin was 23.8%, approximately 50 basis points greater than the fourth quarter of last year. In our Instrumentation segment, overall fourth quarter sales increased 7.9% versus last year, despite approximately 2.4% of FX translation headwind. Sales of electronic test and measurement systems, which include oscilloscopes, digitizers and protocol analyzers increased 3.8% year-over-year despite a tough comparison with the fourth quarter of last year's. Sales of oscilloscopes and protocol analyzers remained healthy with continued strength in products for industry standards such as peripheral component, Interconnect Express or PCI Express and Universal Serial Bus or USB. Sales of environmental instruments increased 9%, compared with last year with greater sales of both drug discovery and laboratory instruments, as well as air monitoring and process gas analyzers. Sales of marine instrumentation increased 9.8% in the quarter, primarily due to a strong marine defense sales and the ongoing recovery in offshore energy markets. Overall, Instrumentation segment operating profit increased 18.4% in the fourth quarter with GAAP operating margin increasing 215 basis points to 24.2% and 162 basis points on a non-GAAP basis excluding intangible asset amortization, which brought the non-GAAP margins to 25.3%. In Aerospace and Defense Electronics segment, fourth quarter sales increased 8.9%, driven by broad-based growth of both defense and commercial aerospace products. GAAP and non-GAAP segment operating profit increased approximately 30% with margins over 480 basis points greater than last year. In the Engineered Systems segment, Fourth quarter revenue increased 6.7%, but operating profit declined given lower margins for some of our electronic manufacturing service products. Before I turn the call over to Sue, I want to make a couple of concluding remarks. First, I was very pleased that Teledyne was able to overcome issues faced by most companies in 2022. Despite the macroeconomic and supply chain challenges noted earlier, our results exceeded the top end of our earnings outlook issued at any point during the year. While difficult to predict outcomes in 2023, we are reasonably confident that a number of our long-cycle businesses serving defense, medical, energy and aerospace markets will grow. While demand is more difficult to predict in our short-cycle instrumentation and imaging businesses, supply chain constraints and the previous premiums for gray market electronic components have begun to ease modestly. Given the strength of our balanced business portfolio and our management's long history of navigating challenging markets, I am optimistic that Teledyne will continue on its successful path in 2023. Thank you, Robert, and good morning, everyone. I will first discuss some additional financials for the quarter not covered by Robert and then I will discuss our first quarter and full year 2023 outlook. In the fourth quarter, cash flow from operating activities was $237.7 million, compared with cash flow of $295.6 million for the same period of 2021. The fourth quarter of 2022 reflected greater interest payments due to the timing of fixed rate bond interest and increased inventory purchases, compared with the fourth quarter of 2021. Free cash flow, that is cash from operating activities less capital expenditures was $203.6 million in the fourth quarter of 2022, compared with $261.6 million in 2021. Capital expenditures were $34.1 million in the fourth quarter of 2022, compared with $34 million in 2021. Depreciation and amortization expense was $81.8 million for the fourth quarter of 2022, compared with $86.2 million. In addition, non-cash inventory step-up expense for the fourth quarter of 2021 was $47.8 million with no comparable amount recorded in the fourth quarter of 2022. We ended the quarter with approximately $3.28 billion of net debt, that is approximately $3.92 billion of debt less cash of $638.1 million. Our stock option compensation expense was $6.2 million in the fourth quarter of 2022, compared with $6.4 million in 2021. Turning to our outlook. Management currently believes that GAAP earnings per share in the first quarter of 2023 will be in the range of $3.57 to $3.69 per share with non-GAAP earnings in the range of $4.37 to $4.47 and for the full year 2023, our GAAP earnings per share outlook is $15.80 to $16.10 and on a non-GAAP basis, $19 to $19.20. The 2023 full year estimated tax rate, excluding discrete items is expected to be 23%. Thank you, Sue. We would now like to take your questions. Operator, if you are ready to proceed with the questions and answers, please go ahead. . Good quarter. And then, I mean, maybe just to start, given your commentary around supply chain and long cycle outperforming in 2023, can you maybe just update us on your expectations for defense across the businesses? I mean, it seems like peers have called out somewhat underperformance on supply chain this year. What are you seeing just in terms of the supply side and also in terms of demand? Frankly, we think defense, while the growth was relatively modest in 2022 was 2% to 3%, that's our generally our U.S. government businesses. We think in 2023, it'll be about 5% organic growth. So we are relatively optimistic. And then⦠And then I mean, I was pleasantly surprised with just margins in the commentary. I mean, some of them seem very outside across the segment. Just in terms of your margin commentary for this year, what are some of the assumptions around price and inflation, add backs and just looking at that Q4 outperformance, anything unusual in that just let me think about the opportunities for 2023. Well, I think basically in 2022, we hit just about every cylinder at the end of the quarter, especially the last month, month-and-a-half that we stand out very favorably. Of 2023, we think Q1 is going to be softer just like we had in 2022. Mostly, we have some headwinds from FX in the first quarter. We think there will be a decline in our revenue, maybe as much as 10%, but we don't know. It's too early. Maybe 1% of headwind, maybe 1% of revenue decline, I would say that. On the other hand, I think, we will pick up in Q2, Q3, Q4, just like we did this year. Right now, early in the year, the first two weeks, we had some slower orders in some of our short-cycle businesses, but the last two weeks they seem to be picking up. So overall, Greg, I am optimistic about 2023 altogether. And then maybe just sneaking one last one in. I mean, how are you thinking about free cash flow in 2023, just given top line growth, margin expansion and any working capital needs? I mean, in the past, you talked about a target, how are you thinking about 2023 in terms of free cash flow? Yes, I think just pausing for a second because this would be asked. In 2022, we were a little short on cash. Well, a little $200 million, to be exact, and we think that's not going to happen in 2023. We think our cash in 2023 is going to be higher, approximately $900 million in cash, whereas in 2022, we really have to be very careful. We build a little more inventory than we wanted to primarily because of the shortages. We fell about $30 million short on revenue in the fourth quarter because of shortages. Also in 2022, there was that lack of R&D deductibility, which everybody has referred to, that costs us about $40 million. And we had about $60 million of more cash taxes, which brings us to just $400 million [ph]. We don't think that's going to repeat itself in 2023. So, we're optimistic. Just a couple of questions. One, in the 5% revenue growth guidance, could you just break out what is price and what is volume in that? I think itâs a little too early to do both, but Iâll tell you thatâs about 3.5% of organic growth and then 1.5% from our acquisitions that we made including the most recent one that we announced. If you look at projections from GDP and inflation at the current time, I am one of those people that doesnât really believe in these projections at this point. But the projections are that pre-GDP in the U.S. will only grow 1.4% in 2023 and inflation will drop to about 2.7%, overall developed markets probably GDP will grow 1.1%. That's where the projections are maybe a little higher in inflation. But Elizabeth, it's a little too early for me. I don't think the economies know either. So, I'll just say that we expect to have an organic growth of 3.5% at this time. If things move like they did in 2022, hopefully, we'll increase that and of course, we'll make more acquisitions, too. Okay. And then, can you give us a little more detail on your outlook by segment and where you see the most opportunity for upside? Sure. First, I think in the instrumentation, which includes marine, environmental and test and measurement, we expect growth to be about 5% or average of the company. Of course, that doesn't have acquisitions in it. In the Digital Imaging segment as a whole, we again expect a 5% growth, maybe 5.1%; aerospace and defense, maybe 4%; and Engineered Systems, maybe a little over 5%. Part of the reason for aerospace and defense being a little less than the average, last year, we had that OneWeb program that we ended successfully, which contributed about $20 million in revenue. On the other hand, in Engineered Systems, we think we'll be a little above the average, because we won that very successfully won the NASA MOSSI contract, which adds about $20 million. So, that's - at this point, that's all I can say about that. Hi, thank you. So is it the short-cycle commercial business where if you looked at 2023, Robert, where there might be some upside or are there some parts of the long-cycle business that could drive the upside versus the 5% that you are talking about for the company as a whole? I think if I broke it down, the marine businesses have a little longer look at them. We think marine as a whole also because the energy â offshore energy markets are improving and our projections for that are over 7%, maybe as much as 7.5% in marine. And in the short-cycle businesses, which is environmental and test and measurement, we think that will be about 3.5% together. We think that I have already talked about some of the others. In digital imaging, where we did have a really good year and a really good fourth quarter which was in DALSA and e2v. We think we are going to be relatively flat organically, but we made some acquisitions, so that should give us about with the acquisitions maybe 3.8%. We think FLIR would do better last next year, maybe a little over 5%, 6%. So â and the - it's built between defense and aerospace, defense is longer cycle than aerospace. If you discount the $20 million that we don't have in web, we think defense will grow some, Aerospace may be flat, more short cycle and I've already talked about Engineered Systems and the MOSSO, which we won which are longer-cycle businesses. We feel comfortable there. . So Robert, it sounds like you are relatively positive on constructive on what you are seeing out in the market. If I look at your commercial businesses, you alluded to some variability in bookings trends in some parts of the business and maybe you can provide a little bit more color on that. But is there anything that you are seeing in the commercial areas, whether it's test and measurement or machine vision that might be consistent with a slowing economy? Yes, a little bit. I think you hit it on the head. Just a sliver, I'd say in â if you look at Marine, our book-to-bill in the fourth quarter was 1.15. That's why I said it's longer cycle, we feel good about it. We're just going to specifically what you said, environmental and test and measurement, while for the whole year, our book-to-bill is about 1 in the fourth quarter, it dropped down to 0.96. To me, that's a sliver lower. So we are a little cautious about that. So DALSA, e2v dropped even further a little bit and I think FLIR would be okay, but some of our vision systems and scientific cameras, we just hit it out of the park in the fourth quarter and we think we're a little cautious about predicting. On the other side, I mean, just to cut to the chase, the other side is that it's very early. Everybody is predicting one thing or another. All we're doing is we are kind of hunker down and we are going to do what we always do. If we have to cut, we have cut and if we have to hire, weâll hire and weâll do what we have to do to make our numbers. Yes, just under 1, about 0.96, 0.97, but that has Engineered Systems in it, which was 0.9%, but that's but it's very lumpy. For the year, Engineered System was 1.12, which is a long-cycle business. For the year, the company was closer to 1. I've been hearing more people talk about risks, what may be in the second half of the year from prices actually going down just given some of the deflationary characteristics you're seeing in prices paid and things like that. Is that something that you're seeing, like how do you think about price and your ability to continue to raise or is it more about supporting where they are now? Well, in 2022, we added, Joe, we added about 4% in pricing. And then, if you hold against that, what we ended up spending, we had wages go up 4.5, overall buying stuff about $2.5 billion of direct and indirect materials, that went up overall, about 6.7%. Of course, that's on the cost of goods sold. I am only saying this because I want to put this in perspective. So we increased prices across the board, 4%. Our materials inflation was 3.7% negative. Our wages were 1% negative to sales. So when you add those two, sales, materials inflation was and wage inflation was 4.7% negative. We increased prices 4%. So net-net, we suffered about 60 basis points of determent between the two. Now, going forward, we expect to increase prices. How much? It's difficult to predict because as you said, some people are talking about decreasing prices in the second half. But we have to increase prices somewhat because we are going to have more inflation that we inherited and we are going to have to â we are giving our employees about 4% raises across the board. So to make up for that we have to increase prices somewhat. It depends on how the market behaves itself. We are right now saying our overall margins are going to improve 50 basis points versus last year and that's pretty good. So, we'll have less broker premiums. Last year, we paid $90 million excess fees to our brokers for parts. We think in 2023, that will maybe be half. So, I mean, it's a long answer to a short question. There is a lot of unknowns, but I feel we'll maintain our crisis and maybe increase on that level. If I think about your â the bottom-end of your guide, I mean it's a pretty narrow guide, but if I think about the bottom-end of that guide, how protected do you think you are if there is like, what kind of recessionary outlook does that have? If we do â some of these macro indicators are pretty bad. If we do go into a recession, do you feel like you have coverage there at the bottom-end of the guide and like which businesses? Like do you â are you anticipating declines at certain businesses at the bottom-end? Well, the longer cycle businesses are less cyclical which would be our government defense about 25%, medical, scientific, energy, aerospace in overall, which constitutes about 40% of our portfolio, I donât think those are going to be affected. On the flip side, the short cycle businesses will constitute 60% of our overall portfolio. If the world macroeconomic really suffers, obviously, we are going to have to take some hits. As you said, we have a very narrow range that we came out with, primarily because we're not sure what's going to happen. We could have probably had a larger range, but coming out of 2020 as strongly as we did, we feel okay about that. Just the last one for me. Have you internally started adding things like, have you started to be a little bit more judicious on expenses and travel and things like that in anticipation of things weakening? Or is that you'll adjust as necessary? Oh no, that's a mode of our operation. It's something we do day in and day out regardless of what the macroeconomics are. We control everything. We controlled expenses in travel, we eliminate square footage of our manufacturing facilities. Everything we do we're vigilant and that's the only way we made it through 2022 as well as we did and we're going to continue that. . Hi, good morning. So it's been about 20 months since Teledyne closed on FLIR. Can you give us a bit of insight as to how to combine the portfolios is progressing, whether there is any â if we've seen some revenue benefits from combining the two technology platforms? I mean in the past, you've done the same with DALSA and e2v. I'm just wondering if there is any comparable success stories or potential success stories to come from that? Thank you, Guy. Good question. The answer is yes. We have some new products. We are â we have some new markets, especially in machine vision and for example, also mapping or FLIR has this Raymarine business and we've had this geospatial business, where we do a lot of hydrographic mapping and the most recent acquisition that we made ChartWorld bridges the gap between those two. I don't know if we would have bought ChartWorld if we didnât have FLIR, we were just hold geospatial. So, those are really good. The other thing is that, FLIR has really exceptional products in the unmanned air vehicle domain. And we have had historically good products at Teledyne legacy in the underwater domain. FLIR also brings now ground-based vehicles. So now, if you look at the combination of the two companies, we have about $450 million or so of revenue in unmanned vehicles, unmanned air vehicles, unmanned ground vehicles, unmanned underwater vehicles. And there is a lot of common technologies between those three in terms of control, because of software in terms of digitization and imaging. So, those are some examples, GUY, after 20 months. But that will, of course, grow as a function of time. Okay. Thank you. And just a quick follow-up. I am just trying to understand the FX guidance implied in your guidance, because it looks like at current rates that FX actually could be a tailwind in the second half? It could be. As we think in the first half, certainly, first quarter, we think it's going to be a 1% headwind versus 2.1% to 2.5% last year. Having said that, I don't think anybody knows. I don't think the economies know, they might say, but they don't know. I don't think anybody knows what's going to happen. I certainly don't ever put it that way. Thanks, Tom, and thanks, everyone, for joining, of course, if you have follow-up questions, certainly feel free to call me or email me. My phone number on the earnings release. And Tom, if you could give the replay information on the call and conclude we'd appreciate it. Thanks you. Absolutely. Thank you. Ladies and gentlemen, this conference will be available for replay starting at 10 AM Pacific and running through February 25 at midnight. You may access the AT&T playback service at any time by dialing 866-207-1041 and entering the access code of 347-2355. International participants, you can dial 402-970-0847. Those numbers again are 866-207-1041. International participants please dial 402-970-0847 and enter the access code of 347-2355. And that does conclude our conference for today. We thank you for your participation and using the AT&T Event Services. You may now disconnect.
|
EarningCall_1141
|
Good day, everyone. Welcome to Western Alliance Bancorporation's Fourth Quarter 2020 Earnings Call. You may also view the presentation today via webcast through the company's website at www.westernalliancebancorporation.com. I would now like to turn the call over to Miles Pondelik, Director of Investor Relations and Corporate Development. Go ahead. Welcome to Western Alliance Bancorporation's Fourth Quarter 2020 Conference Call. Our speakers today are Ken Vecchione, President and Chief Executive Officer; and Dale Gibbons, Chief Financial Officer. Before I hand the call over to Ken, please note that today's presentation contains forward-looking statements, which are subject to risks, uncertainties and assumptions, except as required by law. The company does not undertake any obligation to update any forward-looking statements. For more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements, please refer to the company's SEC filings, including the Form 8-K filed yesterday, which are available on the company's website. Thanks, Miles. Good morning, everyone. I'd like to provide an overview of our 2022 performance and then preface our approach to 2023 before Dale reviews the bank's financial performance. I should also mention that Tim Bruckner, our Chief Credit Officer, is also in the room with us today. Western Alliance had a strong year in 2022. Our diversified national commercial bank grew loans 28%, deposits by nearly 13% and posted record net revenue and net income growth of 30% and 17.6%, respectively. We accomplished all this while maintaining strong and stable asset quality as net charge-offs to average loans were approximately 0% for the year, while non-performing assets to total assets improved to 14 basis points. Balance sheet is well positioned to weather an evolving environment as 27% of the loan portfolio is credit-protected and 53% of the loans can be classified as insured or economically resistant. Our goal is to emerge on this slowing or recessionary environment as the top-performing asset quality bank in our peer group, a position we currently occupy. For 2023, the higher interest rate environment and slowing economy will generate headwinds for the banking industry. As I mentioned on our Q3 earnings call, WAL is focused on bolstering CET1 levels, restraining loan originations with deposit growth, outpacing loan growth while maintaining leading asset quality and growing year-over-year earnings. We are pleased with the substantial progress made towards this goal. Our CET1 ratio ended the year at 9.32%, which was over 60 basis points higher than the previous quarter. The rise in capital was driven by a purposeful facility, reducing approximately $1.8 billion in certain low-margin, low deposit categories such as capital call and subscription lines and corporate finance indications. Without these actions, quarterly held for investment loans would have grown $1.5 billion and generated incremental interest income. Our ongoing investments in diversified deposit businesses should provide liquidity in excess of loan growth. Q4 ending deposits declined $1.9 billion from last quarter, while average deposits declined by only $295 million quarter-over-quarter. This decline was primarily driven by short-term seasonal tax and insurance escrow deposit outflows in the mortgage warehouse group, which has since recovered, with Q1 quarter-to-date average deposit balances up more than $2.4 billion from year-end. Previous investments in our settlement services, business escrow and HOA deposit businesses as well as the soon-to-be launched corporate trust platform, combined with several other initiatives we look to roll out, provide meaningful opportunities to gather incremental deposits this year. We look for predictable balance sheet growth to improve NIM and grow net interest income in 2023. Thanks, Ken. For the year, Western Alliance produced record net revenues of $2.5 billion, net income over $1 billion and EPS of $9.70, the 14th consecutive year of rising earnings. We maintained interest leading performance with return on average assets and return on average tangible common equity of 162% and 25%, respectively. Grew tangible book value per share to $40.25, 6.4% higher year-over-year. As Ken mentioned, we previously identified a near-term priority of bolstering our key capital ratios. We're pleased with the substantial progress made towards this call with our CET1 ratio increasing over 60 basis points to 9.3% in Q4. This strategy led us to proactively restrain balance sheet growth without inhibiting record net interest income and earnings. The year, net interest income increased 43% to $2.2 billion. Our diversified deposit franchises are focused on generating attractive core funding that drives net interest income and EPS higher rather than purely minimizing deposit betas to maximize the interest margin. Non-interest income declined $80 million to $325 million as a result of ongoing softness in the mortgage industry. However, improved mortgage-related revenue in Q4 and the pending withdrawal of a large money center bank from the correspondent mortgage business as gain on sale margins and core servicing income could be in the very early stages of stabilizing. Finally, asset quality remains stable and strong as classified and non-performing assets as a percentage of total assets are still lower than pre-pandemic levels. WAL has dramatically transformed its business over the last decade to become a national commercial bank focused on deep segment expertise, underwriting specialization and greater business diversification. For the year, Western Alliance reported net charge-offs of just $1.5 million or less than 1 basis point of average loans. During the fourth quarter trends and business drivers, Western Alliance generated net income of $293 million, EPS of $2.67 and pre-provision net revenue of $368 million. Operating EPS was $2.74 or $9.95 for all of 2022. Total net revenue was $701 million, an increase of $37 million during the quarter or 25% year-over-year. Net interest income increased 6% from Q3 to $640 million was primarily driven by NIM expansion, but also benefited from higher average earning asset balances. During the quarter, the company completed a credit-linked note transaction, bringing 2022 issuances to total $579 million. As of year-end, the company is protected from adverse credit losses on reference pools of loans totaling $12 billion. Overall, non-interest income remained essentially flat from the prior quarter at $61.5 million as mortgage banking-related revenue increased $9 million to approximately $47 million. This increase was partially offset by a $9.2 million mark-to-market charge included in other income. Non-interest expense included -- increased 9% or $27 million, resulting in an efficiency ratio of approximately 47%, primarily due to higher deposit costs related to earnings credits. The efficiency ratio was adjusted to classify deposit cost as interest expense and 40% as remaining operating expenses were essentially flat. Turning now to net interest drivers. Our asset-sensitive balance sheet benefited from the rising rate environment. Risk investment yields increased 79 basis points from the prior quarter to 4.45% as variable rate securities reprice higher. On a linked-quarter basis, loan yields increased 86 basis points to 570 with an end-of-quarter spot rate of 6.26. Loans held for sale benefited from rising mortgage rates had increased 76 basis points to 5.63%. Irrespective of the Federal Reserve's rate trajectory, our net interest income will continue to benefit from an average of $2.5 billion of loans maturing or repricing higher each quarter in 2023. During fixed rate loans are being replaced by these loans to yield over 2% higher while variable rate loans are repricing on the spreads 50 basis points wider on average. Total funding costs, including borrowings and deposits increased 69 basis points to 1.57% as the use of CDs and short-term borrowings increased since the proportion of average interest-bearing liabilities. Net interest income growth of $38 million or 6% on a linked-quarter basis was powered by a 20 basis point NIM expansion and a modest increase in average interest-earning assets. Increase in total interest income continues to be greater than the change in total funding costs, including ECR expenses, demonstrating our continued asset sensitivity. The rate shock analysis shows that with the plus 100 basis point shock on a static balance sheet, net interest income is expected to lift over 3%. Using the same scenario on a growth balance sheet, we would expect net interest income to grow over 20%. Fed rates declined, as some are projecting that might happen later this year. Growth balance sheet, net interest income still rises to incident with our decreasing asset sensitivity profile. Our efficiency ratio increased 140 basis points to approximately 47% after reclassifying deposit costs interest expense. Adjusted efficiency was essentially flat at 40%, again demonstrating the high operating leverage of the company. Deposit costs increased $26 million from the prior quarter due to higher earnings credit rates on deposits, but at a slower rate than Q3 as earnings credit rate paying demand deposits declined. Pre-provision net revenue climbed 3% to a record $368 million or 14% increase year-over-year, resulted in return on average tangible common equity, excluding all other comprehensive income, 23% for the quarter or 80 basis points higher than last quarter. Western Alliance's leading organic capital generation and continued strong performance provides significant flexibility to fund balance sheet growth, bill capital ratios and meet credit demands. Loans held for investment decreased $339 million to $51.2 billion, and deposits declined $1.9 million to $53.6 million at year-end, primarily driven by short-term seasonal mortgage warehouse factors. Total borrowings fell $16 million over the prior quarter, primarily from a decline in short-term borrowings, offset by issuance of $95 million in credit linked notes on a reference pool of residential loans. Finally, tangible book value per share increased $3.09 or 8% over the prior quarter and 6% year-over-year to $40.25 due to strong organic earnings, along with reduced drag from available-for-sale securities marks recorded in AOCI. This quarter, net loan growth was impacted by our purposeful decision to temper certain C&I loan categories, such as equity fund resources and, to a lesser extent, corporate finance by approximately $1.8 billion in total. These reductions, C&I loans would have grown $220 million with total loans held for investment growth of $1.5 billion on a linked quarter basis. On C&I growth was driven by $651 million from sponsor-backed commercial real estate, $390 million from construction and $250 million from residential. Additionally, the breadth of our business lines generated healthy loan demand in regional banking, which was $696 million higher than Q3. Hotel Franchise Finance rose $315 million, and tech and innovation was up $140 million. We are well positioned to maintain prudent growth through a more uncertain economic environment given our diversified loan mix between national business lines, residential real estate and regional banking. Over the last three years, 68% of our robust loan growth has come from low to no loss categories, which now account for 53% of our entire portfolio. Furthermore, we have structured additional loss prevention as 27% of loans are credit protected, which should fortify our industry-leading asset quality. The range in deposits, competition for funding picked up during the quarter and larger-than-expected seasonal factors combined to temporarily reduced deposit balances. Early deposits declined $1.9 billion, primarily driven by short-term seasonal escrow deposit outflows in our mortgage warehouse group, which are included in non-interest-bearing deposits, but subject to earnings credit rates. As Ken mentioned, these seasonal factors have reversed since year-end, with mortgage warehouse Q1 quarter-to-date average balances already up more than $2 billion from year-end or 15% higher from the same period year-over-year. Additionally, quarter-to-date average balances for total deposits are up more than $2.4 billion from 12/31 and approximately $660 million greater than 4Q's average balance. Western Alliance's warehouse comprised 65% of the reduction in noninterest-bearing DDA. End of year seasonality is evident in the linked quarter decline in average deposits of only $295 million versus the more pronounced decline on a period-end basis. Increased competition for liquidity in a higher rate environment drove an 11% increase in total interest-bearing deposits, including a $1.9 billion growth in CDs Interest-bearing demand deposits grew $1.2 billion from last quarter, in part from migration from noninterest-bearing DDA. Diversified deposit franchise continues to provide meaningful opportunities to attract -- to generate attractive funding to support loan growth. Among our scalable national business lines, we are pleased with the continuing momentum in settlement services and homeownersâ associations. We produced linked quarter growth of $680 million and nearly $300 million, respectively. Going forward, we expect continued growth from our deposit business lines, including business escrow services to continue to generate attractive deposits, fund ongoing balance sheet growth and soften the impact of elevated rates on overall funding costs. Our asset quality remains strong and stable. Classified assets and non-performing assets as a percentage of the total are still lower than pre-pandemic levels. Total assets increased -- total classified assets increased $8 million in Q4 to 58 basis points of total assets, only 2 basis points higher than Q3. Total non-performing assets to total assets were down 1 basis point from last quarter to 14. The prospects for greater economic volatility continues to evolve. We believe our underwriting discipline borne out through our national business line strategies has prepared us well for additional credit stress that may accompany greater macro headwinds. However, we have not observed any preliminary signs of material uptick and credit migration trends, and we also expect to instead of to reduce our exposure to the more sensitive loan categories this year. Sound asset quality decisions will dictate our thoughtful loan growth trajectory and enable us to maintain profitability despite heightened economic uncertainty. Quarterly net charge-offs of $1.8 million in the quarter or 1 basis point of average loans of the full year 2022 net charge-offs to $1.5 million. Those quarterly charge-offs have been stable at approximately $2 million per quarter for the past year, while net charge-off variances result from volatility and recoveries. Provision expense for credit losses was $3.1 million, primarily due to uncertainty surrounding a percentage recession, offset by risk-weighted asset optimization efforts, sale of corporate finance indications and reducing capital call and subscription line exposure. Base cases for a mild recession listed allowance for credit loss assumptions weighted towards Neo's consensus forecast, which has shifted toward increasing the recessionary and more conservative scenario. Total loan ACL to funded loans was 69 basis points, while our ACL to non-accrual loans was 420% at year-end. Testing for the $12 million of loans covered by credit linked notes, where ample first loss coverage is assumed by a third party, the ACL coverage rises to 89 basis points. We believe these superior asset quality trends are sustainable throughout economic cycles due to Western Alliance's deliberate post-GFC business transformation strategy. Coming back to that time period, nearly 70% of losses Western Alliance incurred during rate financial prices came from loan categories comprising 44% of the loan portfolio. Those categories make up less than 6% of total loans. Contrast, 87% of the current portfolio is insured and resilient categories. The insured category consists of credit protected, government guarantees and cash secured loans. Resistant loans are categories which have historically no or low losses. The Categories have experienced de minimis losses since 2014. [Indiscernible] loans are supported by strong collateral and counterparties as well as our underwriting expertise. This category might experience some grade migration, realized losses are minimal due to limited recovery -- uncovered collateral risk with average loss of only 2 basis points and a maximum quarterly annualized loss of just 16 basis points. 13% of the portfolio we blew is more sensitive to economic growth. Lending in this category has been focused on unique sub-segments that offer the highest risk-adjusted returns and where we leverage our sector knowledge and underwriting capabilities to maintain superior relative asset quality. In 2014, these loans have experienced a maximum quarterly annualized loss rate of only 71 basis points with average losses of five. Exceptional post GFC asset quality has been highlighted by minimal net charge-offs of only $29 million since the beginning of 2014. Comparing the ARP performance to the 32 publicly held banks with assets between $25 billion and $150 billion based in the United States, we realized the lowest average net charge-offs and the lowest quarterly annualized maximum charge-offs as a percentage of total loans over the same time period. While the past decade has been a period of relatively low credit stress, our leading performance in low average losses and, more importantly, the lowest loss volatility among peers bodes well as to how Western Alliance will outperform peers if and when credit stress becomes more acute. On our last earnings call, we discussed our renewed focus to rebuild capital and have made strong progress so far. Our tangible common equity to total assets ratio of 6.5% and common equity Tier 1 of 9.3% were both materially higher quarter-over-quarter. In our industry-leading return on equity and assets, we continue to generate significant capital to fund organic growth and to lift well-capitalized regulatory ratios. This strong capital generation during this quarter is the equivalent of issuing approximately 5.5 million shares. As previously mentioned, TBV per share increased $3 to $40.25 and since 2013 has grown 4.3 times faster than the peer group. We believe our business diversification, excellent asset quality and ability to generate solid operating leverage will continue in a softer economy and validate our franchise as a high-performing all-weather growth bank. Thanks, Dale. I was pleased with the management team's ability to adapt to the changing interest rate economic environment to produce record operating results in 2022, a thoughtful balance sheet growth in conjunction with executional focus, position the bank to capitalize on matters income sensitivity while simultaneously growing both sides of the balance sheet with industry-leading performance as the quality remains solid and stable with those signs of elevated stress. Looking forward for the full year 2023, we expect continued careful balance sheet growth driven by our diversified business model with a flexible origination mix designed to maximize net interest income. We expect loans held for investment to grow between 10% and 15% and deposits to grow between 13% and 17%. Our specialized deposit franchises generate funds for more economically agnostic and secularly strong sectors, which offer significant deposit growth opportunities in excess of loan growth. We also expect improved interest expense on the marginal deposits raised as we had fewer term deposits and favorable interest-bearing deposits. Net interest margin is expected to expand between 4% and 4.10% as it moves in concert with Fed fund actions. Favorable earning asset repricing dynamics per quarter will support NIM even if the Fed pauses hikes this year. Net interest income is expected to grow between 20% and 25% for the year in a rising rate environment and to exceed growth in ECR-related deposit costs. Growth and efficiency ratio for the year should remain in the low 40s as we will continue to invest in risk management, technology and new business lines to take advantage of the attractive growth opportunities we see in front of us. In aggregate, we expect pre-provision net revenue growth of 11% to 15%. Excellent asset quality should remain intact, but we could return to more normalized losses if the economy enters into a recession. Our goal remains to prudently bolster key capital ratios in line with macro environment with a CET1 ratio of between 9.75% and 10%. Our bank's industry-leading return on average tangible common equity produces significant organic capital of approximately 45 basis points of CET1 net of dividends per quarter, which provides us with significant flexibility to achieve our strategic objectives, grow capital ratios, on balance sheet growth or to take other capital actions. Thanks. Good morning, guys. No way I cut all that guide, Ken. But I just -- I did hear the NIM guide. I think you said 4% to 4.1%. I'm assuming that's for the year. Can you just give us sort of the progression, how you see it trending throughout the year and exiting the year? And what Fed forecast are you guys assuming? Thank you. So, on the Fed forecast, we actually have only one rate increase at the beginning of the year. That's about a week from now for 25 basis points on the upside. We also have 2 rate decreases, both 25 basis points placed into our Q4 forecast. We're probably less confident about those rate declines, but we think it's a good, prudent thing to do in order to manage our efficiency ratio and not have expenses run ahead of potential revenue increases. So that's the rate forecast. On NIM, we expect it to grow slowly through the year between 4% and 4.10% is pretty tight for us. So probably crosses over 4%, a little more towards the end of Q1 into Q2 and then just grows generally from there. Okay. And within that deposit growth guide, which I think you said 13% to 17%, any sense -- I'm assuming there's a lot of negative mix shift baked into that. But any sense of where DDA as a percentage of total deposits can settle versus that, I think, we're low 40s today? I'll start, and I'll let Dale answer that second half of the question, but deposit is between 13% and 17%. That's $7 billion to $9 billion, right? And just to be clear, what we're trying to do is grow deposits at a rate faster than loan growth, and that's what we mentioned on Q3. In terms of growth areas for us, in terms of businesses, that may give you some confidence around the deposits, our HOA business in 2022 grew $1.3 billion, and we kind of see that still being the same. We also see growth coming from our settlement services and our business escrow services lines of business. And those, we invested in, in 2018 and '19 with a stronger rollout as we got into 2020. And those businesses did rather well. Certainly, settlement services did rather well in 2022, and then the rest is -- in terms of deposit growth will come from the regions. Okay. It's pretty difficult in today's environment to garner new non-interest bearing deposit relationships. But as we indicated, we have seen a recovery of approximately half of the DDA that declined in the fourth quarter, were primarily related to mortgage banking operations and the seasonal trough is 4Q. So I'm going to stick with that, that we think we can hold about half of what came down in the fourth quarter. But again, what we're focused on from here is how do we sustaining our deposit growth trajectory and then putting on loans that have plus 300 more -- or more spread between them, and that can drive net interest income kind of regardless of what the Fed does. Okay. Great. And just kind of tying this all together. You guys talked about the 9.80% number this year, you got there. The Street had you at 10.75% for '23. Do you feel like -- I can input all the components and work it through? But I'm just wondering, do you feel like that 10.75% is doable with this guide? So Casey, what I'd say is our PPNR guide is between 11% and 15%. And from there, you have to take a viewpoint on what you think is going to happen in the economy in terms of determining the provision. So the provision will naturally grow because of balance sheet growth. We're not seeing any cracks in asset quality. We -- it looks pretty good. But listening to a number of the talking heads, many people think towards the back half of 2023, we'll see some weakening in asset quality. Again, we haven't seen any of that, so you're going to need to make your own assumptions regarding charge-offs on top of provisioning. But the PPNR guide is between 11% and 15% for next year. So we talked about kind of both of those numbers. But from here, I expect this to recover about half of the DDA decline in the fourth quarter by period end. Good afternoon. Thanks for taking my questions. I appreciate all the color around guidance. Maybe -- I wanted to maybe delve into credit a little bit more. Dale, you gave a lot of color, but just kind of curious with everything that's going on, all the uncertainty. Just can you talk a little bit more about what were the drivers of the $3 million provision this quarter? I understand that a lot of movement within the risk-weighted assets, you didn't have a lot of loan growth, but it would just seem that most outlooks have worsened in the $3 million provision. Might seem a little light, maybe relative to the environment. But just wanted to get some more color there, particularly maybe as it relates to 2023? Well, let's start with -- if you work backwards from the $3 million and add on to that the sale of the corporate finance applications, which we sold, plus the fact that this is a quarter where we didn't grow and we took down our EFR balances, when you kind of reverse engineer it, we would have been closer to what we've posted in previous quarters. So the $3 million really represents net of those actions. Yes. So we have -- we subscribe to kind of the Moody's kind of performance. And that has, as we indicated, kind of gradually deteriorated. Like I said, we're not seeing that. For us, the most significant variable is really what happens on the commercial real estate metric. I think for most banks it probably has to do with unemployment. And when you look at where they are on a decline on the consensus and then we also consider S-4, those levels are still kind of well above what our advance rates are on -- towards the real estate transactions. And so while they pick up a little bit in terms of loss, it's not as dramatic as maybe some other institutions might realize. Great. And as you think about areas that you want to grow in, in 2023 in terms of the loan portfolio, would those be areas in your mind? I mean you mentioned wanting to grow in less risky areas, maybe areas that more risk would have, maybe more variable rate loans. Just kind of curious how to think about the areas that you want to grow in vis-a-vis kind of how that might impact provisioning. So I'll say our loan pipeline still remains active. I would see us growing a little more in note financing, build-to-rent. Multifamily looks strong as long -- as well as industrial. You'll see some pickup from construction loans that we did in previous quarters that are beginning to fund up, and hotel financing will be active as we look going forward. Specific residential could be interesting. What we don't want to do is get in front of Fed action and kind of decrease asset sensitivity until there's more clarity in terms of where rates are headed, but I do believe that mortgage rates that begin with the 7 is probably going to be something that's going to work out over time. Hi, everybody. I wanted to start on the deposit side. In terms of the deposit growth, the 13% to 17%, could you talk more about how you see the mix evolving through the year? And particularly, I'm curious how much of the growth do you plan on getting from ECR deposits, time deposits. It's obviously a fairly aggressive deposit growth guide? Yes. So like we said, I mean in terms of actual kind of core non-interest-bearing DDA, if we could hold that flat, I think that would be a win. So -- and I think the larger ponderance is going to be in interest-bearing money market accounts, and those come in different varieties in terms of spreads that we offer depending on the relationship and whether there's a credit tied to it as well. I do think that the CV side is probably going to increase a bit more than it has, but probably to a lesser -- at a lower rate than what we've grown recently, and then interest-bearing checking is where I think it's also going to be kind of a strong growth area. Much of our HOA deposits kind of flows into that category at this point in time. So at the end, the DDA, I think you're going to see it's still going to probably diminish as a proportion of total. The growth there is going to be in ECR related, big chunk in money market accounts and a little bit more in CDs. Got it. So Dale, if we follow that through of interest-bearing deposit costs were $197 this quarter, where do you see that moving to by 4Q '23 in terms of what you need to get in terms of this NIM being stable to up a bit? What are you assuming deposit costs rise to interest-bearing? No. I mean it really depends a bit on your rate forecast. But what we see is that interest-bearing deposit costs right now and I throw -- if I throw deposit costs in there from ECR, we grew during the fourth quarter, our net interest income was up about $39 million. If I add the interest expense, plus the ECR charges, gave up about 3.25 of that, I think that, that range is probably going to more or less be intact. So I think we're going to incrementally improve net interest income, including ECR debits against it, but at a diminished rate than what we saw the past couple of quarters. Okay. When I look at where some of your peer regional banks have come out this quarter in terms of what they're paying on deposits, they -- many of them have barely budged on some of these categories. Curious what's the conversation you have with prospects? And is this just a massive opportunity for you to bring over new householdâs businesses? And do you see as more of a consumer or a business opportunity? Thanks. Well, we're a commercial bank, so we don't have much in the way of consumer deposits, and so our deposits are going to be floating at the marginal higher end of interest expense. But we focus on net interest income, and we have the ability take those deposits and put them in 100% beta loans, and hence, make the spread on it. And so that's been the conversation. We're seeing larger clients move some of their money to us and having conversations about moving money to us. We like that. And what's really a little bit different for us in terms of how we approach business, thought it to change somewhere in the middle of Q3 of last year is we used to lead with loans, and now we leave with the deposit conversation. And we're very clear that there will be no credit extended unless there's a very strong deposit relationship, and that conversation has been well received by our client base. Good morning. Yes, a few follow-up questions. Maybe one, I'm not sure if you already mentioned this, apologies. Just around the expense outlook as we think about core expenses. Just remind us in terms of the growth rate you are thinking about as part of your PPNR guidance. And also the one key seasonality that we should be thinking about. So I think about last point. What is the one thing we should be thinking about? Do you hear that point? The first quarter seasonality, like I'm assuming like first quarter historically is marked the high watermark for the efficiency. I'm just wondering if there should be a seasonal lift in expenses that we should be baking in. Yes, I'll take the second part of that first. The answer is yes. Our expenses tend to pop up a little bit more in Q1. But overall, our efficiency ratio we're targeting is in the low 40s, which we've always targeted, and we have one of the leading efficiency ratios in the industry. We kind of feel that that's the right place to be. It allows us to continue to make the appropriate investments in the bank on both risk management and technology as we continue to get bigger and bigger, but it also allows us to invest in new products and new businesses. And many -- for the last several years, we've been investing, as I said, in settlement services, in business escrow services. We've got a new initiative. We just recently launched in deposits that we're not ready yet to talk about, but we built last year that's off to a good strong start. So keeping the efficiency ratio in the low 40s allows us to generate the operating leverage we want, also invest money today for future performance. Got it. And what does that imply just in terms of how you're thinking about just the expense growth for the year? Is it high single digits? So it's going to be high single digits, might be low double. If you look at the kind of the PPNR element, of 11% to 15%, holding the efficiency ratio, basically flat at as to where we are. Could provide for a little more room. But what we're going to do is we're watching this closely. I mean -- and so as things -- we authorize FTE, as we continue to demonstrate performance on growth of the balance sheet, we're going to have revenue feed our expense expansion. I want to make sure we're not talking across each other. So my commentary was on the adjusted efficiency ratio without deposit costs because Dale just talked about that, putting it towards net interest income. So on the adjusted efficiency ratio without the rise in deposit costs, that's what we think we'll be in the low 40s. Okay? Noted. And -- go ahead. Yes. And I guess maybe a separate question. Going back to credit, and I understand the macro uncertainty. But when you look at your PPNR guidance that you've given, even assuming provisions mid-year 2020, would imply earnings at about $10.50. I'm just wondering, is there anything around the loan book that causes that hesitation when you think about EPS outlook for this year relative to your guidance? And obviously, you expressed comfort with the asset quality of the book. I'm just wondering why you -- what would be the scenario in which that $10.50 EPS plus or minus would not be achievable? So as you know, CECL works, it really comes down to the end of the year and then the outlook into 2024. So if Moody should turn more bearish as we put on loans, you're increasing your provision for the life of that loan, not for the risk that's in the book. And so that's why we've been a little bit more reticent on quoting where we think EPS numbers are and then stay more on the PPNR side. Those are the things that we can control. On asset quality, again, we're not seeing any issues at this moment. I would point you to a little bit the last two slides in the presentation, where we think we've been able to grow in loan growth in a very prudent way and keep our charge-offs down. And I would remind you that 54% of the book is either in short or resilient or resistant categories. Got it. And if I may, one just follow-up. When we think about the loan growth, 10% to 15% for this year, a lot of macro uncertainty. Like should we be worried in terms of the quality of loans that you're putting on the balance sheet right now at this point in the cycle? Like what -- how -- just from a client selection standpoint, is there a risk of adverse selection? No. So we're not going to grow for growth's sake. So the asset quality is incredibly important. In my opening comments, one of the things I want to get rid of is any connection to the GFC 2007 and '08, '09. I want no connection to that, and we are a completely different company. So we want to grow above trend. Yet at the same time, we want to have above-trend asset quality or best-in-class asset quality. We're working on doing both. So we're not going to sacrifice the asset quality for higher loan growth. Having said that, after going through our reviews, we think the range that we gave of 10% to 15% allows us to grow the loan book without growing into a recession and also protect or remain with stable and strong asset quality. We will pivot as necessary as new facts and situations emerge. I mean we did this during the pandemic, one of the few banks that sustain a growth trajectory during that point in time and where we go. We weren't sure, how is it two years or four years to a vaccine. So it went into a capital call and a low LTV residential, and never lost a dime on either of those. And so we're going to be nimble about what about our -- using the flexibility of our business model to sustain -- hearing to sustained earnings performance improvement over time. I wanted to touch on loan yields. I know, Ken, you mentioned last quarter, seen a loan committee turn down 31 loans initially getting better pricing. So I wanted to get a sense of what the outlook was for loan spreads going into this year and if you're still getting the same reception from clients? I'll give you another story to that, too. So our loan yields are holding in from that last conversation we had when we did our Q3 earnings. Dale mentioned, spreads are up about, on average, 50 basis points. And we're not getting a lot of pushback on pricing. I don't have any numbers for you, but I can tell you when we say no to a loan that has good asset quality and good pricing, we usually are saying no because it's not generating the deposits that we want to accompany that loan. And what we're seeing is that when we turn down those loans, those loans have been returning to the senior loan committee now with greater deposits. So what we're encouraged about is that the pricing is holding and our determination to see more deposits to accompany the loans has been following through from our credit committee. Okay. That's helpful. And then as far as the risk-weighted asset optimization, is that process complete? Or is there still some work to do going into this year? Yes. Thanks, Ken. That is ongoing, and it's definitely a part of our culture. So something that we'll continue to do. There's definitely remaining benefit to be achieved through optimization. Some of that's in, in the targeted growth portfolio mix, and some of it is just structural with our clients. But ongoing improvements are still expected. Thanks. Got it. Got it. And then just lastly, on the mortgage warehouse deposits, I understand the seasonality in the fourth quarter came back in this quarter to date. But should we expect a similar kind of magnitude as far as seasonality in the fourth quarter of this year and going forward? It was more pronounced in the fourth quarter of '22 than we've ever seen before, and I think some of the reasons for that are -- so we have some of our accounts related to taxes and insurance and others are principal related. So the access in insurance, we expected a decline largely because of California property taxes are due in 4Q. The P&I payments tend to have much more intra-month ebb and flow, but not so much kind of seasonal elements, and that changed a bit this time. So from our view, I think there were very few refinancing and almost very few sales of residential real estate that took place in December. And so as a result of that, when somebody pays off and say somebody pays off the loan or REIT has refinanced, I'll say, the 5th of December, what will show up for us is we'll get a deposit, including that principle of that of that loan. And that is remitted to one of the GSEs two weeks later. Well, that didn't happen, and so I do think that you can make your own projection about what December of '23 is going to look like. But the dearth of activity in the month of December, which I don't see a seasonal trough anyway, but it was more -- it was certainly more significant than usual, and that contributed to this. And that seems to be turning even now, maybe an early turn in terms of kind of the spring buying and selling season, I'm not sure. Good morning. Looking at the capital call loans down around $1.2 billion this quarter. Is that the pace of runoff we should expect out of the book over the next couple of quarters? And I know there are some associated CLNs against the portfolio. I guess, do those securities remain in place as the capital call portfolio comes down? Or would the CLNs fall commensurate with the reference pool? Tim Bruckner again. I'll take the first part of your question on the portfolio runoff. Answer is no. It's not to be expected. That was driven by a handful of large transactions. We elected to exit for return reasons. As we move into the coming quarters, we won't see similar dollar amounts of runoff at all. So we do have a CLN on the -- I appreciate you remembering that, on the capital call and subscription lines. That CLN as opposed to the residential ones, which are closed. So it's a specific pool of loans. And as those loans pay off or whatever, that's done and the CLN runs down. This one is a -- has substitution ability, so it lasts for three years. So we have the ability to -- if something comes out of that, we could put something else in it. That CLN is a fraction of our total capital call and subscription lines, so it doesn't really have much of an effect there. It was really done for, as Tim indicated, for return purposes, not so much for capital management because we've already taken a portion of those down to 20% through that process. Okay. Got it. And then, Dale, do you have what the MSR valuation change was this quarter? And then any thoughts on just run rate for mortgage servicing and then gain on sale income? Yes. We had no change in the valuation of the MSR in Q4, and so what that means is that the hedging basically very materially complete asset what was taking place in terms of market rates. So there wasn't any valuation adjustment that was -- that had happened. Kind of going forward, I think there maybe is going to be some MSR dispositions that take place, and so it's not going to have an effect on the market. But at the same time, I think there's a little more stability in terms of what people expect around refinance behavior, and so that could kind of extend the lives and the confidence in terms of what those servicing rights are worth. I would add that, as you look quarter-to-quarter, I would think about the total mortgage income being relatively flat to Q4. I think that was your specific question. And while too early to call a trend, I would say that the first 20 or so days into January, we are encouraged by margins rising in the business as that large money center bank as the correspondent lending market. And so we've got our fingers crossed that, that continues to move forward. But at this point, that's a positive. That's an emerging opportunity, we think. But right now, I would keep Q1's mortgage income relatively flat to Q4. Okay. Got it. And then if I could just sneak one in on the last point, just the competitive dynamics in the correspondent business, perhaps that does create some tailwind to the gallon sale margin. But does the exit of a large competitor give you kind of greater opportunities to grow the balance sheet at all? We're going to still have the balance sheet relative to our capital CET1 goals of getting towards 9.75% to 10%. As you know, MSRs, if they grow in an outsized way versus our internal capital generation, become punitive. So we will be sellers of MSRs throughout the year. And with that, we also hope if we sell to non-banks that we keep deposits that are accompanied with these MSRs as well as possibly even providing MSR financing to the buyers, and that was always our premise as -- when we bought AmeriHome. Great. Thanks. Dale, the capital build in the quarter, I think the way I'm thinking about it, many thought you would build capital, some thought you build reserves. I'm interested kind of in your dynamic on how you're thinking about building one versus the other. And could you just remind us 10% of the target, I think prior commentary is to get there by midyear. But with recent efforts and maybe some more, like any change in time line there? Yes. So I mean it really starts with the reserves. So we look at our loans, our exposures and overlay that with what Moody says and our own interpretation of kind of market and economic market sentiment outlook. And we drive GAAP compliance kind of seasonal number, and I realize that ratio is lower than other -- some others in the space. And I think you don't look any further than our asset quality in terms of charge-off behavior and changes in terms of kind of what's transpired there. I mean we have -- in the slide deck, we have kind of our segmentation in terms of credit protected, resistant, resilient and then the more sensitive piece. And that is just a small fraction. 1/8 of our loan book is something that we think is going to have some, perhaps, volatility. Another measure that we look at is, I think, your ACL and divide that by annual charge-offs. And if -- I mean are we -- we had zero this year, but even if you took a couple of basis points on it and divide that into 60 basis points, you're going to get 30 years charge-offs. I know this is not -- this is a better than most years, but the average duration of our loan book is only is under 4%. So all sorts of ways we look at it, and we think our reserve works as is. So now it's about what we talk about in terms of what falls down to the bottom line in terms of tangible common equity. I wouldn't move up our time line at all. I know, I think 60 basis points is a fairly significant move for one quarter. But we're going to do both. We're going to grow capital, and we're going to grow our balance sheet at the same time, sustain an improving trajectory in terms of net interest income and sustain our returns while our capital continues to climb toward the high 9s later this year. Chris, to be very specific, I think you can look for us to be in that capital range of 9.75% to 10%, towards the back end of the year. We got a real jump on Q4 by opportunistically selling some loans and then being able to move quickly in the EFR space. That's our capital call and subscription line. So quite frankly, we're pretty proud that we were able to move the capital 60 bps in one quarter, but I think you can look towards the back end of the year for those numbers. You share the run rate for the ECR and the deposit costs as of 12/31, what that would be on kind of a full quarter basis? Yes, I wouldn't say that materially changed from where we were from for the quarterly number. It didn't grow quite as much as maybe something anticipated because the dollars came down in terms of ECR deposits. But I think that we can track from the fourth quarter number, overlay what you think is going to happen in terms of equals actions and what you think is going to happen on the balance sheet in those particular categories. That should work. We have dollars we have in there with consequent those big. Okay. And in terms of the mortgage warehouse deposit book, can you share the breakdown between non-interest bearing and interest-bearing there? Is it notably different from what the mix was for the bank as a whole as of the fourth quarter? So most of the mortgage warehouse deposits are in DDA with an ECR, and that is the preponderance of all the ECR dollars that we have. Got it. Okay. And lastly, in terms of the RWA benefit that you got from the reduction in equity fund resources. Could you expand on that a little bit? I imagine that it must not be zero risk weighting. But given the kind of the risk that those loans tend to have, it must be a pretty low risk weighting, I would have thought. The general construct of providing a credit linked note is to provide protection, i.e., first loss taken by a third party. So we get funds in. We sell the bond to a third party, and they get that interest on that bond less any losses that are -- that arise from this reference school. So on the EFR loans, these subscription lines, they're normally 100% risk-weighted. But because we've done -- we've sold a note to a third party, and they assume first loss, the first 12.5% of losses in that portfolio, they pay. And actually, we already have their money, so we control how much they get back as we only pay them back, less any losses incurred. And because of that architecture, whereby you have moved the now kind of the structured product to a AA or better category, it's basically treated as a 20% risk-weighted asset. So no matter what type of asset you come from, you end up at 20. So residential, you started at 50, end to 20. Capital call and warehouse, you started 100 and you still 20. Okay. Got it. So without the CLN though, the risk weighting is 100. Got it. It's good to know. Thank you. Hi, good afternoon. Just a couple of follow-ups. With deposit growth expecting to exceed loan growth in '23, what's the excess funding going to be used for? Is the primary focus initially to down some of this near-term borrowing? Or is that excess funding going to be layered into the securities book? Okay. Great. And then, again, following up on the large bank exiting the correspondent space, and thank you for not mentioning the bank by name, but pretty large player in the space. What happens to that market share? Is that market share kind of split amongst the rest of the constituents? And are you expecting AmeriHome's portion to grow? Or are you more or less kind of ring-fencing that and keeping the existing business as is? Was kind of competitors maybe getting more of that market share that's up for grabs? So I think like some of the other competitors, they balance market share with gain on sale margin, and that's what we do. So if we can hold our existing market share and grow the gain on sale margin, that works for us, and that's sort of where we've been. And I think that's what the industry is trying to do, and there seems to be a little discipline going on here. But without mentioning that bank that left, it's early days, and we'll wait and see, and we'll clearly have more color on it as we get through the end of the first quarter. During the third quarter, which is when margins dropped, we did a little experiment whereby we pulled back in terms of activity and purchase volume, and we saw margins move up a little bit in that scenario. And I'm not sure that's the reason why, but they basically stayed at a somewhat elevated place from how far they've fallen to in the fourth quarter. So I don't know if we're encouraged by that, and we'll see what happens. Thanks to everyone. Ken, a question for you on the chart you have on the Slide 18, the economically resilient portfolio positioning. That's a mouthful, sorry. What do you expect that mix to look like in one to two years from now? I guess another way is, where is the emphasis in terms of your growth drivers from where we're starting today? Tim Bruckner. You will see us focused growth, particularly through any potential or real recession, any areas that are resistant to recession. At the same time, you'll see us reduce our exposures in some of the more sensitive areas. So we'll do that more with precision than with a broad brush, but specifically getting -- lowering exposure, getting out of industries that are particularly sensitive and then really the resistant areas that's sticking to our net. When we talk about growth there, we're talking about relationship growth. So these are with sponsors that we know not just at the lender level, but at the top of the house. And we're growing specifically at low loan-to-value, high amount of sponsor investment in the deal. What we're doing differently though, right now, we can do it, we can be more selective as we're being very selective about the submarkets as well that we're in if it's real estate related, and that's where we're growing. Okay, okay. Got it. Dale, a question for you. The PPNR growth of 11% to 15%, maybe obvious. But what do you see as the key risks, meaning what brings you closer to 11% or below 11%? And what could put you at the higher end? I mean, first and foremost, we see our task in front of us is sustaining deposit growth. With deposit growth, we've got the balance sheet leverage. We can -- believe we have opportunity in the asset side to deploy this at significant spreads, which will drive NII, obviously driving PPNR, which -- and of course, avoiding much in terms of the provision costs other than the higher balances. So I think that's the number 1 thing, sustaining our deposit growth. And we've got a number of initiatives, and some of them are coming to fruition, I think, now. And we think we're going to be on track. Yes, I can. It's -- as far as the -- you're talking about the qualitative adjustments on the AC upgrade, about 5%. Okay. And then, Ken, just one for you. How are you judged? How are you guys judged? Is it tangible book value growth? Is it EPS? Is it credit? Where are you guys most focused in terms of the financial metrics that we look at for the coming year? Thanks. So as it relates to performance, it's sort of up and down both the income statement and the balance sheet as determined by our short-term or STI compensation, EPS, loan growth, deposit growth, asset quality, operational quality and the growth in our capital base. In terms of the LTI, of course, it's the share price, and the share price is motivated by the growth in EPS. And so those are the things that we focus on. Thank you. There are no additional questions at this time. I will now hand the call over to Ken Vecchione for closing remarks. Thank you all for joining us today, and we look forward to talking to you about the Q1 results in the next couple of months. Thanks.
|
EarningCall_1142
|
Good day, and thank you for standing by. Welcome to the Peloton Interactive Second Quarter 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions] Please be advised that todayâs conference is being recorded. I would now like to hand the conference over to your speaker today, Peter Stabler, Head of Investor Relations. Please go ahead. Good morning, and welcome to Pelotonâs fiscal second quarter conference call. Joining todayâs call are CEO, Barry McCarthy; and CFO, Liz Coddington. Our comments and responses to your questions reflect managementâs views as of today only and will include statements related to our business that are forward-looking statements under federal securities laws. Actual results may differ materially from those contained in or implied by these forward-looking statements due to risks and uncertainties associated with our business. For a discussion of the material risks and other important factors that could impact our results, please refer to our SEC filings and todayâs shareholder letter, both of which can be found on our Investor Relations website. During this call, we will discuss both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP financial measures is provided in todayâs shareholder letter. Want to do something a little bit out of the ordinary just to kick off today's call if you'll indulge me. A good friend of mine and Gail Tifford once best summarized what's special about Peloton. I think when she described the brand as golden and the members community as platinum. And what makes that possible is incredible work done by our content team and by the instructors who give it life. And because of that, and in particular, I want to welcome back to the platform today one of our Instructors in London by the name of Leanne Hainsby, who after disclosing her recent battle with cancer, and her announcement that she's cancer free, is today, once again back on the platform, and started her class just coincidentally happens to coincide with the start of this earnings call. Thanks for taking the questions. Barry, you wrote about how the new initiatives across rentals and retail partnerships and just changes in the overall go-to market drove 19% of CFU volume in the quarter. So, if you could talk more about how you think that will progress over the next 12 months? And which of these initiatives you expect to be most impactful to drive growth going forward? Thanks. Well, based on the last quarter performance and quarter to-date, I think perhaps and the preowned business will be the most significant on a quarter-over-quarter basis, last quarter to the quarter before, our pass has doubled by way of example, and is continuing to grow rapidly this quarter. And a large, very large percentage 63% I think with a 95% confidence is incremental to the business. They are tend to be slightly higher household income, who -- but to the fact that don't have to make a tricycle commitment would not have come onto the platform. Now, one, two, what about the third-party retail? It has less incrementality. But we don't have enough data to be confident that we know how much of the revenue is incremental, meaning, whether we would have sold it on our own platform, but for the fact that that we partnered with third parties. It did outperform our expectations in the quarter. But of course, we had no history going into the quarter. So it's difficult for us to know as with FaaS and CPO how exactly to forecast it. So, we continue to be optimistic. We're quite pleased with the performance during the quarter. Uncertain about the incrementality, although we are invested in continuing to grow it and will no more [Indiscernible]. If I could just follow-up, you know Leslie joining the new CMO. Do you do you feel like there's strong awareness of the new initiatives in the go-to-market strategy among potential consumers or is that going to be a big focus in your advertising and marketing efforts? Well, it's -- awareness is low, still, but it's new. Are we going to make it a focus? No, not particularly. I think the focus is going to be anyone anytime anywhere. It would be less about bike, it will be about all of the occasions for use and inclusiveness. Thank you. Our next question comes from the line of Justin Post with Bank of America, your line is now open. Great, thank you. Can you talk about hardware gross margins in the quarter? What were some of the puts and takes there? What it's going to take to get those to breakeven? And when you think about the model, like how much are you willing to lose or take upfront costs to get a subscriber? And do you think the model is working now, as you think about your hardware sales producing subscribers? Thank you. Liz, and I will tag team this. Let me do the high level stuff and sheâll backfill on the specifics. So let me say we manage to LTV to CAC. And in making those calculations, we take a holistic view of the revenue stream and the expenses associated with both the hardware and the subscription associated with it. So from my part, I don't particularly care about the hardware margin, or particularly about the subscription margin. I care about it on an aggregate basis, and I care about the relationship between the lifetime value of the customer relative to the cost of acquisition. And that's the framework we use in deciding whether or not the model is working. And in the recent model, I think we were operating at 1.4 to 1 LTV to CAC, which means that each time we add a new subscriber to the business, we increase the enterprise value because that customer will be net profitable over their life. Yes, to just to just add a little bit more detail to what Barry mentioned. Because we did enrich our holiday promotion, that of course has an impact on our hardware gross margin. And we did manage to our LTV to CAC ratio, so we may have spent more on promotion, but it balanced out and resulted in that 1.4 ratio of LTV to CAC. I also want to comment that our overall gross margin when we outperform on connected fitness, what that means is the lower margin of our hardware becomes a sort of - has a higher penetration relative to subscription. And so that will depress the overall margin a bit. But we're happy with that, because we get the subscribers and the subscription revenue over time that comes with them. The only thing I think that is worth pointing out here on our gross margin is that this quarter, we did take a number of reserves, we had higher costs, the cost of revenue were impacted by some excess and obsolescence reserves. So after we got through the holiday period, for example, we looked at our guide inventory and realized that we had more than we needed and took a reserve against that. We also had some very specific returned inventory that we had on hand that we no longer plan to refurbish and sell, so we took a reserve for that. And then we continue to have some reserves associated with inventory from our tonic manufacturing facility. So all of those had roughly about a $32 million impact on our connected fitness gross margin in the quarter. I think there was a question about when is our hardware connected fitness margin going to turn gross margin positive? And we're not giving any guidance on that timing. But as Barry said, we are continuing to focus on optimizing our LTV to CAC. And if you think about the fact that some of the levers that go into that, as we mentioned, promotions are part of that, financing is part of that, third-party channel strategy is part of that equation, all of those things have create a drag on our gross margin. And those get offset by lower sales and marketing expenses in the form of lower media spending. So you have to look at very set as a whole thing and not just micro focus on gross margin. One additional comment, and that is to remind everyone that there are clear tradeoffs between the rate of growth of the business fueled by the pace of marketing - sales and marketing spending on the one hand, and the impact that spending has on free cash flow. So, we spent more on marketing, we could have grown faster, but it would have come at the expense of free cash flow. And our overarching objective, which is to move the business to free cash flow on a sustained basis so we can control our own destiny. So our first priority is to manage the business free cash flow, and then within that framework to manage for growth. Thanks so much. Maybe if I could ask a two-parter. Obviously, there was a lot of demand pull forward through the pandemic, and you went through this sort of normalization dynamic post the pandemic. Are we back on a firm ground where you think you understand with the sort of normalized end demand trends are in the category. And therefore, you're now in a mode of sort of executing on leaning in or leaning out with respect to promotion and marketing and we could be back to some sort of normal seasonal cadence in the business? That's number one. And number two, maybe following up on Doug's question from earlier, just can you help us better understand how the mobile app strategy fits broadly into the Connected Fitness goals? Are you still viewing it as a potential feeder product for conversion and the subscriber funnel? Or is there an increasing view that maybe this can operate as sort of a stand-alone strategy for folks who might never come around to the hardware? Thanks so much. I'll jump in first, and I'll hand it over to Liz. We outperformed in the quarter. The good news and the bad news is - the good news is we outperformed. The bad news is the accuracy of our forecasting -- our ability to forecast the business and particularly given the many changes we made in the business model is not as highly evolved yet as it will be. Is that because of the changes we made in the model or because there's consumer behavior is different than we have understood it to be historically? I think maybe it's some of both. And the reason I think that is because we've continued to outperform even our updated forecast in the quarter. And so we don't quite have our handle -- our arms around consumer behavior. So I think the answer to your question is, no, we're not back to normal yet. There's some new normal that's happening, and I don't feel like we're quite grasped what it is, one. Minor point with respect to seasonality, I should have mentioned in answering Doug's question about SaaS, that among the things we're seeing that we didn't expect is that FaaS does not -- has not been exhibiting seasonal characteristics of the rest of the business. I wasn't -- didn't spike at all, for instance, during the holidays, it's just continued its march as if holidays didn't happen. And then lastly, with respect to the app, I think of it as its own end game. And maybe we'll see the all access subscription hardware business or maybe not -- I don't really care. The end goal for that strategy is to expand the TAM by reaching a user base that historically we've not been able to access to do it with our core strength, which is all of the content and the user experience that our instructors give life to and to enable consumers to use that content on competitive hardware and to use it in the home and to use it in the gym and to use it outside, whether it's strength or a yoga or it's running outside or run a treadmill, whether it's rowing what have you. And today, it's a bike, itâs a tread, it's a row. It's in your home. But tomorrow, it's all those other things. And the path to the promised land is the app, I think, at least that's how I conceptualize it, and that's the opportunity we're trying to pursue. Liz, do you want to add anything? I think you actually explained it quite well, Barry. The only thing that I will add is there was a comment in there on Eric's question about seasonal cadence. And I just want to say that from a modeling perspective, we still expect that our revenue for the year is going to most closely resemble that of fiscal '22. Let me just drive home the point not to read too much hype into this call. But today, we have as many subs as we're forecasting we're going to have at the end of the quarter. We have seen plenty of churn historically, particularly at the end of the seasonal rush. And so we're forecasting that whatever incremental growth we have, we will get back in the form of churn. We're not forecasting a spike in the churn rate, it's just the math, to be clear. But it could be right, it could be wrong. We're going to find out. Thank you. Our next question comes from the line of Shweta Khajuria with Evercore ISI. Your line is now open. Shweta, your line is open, please check your mute button. I'm sorry about that. I guess I have a quick question on free cash flow. You got to positive free cash flow this quarter, excluding some of the supply-related costs. How should we think about the magnitude of each of the key drivers of getting to positive free cash flow in fiscal year '24? So specifically, I'm talking about the cost cuts you've made have an impact, supplier contracts you've renegotiated have an impact, but also inventory drawdown has an offsetting impact. So could you help us in terms of what will be driving the trajectory of sustainable positive free cash flow? Thank you. Sure. So, Shweta's question is really about like what is going to drive sustainable free cash flow into fiscal 2024. So, you mentioned inventory. Inventory will continue to be a tailwind for us in fiscal '24. So that is a benefit. And then it's really all about being very conscious about our OpEx and making sure that we are as efficient as we possibly can be. And then doing that LTV to CAC analysis to make sure that we are acquiring subscribers efficiently. And then it's about growth. We have to continue to figure out how to grow the business so that we have enough cash inflow to cover our operating expenses over time, that as a fact that we've already bought a lot of the inventory and have a lot of it on hand already. So it's really just about operating the business in an efficient way to maintain that positive free cash flow or break-even free cash flow ideally. And yes, the key is really figuring out how to continue to grow the business. And by the way, as we grow the app part of the business, that is a higher gross margin business that is good for us over time as well. Let me jump in and add that let's talk about maybe some of the changes in the year ahead compared with the past year in terms of savings. So we saw a significant reduction in head count in the past year and savings commensurate with that. Will we see more of that on a go-forward basis? No, we won't. I made it clear in a previous call that as far as I concerned, we're done with headcount reductions. And let me reaffirm that to all of our employees who are listening on the call. But we have significant opportunities for additional expense reduction in the business, and I expect that we will realize those in the next one or two years. They're in middle mile, they're in last mile. They're in all of the operating systems we use. ERP, warehouse, order management system, which has resulted in lots of manual processes. We still have a lot of inventory, and we pay a lot of money in storage costs. And as we work down our inventory positions, we have substantial additional savings to be realized by limiting those storage costs just as we have in the past year. So the only offsets important to bear in mind, is the trade-off between growth and cash flow and savings. So if we lean back into international growth by way of example, we're going to lose more money. We'll grow faster, and we'll only grow if the LTV to CAC shows net profit over time. But as you add new subscribers, you lose money. It's true with Netflix, it's true with Spotify, it's true with Peloton. And so we just need to figure out what -- partially what the appropriate balance is. Great. Thanks for taking the question. Maybe, Barry, I wanted to follow up on your comments on churn just now. And understood there's no real change and you have maybe a little bit higher churn on seasonality, just given the holiday. But do you think this 1.1% churn is, call it, the new normal for maybe full members now that we're in three quarters into the price hike? And maybe any insights on the churn around FaaS subscribers. I think we added shoes and some benefits to the program this quarter that might have brought churn down for these FaaS subscribers. So any insights there would be helpful on churn? And then Liz, I think from a guidance perspective, because we're assuming greater FaaS and 3P distribution sales, and I think it's more fast than CPO. Talk to us about how that role flows through the P&L. Thank you. Let's talk about the overall churn number. Let me talk about fast. So SaaS has a higher churn rate than the typical all access customer. It's running about 4.5%, 4.7%. That should not alarm you. And here's why. The sub base is still quite young. And over time, if you were to look at individual cohorts, the question that we need to answer for ourselves and for you is, what's the shape of the retention curve, the churn curve looks like. So -- and as the sub base ages, the average churn rate, which is what the 4.5, 4.7 represents will come -- of course, will come down. The question is what's -- where does it turn asymptotic and at what rate does it turn asymptotic? It's going to be 1% or is it going to be 3%? Based on our understanding of consumer behavior to date, we think the payback for fast customers who receive a new bike is that 18 months. And for customers who receive a used bike is 12 to 14 months, which is as good as we hoped, I thought. Worst case, it'd be two years, and we need to go back and reengineer the numbers to get to a better outcome. And the best we could possibly hope for would be a 12-month payback. So looks to us at least we initially like the program that's working. And by the way, we're still not doing any kind of credit check verification on the front end to identify customers and shouldn't be doing business with, all of which would contribute to a better lifetime experience. So we're still learning how to operate the program. But at least initially, based on the churn behavior we're seeing so far, and we're only talking about 20 -- roughly 24,000 FaaS customers in total. I think there's reason to be optimistic about it. Now -- it is -- have some negative adverse consequences for cash flow because it's -- from a cash flow perspective, you're not selling hardware upfront. So you're not recouping that investment in working capital as quickly, but we are seeing faster growth as a consequence. So I just want to remind everybody that the program is really successful, growing really fast with attractive paybacks, then we're going to have to also figure out what the financing strategy is going to be for it because it will have different working capital attributes than the core business currently have. But we should be so lucky to have that challenge. And if we have it and I'm pretty confident in our ability to figure it out. Yes, sure. I just wanted to add one thing that for the quarter for Q2, we were actually closer to 28,000 FaaS subscribers at the end of Q2. It was about double the number that we had in Q1. So really, really great growth, great for FaaS. Well, but let's talk a little bit about churn. So our churn flat quarter-over-quarter, and we're very pleased with our Connected Fitness potential levels overall. FaaS has a very minimal impact on overall churn at this point. And right now, we don't expect any significant changes to our current churn levels aside from the fact that we do have small seasonal variations from quarter-to-quarter. So that's a little bit about churn. Ron, I think there was a part of your question that was asking about how like 3P FaaS and refurbished program flow through our P&L, and I can give a little bit of perspective on that. Barry already gave some. So the fact that FaaS is becoming a bigger growth driver for us. Means that we do get less revenue from a new FaaS number than we do from somebody who buys a connected fitness hardware product because they just pay for the $150 delivery fee and then the cost of their membership. That also impacts our gross margin in the month that they become a fast member. And we've talked about that before. So that is a near-term drag on margin. It's also a near-term drag on revenue, just as -- but over time, we recoup that. For 3P, we've talked about that as well that because our third parties do extract a margin from us, there is a little bit of an impact to revenue from them. We also have terms in accruals. We also consider our marketing expense as a contra revenue adjustment for those relationships. So those are a drag on revenue as well and a bit of a drag on gross margin, too. And then for refurb, because it is a lower price point, obviously, we're getting less revenue from when we sell a refurbished spike. But on a cash margin perspective, it's great because we are getting cash for products that we would have otherwise just had as a return and not been able to do something with. So it's great overall economics, although from a P&L standpoint, you will see the negative impact from that. Hi, good morning. Thanks for taking my question. So maybe a couple of questions. Maybe unrelated, I'll show into one to just make it simple. So first off, with regard to the now expanded distribution infrastructure with Amazon and Dick's. Any additional insights there is how you may further develop that infrastructure? And then my second question, I know we've talked about FaaS a bit here, but as you look at the initial growth there, are you basically just allowing that growth to be dictated by the market, or are there governors in place right now that you could adjust over time to drive that growth one way or the other? Well, the answer to that is yes. Let's say that we are concerned about the cash flow, the tax on cash flow, we just slow it down. We could hear -- let's say 300 units a day and decide we're not selling anymore in a particular day, and we just take it down from the web so that [indiscernible] can't order any more parts in any particular day or week or month or quarter, by way of example. Secondly, it's right for international expansion. The pace at which we decide to go is another lever. A third lever is, why don't we just change the value proposition and we make it more expensive. That is churn implications, of course, which has lifetime value implications and CAC implications but it's absolutely one of the variables that we factor into the mix and deciding how to modulate growth or we can lower prices and almost certainly grow faster as a consequence. The only thing to add, the first part of the question, I think, was around any insights on developing our infrastructure with Amazon and Dick's as third parties. I think right now, if you look at these partnerships, it's still very new to us. We've only been roughly a quarter in terms of our relationship with Dick's. We just went through our first holiday season with our third parties. And so while our third-party sales, along with the rest of our sales outperformed our expectations during holiday. We're still learning about those partnerships and figuring out how we want to continue to partner to make it a win for both our business as well as Amazon and Dick. Do you want to add anything to that? Great. Thank you. Two questions for me. First, can you maybe speak to the level of promotional intensity in the quarter and your plans and expectations for the second half? In other words, kind of what does the guide imply in terms of promotional activity? And two, maybe just a clarification, Liz, on something you said earlier about the seasonality you're seeing this year similar to what you saw in 2022. In 2022, Q4, your fiscal Q4 was the lowest revenue quarter at about 19% of revenue. So I'm assuming that's kind of what you're telegraphing but what else you'd like us to know about how maybe Q4 will turn out. I know you're not guiding yet. So maybe just directionally. Thank you. So with regard to revenue, that second part of your question, we are not providing guidance on Q4. So I think you can interpret my comment earlier about revenue seasonality, how you want, but we're not providing specific guidance on the quarter. On promotional intensity, and Barry, you can sell in for us anything I miss here. But I think the wish that we think about promotional levers, we have to come back to the whole concept of LTV to CAC and that promo is part of one of the key levers in that equation. So as we look in the quarter, we are going to make trade-offs between our media spending, our financing offers and also promotion as an opportunity. And especially as we have a lot of inventory right now, it is a lever for us. And so we don't comment too much about promotional strategy that's for competitive reasons, in part, but we are trying to balance across our inventory reductions, managing margin and cash flow. All of those are important parts about how we think about promotional activity. Just remind everybody that it's just a form of marketing spending, just happens to land is a different part of the P&L, one, two, proven to be enormously affected for us. Three, more to do it, the more you erode the brand value proposition. And so you do well to use it sparingly. In the years that I've been here, we've had some form of promotional activity in almost every quarter, I think, to varying degrees. It's up for Leslie to decide how aggressively or not. She wants to use it as part of the marketing mix on a go-forward basis, so TBD. Good morning. Thanks for taking the question. Barry, in one of your earlier answers, you talked about the puts and takes on from international growth and just that faster growth would cost more money. I know you cited that restoring international growth as a goal in year 2. Kind of what do you see other than the promotional level that could help do that? And do you expect to enter new countries? Thank you. Still figuring it out is the long and the short answer. I would like to enter new countries, probably Western Europe first. But I don't know when, and I don't know how much we would spend doing it. And I hope to have the answer to those questions in the next three months, but we just don't have it today. Long story short. Hi, good morning. So two questions, please. So the first one is with higher FaaS demand and faster deliveries at the end of the quarter, does that suggest that there should have been some lag subs as in January? And is that already baked into your guide of 3.08 to 3.09 for Q3? And then second, marketing is down even as a percent of sales. I'm curious if you could give us some color on how much of that is temporary as you're -- it sounds like you're holding back marketing on the digital app until you've relaunched it versus structural declines, including leaner team, lower field expenses and maybe even structurally lower as you broaden your distribution footprint and maybe need less marketing. So any color on that would be helpful. Thank you. The sales and marketing line item on the P&L is hot pudge, a couple of different things, just by way of reminder, -- so some of it relates purely to marketing spend for the core business. Some of it relates to the commercial and wellness business. And with the retail -- and the last piece is retail. And we've fairly dramatic. We're in the process of dramatically shrinking the loss associated with that component of the business. Now all things being equal, as the subscription revenue grows, sales and marketing expense should shrink pretty dramatically as a percent of revenue. This is all part of tutorial, I gave investors at the Investor Day that Spotify hosted before it's direct listing, by way of example. And at Netflix, as I recall, Sales and marketing expense fell from something like 24% to 14%, even as CAC remained relatively constant just because of the attributes of the well-run subscription business. You only pay to acquire the marginal new sub. You don't pay for the recurring revenue and the recurring revenue grows as a percentage of the total over time, which is why you see the reduction. Now the offsets for us will be, let's say, international expansion. Well, our unaided brand awareness in new countries is quite low as you would expect. That means it's that CAC will be higher as you roll out your presence in those new markets. And so we're just going to have to balance it from an earnings and a cash flow perspective as we try to nail the growth. But we should be beneficiaries of increased word of mouth as the unaided brand awareness grows, particularly in North America and because of the growth in recurring subscription revenue, offset by growth in new markets and in new product categories that have relatively low growth like the digital app because last time I looked, I'm not sure what it is today, it was 4% unaided brand awareness. And the net promoter score was the highest of all of the products we offer something like -- I can't remember if it's the low 80s or mid-70s, anyway, enormously high. So question, how heavily from a marketing perspective where we're going to lean into to that opportunity. And the answer is, as you just walked in the door, give us some time to figure that out. So, over the holidays, we -- this is not a particular impact that is unique to this particular holiday or this particular calendar year. Over the holidays when we sell a lot of Connected Fitness units over the Black Friday, Cyber Monday, it does take us time to be able to deliver those. And so we generally do have situations where somebody may have ordered a Peloton bike or tread or roller we -- but they -- we don't actually deliver it to them and they don't activate their subscription until January. That's not a unique phenomenon to this year. So it's something that happens every holiday quarter into the -- from quarter two into quarter three. Yes, relative to other quarters. Yes. But it's not -- it's contemplated in our guidance. And it is not unique to this year versus other years. By the way, shout out to the to all of the folks at Peloton involved in the delivery of Connected Fitness units to consumers' homes because. They substantially outperformed our expectations for the quarter, and we're quite grateful to them for the efforts that they exerted on behalf of the business. Everybody, good morning. Can you maybe just talk about -- you've laid out your various initiatives in some detail. Can you maybe just talk about the decisions on Precor and the Ohio facility? And if there's any sort of shift in strategy or any impact keeping those assets for a bit longer may have on some of the initiatives you've outlined? Thanks. Liz will take Pop, and I'll take Precor. Let me begin with Precor. When I think it was in my first earnings call with investors, I said, look, strategy is to be choice and our choice is to commit ourselves to Connected Fitness. So if it's not Connected Fitness, we're not doing it. And that begs the question, well, okay, where does Precor fit and you doing it? And we had the worst kept secret in the planet is that we've been exploring the sale of Precor. And we got pretty far down the path and the price that the buyer was willing to pay dramatically dropped. And we walked away from the table. I mean at some point, across a stupid line to the point where you're just not willing to dance anymore. And that happens for us. Now for all of the time that we have owned it we've done nothing to invest in the performance of the business to its own detriment. And we've done a reasonable top of kind of running it for our benefit, including stocking some talent out of it into our own hardware business. It was good for us to answer them. So we're going to reverse course. I think we understand how to add some incremental value without great expense and have a disproportionate increase in the value of the business and the overarching strategy would be run Precor for the benefit of Precor and to not dilute those efforts for the benefit of our own operating business, run it as a freestanding subsidiary. And so that's the path we're on. And when we see success, we will see a dramatic increase in its market value. And then unless we have a shift in strategy where they have a shift in their product strategy. At some point, we would look to divest. So I'll take the question about POP. So we had expected to sell or to sell the Peloton Output Park facility in Ohio by the end of calendar year '22. Unfortunately, that process got delayed, but we are hopeful that we will be able to sell it by the end of the fiscal year. And we are confident that we will be able to sell it. It's just -- it's literally just taking us longer. Now end of the fiscal year is not guaranteed, but that is our goal. This is Nathan Federer [ph]. I am filling on for Lauren Shank. Can you just talk through how the initial demand for the rower spend and where you and think that production and distribution? And then what portion of demand is coming from new versus existing subscribers? And then just a follow-up last question, what exactly is causing the delay in selling POP? And how are you getting that fixed? Thank you. Okay. So as far as the demand for the rower, just like our other products over the holiday season, the rower outperformed our expectations. It is a newer product for us and awareness outside our Peloton member base. We're still building that quite a bit. So to your point, a larger share of the rower sales did go to existing numbers. It was roughly as high as 65% over the holiday period. Now since the holidays, it has moved to be more in line with the percent of existing numbers that are purchasing our tread product, and that's in Q3, the trend is more in the 40-ish percent range in terms of overlap with existing subs. So that's a little bit about the rower and new versus existing. On POP, the POP facility is a large facility. It's in Ohio. It's a great facility for the right use case for it, but we just have to find the right buyer for that facility. And so we're taking the time to be able to do that. Thank you. And I'm currently showing no further questions at this time. I would like to turn the call back over to Peter Stabler for closing remarks.
|
EarningCall_1143
|
Thank you for standing by, and welcome to Intel Corporation's Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Mr. John Pitzer, Corporate Vice President of Investor Relations. Please go ahead, sir. Thank you, Jonathan. By now, you should have received a copy of the Q4 earnings release and earnings presentation, both of which are available on our investor website, intc.com. For those joining us online today, the earnings presentation is also available in our webcast window. I am joined today by our CEO, Pat Gelsinger; and our CFO, David Zinsner. In a moment, we will hear brief comments from both followed by a Q&A session. Before we begin, please note that today's discussion does contain forward-looking statements based on the environment as we currently see it. As such, it does involve risks and uncertainties. Our press release provides more information on the specific risk factors that could cause actual results to differ materially. We've also provided both GAAP and non-GAAP financial measures this quarter, and we will be speaking to the non-GAAP financial measures when describing our consolidated results. The earnings release and earnings presentation include full GAAP and non-GAAP reconciliation. Thank you, John, and good afternoon, everyone. Q4 revenue came in at the low end of guide and was impacted by persistent macro headwinds, which began in Q2 and underscored a 2022 characterized by unprecedented volatility, which will continue in the near term. We made meaningful progress on several fronts in calendar year 2022, notwithstanding all the challenges, but we readily admit our results and our Q1 guidance are below what we expect of ourselves. We are working diligently to address the challenges brought on by current demand trends and remain confident in our long-term plans and trajectory. Accordingly, we are even more aggressively executing on the cost measures we described in Q3, even as we keep the investments critical to our long-term transformation intact with a clear eye of making the right capital allocation decision to drive the most long-term value. Today, I'd like to address three areas. One, our view on the macro and the markets in which we participate; two, the operational progress we made in 2022; three, as we enter the New Year outlining the commitments we are making to all our stakeholders. First, on the macro. We expect macro weakness to persist at least through the first half of the year with the possibility of second half improvements. However, given the uncertainty in the current environment, we are not going to provide revenue guidance beyond Q1. Dave will provide guidelines for capital spending, depreciation and adjusted free cash flow in his prepared comments. Having said that, let me give you additional color regarding our view of our markets in 2023. To various degrees, all our markets are being impacted by macro uncertainty, rising interest rates, geopolitical tensions in Europe and COVID impacts in Asia, especially in China. In the PC market, we saw a further deterioration as we ended calendar year 2022. In Q3, we provided an estimate for the calendar year 2023 PC consumption TAM of 270 million to 295 million units. Given continued uncertainty and demand signals we see in Q1, we expect the lower end of that range is a more likely outcome. Near term, the PC ecosystem continues to deplete inventory. For all of calendar year 2022, our sell-in was roughly 10% below consumption with Q4 under shipping meaningfully higher than full year, and Q1 expected to grow again to represent the most significant inventory digestion in our data set. While we know this dynamic will need to reverse, predicting one is difficult. Importantly, PC usage data remains strong, reinforcing that use cases brought on by COVID are persistent even as the economy has reopened. And as we highlighted in our recent PC webinar, strong usage and installed base, which is roughly 10% higher than pre-COVID levels and what we see as a conservative refresh rate supports a longer term PC TAM of 300 million units plus or minus, post this period of adjustment. We intend to capitalize on this TAM through a strong pipeline of innovation and based on the growing strength of our product portfolio, customers are increasingly betting on Intel. We grew share in the second half of 2022, and we expect that positive momentum to continue in 2023. We remain clear eyed on managing to near-term weakness in PCs but we also see the enduring and increasing value PCs have in our daily lives. In the server market, the overall consumption TAM grew modestly in calendar year 2022, albeit at diminishing rates as the year progressed. Inventory burn drove server CPU shipments down mid-single digits year-on-year in calendar year 2022 with hyperscale up, offset by declines in enterprise and Rest of World. Our share in calendar year 2022 was in line with our subdued expectations, and our revenue volatility was a function of TAM, especially given our outsized exposure to enterprise and China. We expect Q1 server consumption TAM to decline both sequentially and year-over-year at an accelerated rate with first half 2023 server consumption TAM down year-on-year before returning to growth in the second half. While all segments have weakened, enterprise and rest of world, especially China, continues to be weaker than hyperscale. However, we'd highlight that the correction in enterprise and rest of the world, where we have stronger positions are further along than hyperscale. Lastly, in our broad-based markets like industrial, auto and infrastructure, demand trends throughout calendar year 2022 were strong but not completely immune to the macro volatility. Strong demand in these markets was mirrored by strong Q4 and record calendar year 2022 revenue in NEX, PSG, IFS and Mobileye. We see calendar year 2023 as another growth year for us in these areas even though the absolute rate is difficult to predict today. This is in contrast to the semi market ex-memory, which third parties expect to decline low to mid-single digits. We entered 2023 with a view that much of the macro uncertainty of the last year is likely to persist, especially in the first half of the year. As such, we are laser focused on executing to our $3 billion in calendar year 2023 cost savings that we committed on our Q3 earnings call. We are making tough decisions to rightsize the organization and we further sharpened our business focus within our BUs by rationalizing product road maps and investments. NEX continues to do well and is a core part of our strategic transformation, but we will end future investments in our network switching product line, while still fully supporting existing products and customers. Since my return, we have exited seven businesses, providing in excess of $1.5 billion in savings. We are also well underway to integrating AXG into CCG and DCAI, respectively, to drive a more effective go-to-market capability, accelerating the scale of these businesses while further reducing costs. While it was important to focus on what we are doing to address the current macro uncertainty, it is also important to highlight that despite disappointing financial results, calendar year 2022 did see considerable progress towards our transformation. We remain fully committed to executing to our strategy to deliver leadership products, anchored on open and secure platforms, powered by at-scale manufacturing and supercharged by our people. Success starts with our people and execution follows culture. In calendar year 2022, we took important strides to rebuild the leadership team, promoting from within and adding fresh perspectives from the outside. This includes the Board of Directors, with the addition of Lip-Bu Tan and Barbara Novick, both of whom have already made significant contributions and the appointment of Frank Yeary as Chair. In addition, a year ago, we reestablished OKRs to drive accountability and transparency across the organization, and we reintroduced TikTok 2 to establish a rigorous methodology of design and product development. Both are key spark plugs to our execution engine. Rebuilding the culture has begun to show benefits in manufacturing and design. Our progress against our TV road map continue to improve throughout calendar year 2022 and every quarter, our confidence grows. We are at/or ahead of our goal of 5 nodes in four years. Intel 7 is now in high-volume manufacturing for both client and server. On Intel 4, we are ready today for manufacturing, and we look forward to the Meteor Lake ramp in second half of the year. Intel 3 continues to show great health and is on track. Intel 4 and 3 are our first nodes deploying EUV, and will represent a major step forward in terms of transistor performance per watt and density. On Intel 20A and Intel 18A, the first nodes to benefit from RibbonFETs and PowerVia, internal test chips and those of a major potential foundry customer have taped out with the silicon running in the fab. We continue to be on track to regain transistor performance and power performance leadership by 2025. Progress in [TD] (ph) continues to be validated by our IFS pipeline. I am happy that we were able to add a leading cloud edge and data center solutions provider as a leading edge customer for Intel 3 including prior customers such as MediaTek, we now have lifetime deal value of greater than $4 billion for IFS. We also have an active pipeline engagements with seven out of the 10 largest foundry customers coupled with consistent pipeline growth to include 43 potential customers and ecosystem partner test chips. Additionally, we continue to make progress on Intel 18A, and I've already shared the engineering release of PDK0.5 with our lead customers and expect to have the final production release in the next few weeks. In addition, we are working hard to complete the Tower acquisition, which will further amplify our momentum as our foundry business becomes even more compelling to customers. On the product front, the PRQ of Sapphire Rapids in Q3 and the formal introduction of our fourth gen Xeon scalable CPU and Xeon CPU MAX series better known to many of you as Sapphire Rapids and Sapphire Rapids HBM, respectively, on January 10 was a great milestone. It was particularly satisfying to host a customer-centered event, including testimonials from Dell, Google Cloud, HPE, Lenovo, Microsoft Azure and NVIDIA, among many others. We are thrilled to be ramping production to meet a strong backlog of demand, and we are on track to ship 1 million units by midyear. In addition, as part of AXG moves into DCAI, it is noteworthy that our Intel Flex series optimized for and showing clear leadership in media stream density and visual quality is now shifting initial deployments with large CSPs and MNCs, enabling large-scale cloud gaming and media delivery deployments. Our DCAI road map only improves from here. Emerald Rapids is sampling and has completed power on with top OEM and CSP customers, and it remains on track to launch in the second half of 2023. Granite Rapids, our next performance core addition to the Xeon portfolio is on track to launch in 2024, running multiple operating systems across many different configurations. Further, our first efficient core product, Sierra Forest is also on track for 2024. Lastly, it is appropriate to continue to highlight PSG for its standout performance delivering record Q4 revenue up 42% year-on-year. We are planning to have a more fulsome look at our progress in DCAI at our next investor webinar later in Q1. Stay tuned for the invitation. In CCG, we continue to build on our market share momentum across the PC stack by focusing on delivering leadership products with our broad open ecosystem. I'm particularly pleased that our clear performance leadership at the high end drove record client ASPs in the quarter. In Q4, the 13th Gen Intel Core desktop processor family, codename, Raptor Lake, became available, starting with the desktop K processors and the Intel Z790 chipset. In partnership with ASUS, we officially set a new world record for overclocking, pushing the 13th Gen Intel Core past the 9 gigahertz barrier for the first time ever. Hands down, we provide desktop enthusiasts and gamers with the best processors and features for overclocking in the PC industry. We also introduced our notebook Raptor Lake family at CES, including the world's fastest notebook CPU and the first 24 cores. We look forward to ramping the more than 300 mobile design wins we have already secured in the first half of 2023. Meteor Lake, our first disaggregated CPU built on Intel 4, remains on track for the second half of the year. And with Meteor Lake progressing well, it's now appropriate to look forward to Lunar Lake, which is on track for production readiness in 2024, having taped out its first silicon. Lunar Lake is optimized for ultra-low power performance, which will enable more of our PC partners to create ultra-thin and light systems for mobile users. In addition, as we outlined on our webinar, we are excited by the strength of the Evo brand. The introduction of Unison for leadership multi-device experience as we ramp the more than 60 design wins and the uniqueness of vPro in the enterprise market, helping our customers drive an almost 200% return on investment by deploying vPro platforms to their end users. Lastly, as consumer graphics reintegrate into CCG, enthusiasm for our latest Alchemist-based discrete graphics products continue to build and we expect volume ramp throughout the year. Turning to NEX and Mobileye. Both businesses have performed well in Q4 and calendar year 2022, partially insulated by some of the market forces impacting PCs and server. NEX hit the key product milestones with Mount Evans, Raptor Lake P&S, and Alder Lake N and Sapphire Rapids to drive a second consecutive year of double-digit year-on-year growth in calendar year 2022. We expect market share gains and outperformance to continue in 2023. Mobileye increased revenue by almost 60% year-on-year in Q4 and is on a solid growth path for calendar year 2023. Calendar year 2022 design wins, including supervision, are projected to generate future revenue of approximately $6.7 billion across 64 million units. In addition, our manufacturing organization performed well throughout calendar year 2022. Starting the year, navigating the worst supply-constrained environment in over 20 years, only to have to pivot in Q2 to respond to rapidly changing demand signals, which are now driving near-term under-loading in our factory network. More importantly, we continue to push forward with the next phase of IBM 2.0 creating an internal foundry, evolving our systems business practices and culture to establish a leadership cost structure. This new approach is already gaining momentum internally. As a reminder, the internal foundry model will place our BUs in a similar economic footing as external IFS customers, and will allow our manufacturing group and BUs to be more agile, make better decisions and uncover efficiency and cost savings. We have identified nine different subcategories for operational improvement that our teams will aggressively pursue. In addition to establishing better incentives, this new approach will provide transparency on our financial execution, allowing us to better benchmark ourselves against other foundries and drive to best-in-class performance. We'll also provide improved transparency to our owners as we expect to share full internal foundry P&L in calendar year 2024. Ultimately, allowing you to better judge how we are allocating your capital and creating value. We expect additional efficiencies as we implement our internal foundry model, which is a key element to accomplish our $8 billion to $10 billion of cost savings exiting 2025, as we outlined on our last call. I want to remind everyone that, we are on a multi-year journey. We remain focused on the things that are within our control as we navigate short-term headwinds, while executing to our long-term strategy. While I remain sober that, we have a long way to achieve our financial expectations, I am pleased with the transformation progress that we are making. I can tell you, in addition to obviously focusing on the day-to-day running of the company we continue to examine numerous additional value-creating initiatives for 2023 as we always do. We will update you as we move along on any we deem appropriate. Rest assured, we remain committed to creating value for our owners and to delivering the long-term strategic road map we laid out at the beginning of this journey, and we are confident in our ability to do so. We will, one, deliver on five nodes in four years, achieving process performance parity in 2024 and unquestioned leadership by 2025 with Intel 18A. Two, execute on an aggressive Sapphire Rapids ramp, introduce Emerald Rapids in second half 2023 and Granite Rapids and Sierra Forest in 2024. Three, ramp Meteor Lake in second half 2023 and PRQ Lunar Lake in 2024, and four, expand our IFS customer base to include large design wins on Intel 16, Intel 3 and 18A this year. We also need to improve our cost structure and drive operational efficiency. On this front, we will, one, return to profitability and deliver the benefits of our calendar year 2023, 2024 and 2025 efforts to reduce costs and drive efficiencies. Two, execute on our internal foundry P&L by 2024. And three, expand on the use of our smart capital strategy to leverage multiple pools of capital, including SCIPs and Chips in the US and Europe to balance our long-term capacity aspirations with near-term realities. Before I turn it over to Dave, I'm going to close by saying, we take our commitments to all our stakeholders extremely seriously and ultimately, we strive to create value for each of them. For our customers, it is rebuilding our execution engine to provide a predictable cadence of best-in-class products to support their ambitions. For our employees is to provide them with the opportunity to develop and bring to market world-changing technologies. It is what inspires each of us inside of the company. For our external owners is to make thoughtful, deliberate decisions around capital allocation, which drives the highest return on investment we make with your capital. Our ambitions are equaled by our passion, and our efforts across manufacturing, design, products and foundry are well on their way to driving our transformation and creating the flywheel, which is IBM 2.0. Thank you, Pat, and good afternoon, everyone. We saw solid business execution in the fourth quarter despite persistent macroeconomic headwinds impacting the semiconductor industry. As Pat indicated, we expect challenging macro conditions to continue through at least the first half of the year. As outlined last quarter, we'll continue to prioritize investments critical to our transformation, prudently and aggressively managed expenses near-term and drive fundamental improvements in our cost structure longer term. We're executing well towards our $3 billion target in 2023 and $8 billion to $10 billion exiting 2025. Fourth quarter revenue was $14 billion, landing at the low end of our range and down 8% sequentially. Revenue from DCAI and NEX were in line with expectations, while CCG was impacted by softening demand for PCs. Gross margin for the quarter was 44%, slightly better than we had expected for the low end of our revenue range. Q4 gross margins were impacted 220 basis points from factory underload charges, offsetting a sequential 170 basis point benefit from an insurance settlement. EPS for the quarter was $0.10. $0.10 below our guide on lower revenue and increased inventory reserves. Operating cash flow for the quarter was $7.7 billion. Net CapEx was $4.6 billion, resulting in an adjusted free cash flow of $3.1 billion and we paid dividends of $1.5 billion. We finished FY 2022 with revenue of $63.1 billion, gross margin of 47.3% and EPS of $1.84. We generated $15.4 billion of cash from operations and an adjusted free cash flow of approximately negative $4 billion at the low end of the range we provided last quarter, despite approximately $3 billion of capital incentives that shifted from Q4 into 2023. When we spoke at Investor Day last February, we forecasted revenue of $76 billion and adjusted free cash flow of negative $1 billion to $2 billion for FY 2022. As macroeconomic conditions deteriorated at a rapid pace in second half of 2022, we committed to optimizing the areas of the business within our control. Through reductions in spending and significant working capital improvements, we offset a $13 billion reduction to revenue expectations to come within $2 billion of our initial adjusted free cash flow guide, while still making the needed capital investments in support of our IDM 2.0 strategy, and to position ourselves for long-term growth in a market expected to reach $1 trillion by 2030. Our balance sheet remains strong with cash and investment balances of more than $28 billion, modest leverage and a strong investment-grade profile. Moving to fourth quarter business unit results. CCG revenue was $6.6 billion, a decline of 36% year-over-year as PC TAM deteriorated faster than expected due to macroeconomic headwinds. Customer inventory remains elevated beyond our previous expectations and will continue to burn into the first half of 2023. CCG realized record CPU ASPs, up 11% year-over-year as we continue to see relative strength in our premium segments driven by leadership performance and attractive features of our Evo and vPro platforms. Q4 operating profit was $0.7 billion, down year-over-year on lower revenue and increased Intel 7 product mix. DCAI revenue was $4.3 billion in Q4, up 2% sequentially, with higher ASPs offsetting demand softness and down 33% year-over-year, driven by TAM contraction and competitive pressure. DCAI operating profit for the fourth quarter was $371 million. While still under satisfactory, profit was up more than $350 million sequentially on reduced factory costs. Operating profit was down substantially year-over-year, impacted by lower revenue, increased advanced node start-up costs and higher product costs. Within DCAI, PSG achieved record Q4 revenue, up 42% year-over-year, along with record full year revenue, up 29% year-over-year, through increased ASPs, improved external supply and strength in the infrastructure segment. PSG enters 2023 with still significant unfulfilled backlog. NEX quarterly revenue was $2.1 billion, down 1% year-over-year, as declining global GDP impacted the Edge business, offsetting growth in Xeon network CPUs and the ramp of our Mounts Evans infrastructure processing unit. Despite second half macro headwinds, NEX set another full year record revenue at $8.9 billion, up 11% year-over-year and marking consecutive years of double-digit revenue growth. Operating profit was $58 million in the fourth quarter, down on mix shift to lower-margin segments and higher factory start-up costs. AXG achieved record quarterly revenue of $247 million, up 34% sequentially and up 1 point year-over-year, supported by the launch of Sapphire Rapids HBM. Operating loss was $441 million, down $63 million sequentially, with inventory valuations negatively impacted by softer demand, especially for crypto processors. Mobileye delivered another record revenue quarter of $565 million, up 26% sequentially and growth of more than $200 million and 59% year-over-year. Full year revenue of $1.9 billion was also a record for Mobileye, growing 35% year-over-year. Fourth quarter operating income of $210 million represents 71% growth year-over-year. IFS achieved record quarterly revenue of $319 million, up 87% sequentially and 30% year-over-year on increased automotive shipments. Operating loss was $31 million, a $72 million improvement sequentially on higher revenue. We continue to reshape the company to drive to world-class product costs and operational efficiency. We remain committed to the $3 billion of 2023 cost savings outlined on our Q3 earnings call, while mindfully protecting the investments needed to accelerate our transformation and ensure we are well positioned for long-term market growth. Before turning to Q1 guidance, let me take a moment to discuss an accounting change that will impact our results beginning in the first quarter. Effective January 2023, we increased the estimated useful life of certain production machinery and equipment from five years to eight years. This change better reflects the demonstrated economic value of our machinery and equipment over time and is more aligned with the business model changes inherent to our IDM 2.0 strategy. The growth of the IFS deal pipeline will extend the life of manufacturing nodes beyond what was practical within IDM 1.0. Disaggregated CPU architecture allows performance and cost optimization for each chiplet better leveraging older nodes. And we are optimizing our core business around more sustainable capacity quarters to improve equipment utilization and maximize ROIC. The change will be applied prospectively beginning Q1 2023. When compared to the estimated useful life in place as of the end of 2022, we expect total depreciation expense in 2023 to reduce by roughly $4.2 billion. An approximate $2.6 billion increase to gross profit, a $400 million decrease in R&D expense and a $1.2 billion decrease in ending inventory values. This change will not be counted towards the $3 billion short-term or $8 billion to $10 billion long-term structural cost improvements we committed last quarter, and is intended to provide the most accurate reflection of company financial results to our owners. Now turning to guidance. For Q1, we expect first quarter revenue of $10.5 billion to $11.5 billion. In addition to continued macro headwinds, we expect customers will burn inventory at a meaningfully faster pace than the prior few quarters in response to macro TAM softness impacting CCG, DCAI and the x lines of business. We see potential for market conditions to improve faster than typical seasonality as third-party data shows macro headwinds easing in the second half of the year. While we're progressing toward a $3 billion spending reduction with significant austerity across the company, given the fixed cost nature of our business, we expect the sequential revenue decline will result in negative operating margin in the first quarter. We're forecasting gross margin of 39%, a tax rate of 30% and EPS of negative $0.15 at the midpoint of revenue guidance, inclusive of $350 million to $500 million of operating margin benefit from the useful life accounting change, split approximately 75% to cost of sales and 25% to OpEx. Factory underload charges are projected to impact Q1 gross margin by 400 basis points. We continue to evaluate all investments and will remain laser-focused on optimizing for ROI, adjusting for market conditions across operating expenses and capital assets. While we're not providing guidance beyond Q1, I'll touch on a few elements of our outlook. At Investor Day, we noted that during the investment phase of IDM 2.0 from 2022 through 2024, our model was to operate at approximately 35% net capital intensity. For FY 2023, despite the lower revenue level, we expect to be at or below the 35% model. Embedded in our assumptions are capital offsets of around 20% to 30% of growth CapEx including our innovative SCIP partnership with Brookfield. We expect FY 2023 operating expenses of under $20 billion, a roughly 10% year-over-year decline, consistent with committed cost-cutting measures totaling $2 billion, adjusting for the depreciation change. Adjusted free cash flow will be below our Investor Day guide of approximately neutral in the first half of 2023 and return back towards guardrails in second half 2023. In closing, we remain committed to the strategy and long-term financial model we laid out at Investor Day last year. The opportunity for strong revenue growth across our business unit portfolio and free cash flow at 20% of revenue remains. While we're not satisfied with near-term results, this market downturn represents an opportunity to accelerate the transformation necessary to achieve our long-term goals. I look forward to providing updates on our transformation journey as the year progresses. Thank you, Dave. We will now move into the Q&A portion of our call. As a reminder, we ask each caller to ask one question and a brief follow-up question where applicable. With that, Jonathan, can we please take the first caller? Hi guys. Thanks for let me ask a question. I guess, Dave, to hit on some of the revenue questions or items you just said, do you expect the first quarter to be the bottom in absolute dollars through the year? And any color between the segments? It seems like it's exceedingly a CCG problem right now in the quarter, or is it broader than that? So let me -- I'll start, and Patâs going to add some color. So on the $11 billion, we're expecting most of the business units to be down sequentially, double digits. We're not going to provide guidance for the rest of the year. But I did say that the first half is likely to be seeing these inventory corrections. The other thing I would just add is maybe color to position the year is that we're expecting Q1 to be the most significant inventory decline at our customers that we've seen in recent history. So it's -- if you look back over the last four or five quarters of reduction, this will be meaningfully higher than all of those quarters. So, obviously, that is impacting the Q1 outlook. Yeah. And clearly, as we look at Q1, affected by macro significant inventory adjustments, and that's affecting clearly clients but also data center as well. And we do see that year-on-year, quarter-on-quarter data center to be down as well. And we think that's a macro statement across all segments across cloud, enterprise, government and uniquely China. Part of our more positive expectation for the second half of the year is clearly from our customers and what we've heard from them but also with expected some level of recovery from China as well. So overall, clearly, a major inventory correction cycle and coming after back-to-school and how do they refresh our customers clearly wanting to take more aggressive steps as they adjust. But that inventory adjustment is well below their sell-out rates. So for that, we do believe that we will see recovery as they have made those inventory adjustments, and we'll see the business be stronger as we go through the year. I do. Quickly, Dave, I want to pivot to the gross margin side of things, excluding the change in the depreciable life side of the equation, I know revenue is the biggest headwind right now. But you had talked at the Investor Day last year about a 51% to 53% gross margin range and you want to operate within those bands. What does it take to get back to that? Is there a revenue level? Do you have to be above $17 billion, $18 billion? Are there offsets, any framework you can give to give investors confidence that we never thought we'd see a three handle on your gross margin. And so we really want to know what it's going to take to get back to a five handle. And if that's significantly changed from the last framework that you provided us? Yeah, good question. So, obviously, revenue is the most significant impact to gross margins. We obviously did not expect to be down at these levels. That said, it's a function of some significant inventory burn. So it's not necessarily a reflection of the demand in the market. So, obviously, we would expect that to ever at some point, which will be a significant lift to the gross margins. The other thing is, in the first quarter, we're going to have about a 400 basis point impact on our gross margins just from under loading, because of the demand softness. And we would expect loadings to improve once we get past the inventory correction we're currently experiencing. In addition to that, we have a number of initiatives underway to improve gross margins, and we're well underway. When you look at the $3 billion reduction that we talked about for 2023, $1 billion of that is in cost of sales, and we're well underway on our way to getting that $1 billion. And then when you start click it further into the $8 billion to $10 billion that we want to hit by the end of 2025, about 66% of that, two-third of that is cost of sales improvement. And we're getting a lot of that from our internal foundry model that Pat mentioned. We're already seeing significant opportunities to be efficient â more efficient between our business units and our factories. And I think we'll have a lot of things to say over the course of this year about areas that we see meaningful improvement. Also, we have smart capital that was modest in 2022, it's going to be more significant in 2023 and much of that smart capital does translate to a better cost structure for us that will help gross margin. So net of that, I feel very confident we will get back to 51% to 53% in the medium term. And in the long term, I feel very confident we will get back to 54% to 58%. And I think Pat said it in the past, we aim to beat that range. Thanks for taking my question. I'm curious, how many weeks of PC microprocessor inventory is still in the channel? I'm trying to understand, whether the demand assumptions are not what they should be, right, or is it the supply assumptions? So when you say that, the consumption this year will be $270 million, right, which is the low end. How do we know that for sure? What if the consumption rate is much lower than that? So just how many weeks of PC microprocessor inventory is there? And do you think Q1 is that clearing quarter, or you think even in Q2, you could be shipping below consumption levels? So overall, as we said, we saw the range $270 million, $295 million. We believe the sell-through rate will be to the lower end of that. The consumption that we saw in Q4 was well below that, and the consumption rate or the sell-in rate in Q1 is even more significantly almost 2x more significant below the consumption rate. Obviously, these are the macro effects that we can't predict, and that's what's taken us a bit more to the low end of the range. But clearly, as we've been working with our customers and channel partners, we've been monitoring very carefully the sellout that they've seen. So we're pretty comfortable with that range. Also, we would point to China and a very unique circumstance there as is well known. And we do expect that, there'll be some level of economic recovery there, particularly we forecasted in the second half of the year. And this is a topic that we continue to work closely with our customers. That said, overall, and as we updated on our PC webinar, we do expect that the long-term market is in the 300 million unit range. So as we overcome this inventory adjustment cycle, and some of this near-term economic. And I think as you heard from Microsoft, PC usage is up, , the number of hours per PC continues to be up. The installed base has gone up. So all of those factors give us reasonable confidence that post this period of inventory correction that will have a very healthy $300 million unit plus or minus market that we're selling into. Yes. Thank you, John. And thank you, Pat. Second question is on the data center. Historically, the semiconductor market likes incumbency, and there is only a share shift if and when the incumbent messes up. And right now, your competitor seems to be becoming a larger incumbent in a lot of cloud deployments, doesn't seem to be messing up. Doesn't it make it harder to displace them? I'm just curious that what edge do you think Intel has to change the status quo of share shift in cloud server? Do you think your design will get noticeably better? Is it architecture? Is it manufacturing? What helps you specifically to change this current momentum of share shift in cloud servers, specifically? Thank you. Yes. Thank you. And I think the most important thing is what we just did with Sapphire Rapids, right? Our customers were anxious for a great product from Intel. Obviously, we would have liked it to be earlier, as we had initially estimated, but we are now shipping a very high-quality product with significant areas of leadership in areas like AI performance, power performance, security feature function, high-performance computing workflows that are 5x the competition and features in areas like confidential computing and security that are quite differentiated from anything in the marketplace. Obviously, share shift, right, particularly in the data center space, these designs were one a year ago, right, or two years ago. And so it takes some amount of time. And against that, we're seeing a very strong outlook for Sapphire Rapids ramp through the year, as I said, 1 million units in the middle of the year, so very strong demand from our customers. And the other thing, as we've indicated, is have we rewon our customers' confidence that they could bet on our road map. And Emerald Rapids, looking very healthy for later this year. Granite Rapids and Sierra Forest looking very healthy for next year. And all of those, I believe, are rebuilding our customers' confidence. And I believe with that, given the massive incumbency that Intel has, and I would just emphasize that even though we have seen the share shift in recent sell-in, the installed base is Intel, right? There's an enormous on some -- many of the cloud customers, 95-plus percent of their installed base is Intel that gives us a very strong incumbency that we get to renew as we rebuild our customers' confidence. So as you put all of those things together, yes, we realize that we stumble, right? We lost share. We lost momentum. We think that stabilizes this year, and we're going to be building a road map that allows us to regain leadership for the long term in this critical market. Thanks a lot. Dave, I had a question on CapEx. I know you don't want to guide for the full year, but you did say that 20% to 30% of the gross CapEx, whatever the number is this year, is going to be sets. I know you don't have a lot of visibility on the chips money you're going to get. But it seems like, best case, revenue is going to be in the mid-50s roughly. And if I take a little less than 35% of that, because you said that it's still going to be 35% or less, that will be the net CapEx intensity. And I sort of divide the numbers, it implies a gross CapEx number, something in the range of $20 billion, give or take. Can you sort of help us just handicap that number? Yes. So let me see if I can -- obviously, we're trying to avoid guiding beyond the first quarter given the murkiness. I would just say we are very focused on the appropriate level of investment necessary for the long-term strategy of IDM 2.0, while being very thoughtful around how much CapEx we spend to manage our free cash flow. I think Smart Capital offsets will be pretty healthy this year, much better than last year. Partly, that's because we'll be fully along with SCIPs 1 with our partnership with Brookfield. We are expecting grant incentives to be a part of this year's Smart Capital offsets. And so those -- and then lastly, we do have already in place, the investment tax credit, which could have some benefit to us this year. So certainly, Smart Capital will be healthy, but we are being very prudent around our gross capital spend through the year. And we'll -- as we kind of progress through the year, we'll see how things develop, and we'll -- you can expect us to manage it accordingly. I think most importantly, we -- we did not expect to be at this revenue level, obviously, for 2023 when we talked about this, net CapEx intensity of 35%. And yet we still maintain the discipline to stay at or below that 35% for the year. And I think that's what investors should take away from that message. Yes. Also, I'd just add, we do and Dave sort of implied it, but we do expect to do SCIP 2 this year as well, which is another source and also the credit center clearly there's motivation on the part of commerce to get that underway and the rules making in place in the near future and start to dispense funds this year. Also, I'd point to Europe as well. So it's EU chips as well as US chip. So all of those efforts are part of Smart Capital for us. We do believe that we'll have the capital necessary to meet both our near-term but more importantly, the strategic long-term investments. And that's what we say we're on track with IDM 2.0. We're on track with the capital, the builds that allow us to restore leadership in our process technology as well as have the factory capacity to both deliver that for our products as well as for our foundry customers. I do, John. Dave, can you just sort of walk through maybe some of the gross margin puts and takes. I know that, again, you don't want to guide for the full year. But -- can you just help us think about what some of the puts and takes might be? I mean, obviously, as volumes grow, that will help gross margin. But are there any other puts and takes that you would sort of call out for us? Thanks. Yes. I think clearly, revenue is going to be the most significant driver of gross margins. We're a high fixed cost model. So we suffer the consequence of that, obviously, when revenue is declining, but we also get the benefit when revenue is expanding. And so what will -- what is currently a headwind does turn to a tailwind as the business recovers. The second most significant impact we have is the underload charges. So that's 400 basis points or so this quarter. And we'll make a determination as to what loading makes sense for the second quarter as we get closer to the second quarter. But we're doing this to be appropriate in terms of our management of cash flow. But again, as business conditions adjust, we will start loading the fab at a higher rate, and that will improve gross margins. I think beyond that, it really is around a lot of the cost initiatives we have underway. It's the $3 billion for 2023, and it's the $8 billion to $10 billion improvement over the course of the next few years that really will help drive the costs and drive the gross margins beyond just revenue and loadings. Thank you for taking the question. Another question on CapEx. I guess bigger picture, can you speak to your CapEx philosophy in a slower demand environment? Is it finding the right number to fit a free cash flow model, or are you looking at your overall demand picture and saying, we need X minus Y wafer starts, and that's why we can spend less. Would love to get a sense of how the slowdown here is potentially changing or potentially not your strategy of spending? And if it's not, is it just simply delaying investments into 2024 and 2025? Thanks. Yeah. Thanks, C.J. I'll start and ask Dave to jump in. We think about the capital budget with two lenses in mind, right? One is the strategic lens. Am I going to get back to leadership at 20A and 18A? Yes, am I going to make the capital investments required to do that? Absolutely. To some degree, do we scrub those? Could we look hard at those? Where can we save tens or hundreds of millions of dollars on those? Yes, we will. But we're not going to diminish from the capital required for strategic leadership for the long-term. So strategic capital, largely unchanged. The second bucket, of course, I'll just call it, capacity capital, right, and adjusting to the near-term ebb and flows of the business requirement. And, obviously, in this macro environment, that's been adjusted meaningfully downward and we're finding everywhere we can to squeeze our existing capacity more effectively to be more aggressive in terms of how we work with our equipment suppliers in those areas and doing everything we can to minimize the capital that's required for capacity driven requirements as well. And that's where the larger trade-offs have been. And, of course, in a business as large as ours, we have labs and buildings and everything else. We are scrubbing those like crazy as you would want us to. You took one of mine. Obviously, the OpEx area, yeah, is an area that we've really focused on and Pat mentioned the lab piece, which is an area -- one of the areas that we have found efficiency. And I guess the last thing is that we have seen our capital offsets be higher than our original expectation. We were planning for probably one-third of what we think we'll get in 2023 when we announced our smart capital initiative in -- at the Analyst Day. So that's obviously coming in stronger. Of course, Pat already alluded to the fact that a lot of that is -- Skip has turned out to be a pretty powerful tool, and this will enable us to do a Skip 2 this year as well, which obviously helps. I do a quick one. And again, I know you don't want to guide the full year, but as you look at different scenario analysis for 2023, how do you see return to positive free cash flow playing out? Is that something that could come in the second half, or that's really a 2024 event? Well, 2023, we were thinking was a breakeven free cash flow year for us back at the Analyst Day last February. Obviously, in the first half of this year, we're going to be below that model. But as we look into the back half of the year, we would expect to approach the model in 2023. And of course, 2024 is a bit away from where we are right now, but this is the thing that we spend a lot of time on. I would tell you one thing, if you look at our free cash flow for 2022, we came in roughly around minus $4 billion. If you remember in the quarter before, we forecasted that we would be somewhere between minus $2 billion and minus $4 billion. We were actually assuming a higher level of capital offsets, which is still coming, but pushed into 2023. And yet we still hit the high end of that range. And the way we did it was through working capital initiatives. So this is a big part of our strategy around managing free cash flow, is more attention to working capital. It's something that I think in the past may not have been a big focus here, but is a very big focus here. It's how we -- how our shipments are managed in terms of linearity, how we manage payments, how we manage our inventory. The fact that we're taking underload does affect the gross margins, but it also improves our cash flow, because we're spending less on variable costs. So these are areas that we think can be pretty beneficial to us and be a tailwind for us in terms of free cash flow as we progress through the year. Good afternoon, guys. Thank you. Dave, the first question, I get it a lot is, just with the challenges that you just mentioned at C.J.'s question on free cash flow. And I guess, well done to you and your team of extracting as much cash as you did out of working capital in the quarter. But I get questions about the security of the dividend all the time. And maybe that's a Board-level decision, but maybe you and Pat could address it a bit. Is that the current levels of dividend? Is that sort of a sacrosanct thing at Intel in your current operating plan? Are there discussions around it either way? Donât shoot the messenger, itâs a question I get a ton. Thanks. Yes. Well, obviously, we announced a $0.365 dividend for the first quarter. That was consistent with the last quarter's dividend. I'd just say the Board, management, we take a very disciplined approach to the capital allocation strategy, and we're going to remain committed to being very prudent around how we allocate capital for the owners. And we are committed to maintaining a competitive dividend. Yes. Thanks, guys. Thanks, John. I guess, as my follow-up question, guys, I wanted to dig into the DCAI business a little bit. And that you guys talked about, I think, the PSG or Altera being up, I don't know, 40-odd percent year-over-year, which, if you just kind of rough math, it means that the core cloud plus enterprise server business is down 40%, something like that. And so, maybe, Pat, could you walk us through what -- is that roughly right in terms of math and just where your -- how you see share loss versus ASP versus weakness in the markets in China and enterprise? Just how do you break that down for us, what operationally is happening in the server share space? Thank you. Yes. So PSG did have a very good quarter, has a very strong backlog, continues to grow. But I'd say the math that you suggest is quite incorrect, given the relative size of those businesses. So we'll happily offline talk a little bit more through that. That said, we did -- we grew less than the market last year and saw some share loss. We see that stabilizing this year. The key factor is better products, right? And we've just released that with Sapphire Rapids and getting great response and our announcement event on January 10 was a customer-centric ramp this baby product line. We had strong participation from all the CSPs, all of the OEMs, all of the ISVs, end users. So it was seen as a very strong event. This year, we'll be very much about ramping that and we'll see the improvements in both market share position as well as ASPs as we ramp that product through the year, and the confidence in the road map. And that will be the determinant, okay, you have a better product now, great. Customers are building it on an installed base. But do we have confidence in your long-term? So I'd say we've reestablished a very credible road map. You'll see lots of news coming from us this year as we start delivering on samples, et cetera, of the next-generation products as well as the continued ramp of Sapphire Rapids with highly differentiated features and capabilities. So we feel like we've put the worst behind us, right? And we're now coming back to the front foot in this business area. And I'll say in a very customer-centric, ISV-centric way that delivers our customers the use cases that they need in their business. Certainly. One moment for our next question. And our next question comes from the line of Toshiya Hari from Goldman Sachs. Your question, please. Hi, good afternoon. Thanks so much for taking the question. Pat, I was hoping you could talk a little bit about the demand environment in DCAI across cloud, enterprise and perhaps your comms customers. I think in your prepared remarks, you talked about the inventory correction in enterprise being ahead of cloud. So do those comments kind of imply that going forward, cloud could -- the demand there could moderate or decline as we progress through the year, or if you can expand on that, that would be helpful. Thank you. Great. Great. Thank you, Toshi. The -- what we said, clearly that we did see demand softening through the year in data center overall. That's a market statement. Obviously, we have more exposure to enterprise in China, which we believe weakened our position a little bit more in the year, but we're seeing those same characteristics now with the cloud providers as well. So we see all of them weaker in the first half of the year. We are, I'll say, a touch optimistic that China will come back and enterprise will come back more rapidly than the cloud. And with our stronger exposure in those segments, we believe that is a potential good news for us as we go through the year relative to competition. The networking space is one where we have very sustained leadership and strength in areas like vRAN and O-RAN are ones that our platform is dramatically better than competitors. And with that strong market share through the year, we also expect some level of softening there in those in the networking area, but not as much as some of the other segments that we would have. First half of the year, we expect to be down year-on-year in the second half of the year to returning to growth. So inventory adjustments, a weaker market in first half, recovery in the second half of the year is what we expect. Overall, and obviously, the relative position, we believe that we have is stabilizing and the markets that we're stronger in, we're optimistic that they'll come back a little bit stronger as we go through the year. I do. Thanks, John. Pat, you also talked about your focus and commitment toward value creation, you mentioned how you guys are pulling future investments from the switching business. As you look across your portfolio as of today. I think to your point, you've done quite a lot since coming back. Like where is the incremental opportunity as you think about improving the portfolio going forward and creating value? Thank you. Yeah. And I'll just say here without being too specific and some of these things are under evaluation, discussion with customers and the best way to handle it. We're doing a thorough analysis across the portfolio. And I would say we are looking at every aspect of the portfolio, where we're getting good returns, where we're not. And we're making decision after decision to optimize the portfolio. And as you say, we haven't been hesitant to make those decisions inside the back. And we have a few more that we're looking carefully at. But we're also looking at every area of the business. Dave suggested in his comments, hey, can we do a better job with our line? Could we do a better job with our building assets? We've also discussed as part of the internal foundry model that we're making major steps to improve our automation and ERP efficiency to run the company more. Some of our people actions. We've been very scrutinizing and benchmarking ourselves against best-in-class in every aspect of how we run the business. So one-by-one, we're saying we're going to be world-class as measured by benchmarks in these areas and all the business areas that we're in, we believe they're strategically important and yielding good results with our shareholders' investments. Great. Thank you. Weâre going to talk about the reception you're seeing with Sapphire Rapids. And in particular, it seems like it's a really good chip. But I think the price at the platform level is getting more expensive, DDR5 is more expensive. What's it like right now migrating to a more expensive platform and environment or budgets are under pressure, does that change the ramp relative to other CPUs that you have? Yeah. Thanks, Joe. And you are touching on a very important issue, the memory. And obviously, the memory pricing for DDR4 has collapsed, right, and making that pricing gap versus DDR5 very visible currently. That said, customers don't buy these platforms on memory prices. They buy them on TCO, right? The total cost of the operations that they get for the performance as they put them into operations. So memory price is one piece of that. But I'd also say DDR prices are expected to decline as we go through DDR5 price and the gap to DDR4 is widely forecast to decline, and that gap will diminish as we go through the year. However, right, you contrast that to the significant performance capability. And in some areas like AI, we're seeing five to 6x performance benefits. And when you put that into a TCO calculation, it's overwhelmingly positive. Security is not measured on TCO. It's measured on absolute statements of security and confidential computing. So overall, we are driving this ramp very aggressively through the year. We have strong demand of customers. We're ramping our factories quickly. And we do believe that we'll have a strong ramp of the Sapphire Rapids platform as we go through the year. Yeah. I also just wanted to touch on, I mean, you mentioned the migration of the AXG business into DCAI and CCG. Is that -- is there a change there in any of the priorities, or is it just a restructuring of where those businesses reside? Yeah. It's a restructuring of where the businesses reside. And as we move past this, I'll say, launch phase of those products. And we're now into the scale phase of those product lines. And for instance, discrete graphics, driving the attach rate and channel motions with our enormous client business. In the data center, bringing a broader portfolio across HPC, our Flex product line, the AI capabilities that we have that we're uniquely delivering through data center. So all of this is about is the efficiency and scale of those business areas. And we've been having numerous discussions with our customers about these changes, and they have been very well received. And I'd say all the products that we launched out of AXG, the Flex product line, the discrete graphics product line, the MAX product lines. All of those products are continuing forward, and we believe all of those will have strong ramps in their volumes, revenues and market impact as we go through the year. So with that, let me just wrap up our time together. First, thank you. We're grateful for you joining us today, the opportunity that you've given us to update you on our business. And clearly, the financials aren't what we would hope for. But we're also pleased with the execution progress we made. And as a result, we're confident in the strategic outlook that we have for our business. Though the macro is difficult. It was difficult in Q4. We expect it to remain difficult as we go through the first half of the year, but we're laser focused on controlling the things that we can and every aspect of our execution, cost management and transformation is in our hands and we are well underway in executing against those paths. So with that, we look forward to seeing many of you throughout the quarter, updating you on our progress next quarter. Thank you very much. Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.
|
EarningCall_1144
|
Good day, ladies and gentlemen. And welcome to the Sands' Fourth Quarter 2022 Earnings Conference Call. At this time, all participants have been placed on listen-only mode, but we will open the floor for your questions and comments following the presentation. It is now my pleasure to turn the floor over to Mr. Daniel Briggs, Senior Vice President of Investor Relations at Sands. Sir, the floor is yours. Thank you, operator. Joining the call today are Rob Goldstein, our Chairman and CEO; Patrick Dumont, our President and COO; Dr. Wilfred Wong, President of Sands China; and Grant Chum, EVP of Asia Operations, Las Vegas Sands and COO of Sands China. Today's conference call will contain forward-looking statements. We will be making those statements under the safe harbor provision of federal securities laws. The company's actual results may differ materially from the results reflected in those forward-looking statements. In. addition, we will discuss non-GAAP measures. Reconciliations to the most comparable GAAP financial measure are included in our press release. We have posted an earnings presentation on our website. We may refer to that presentation during the call. Finally, for the Q&A session, we ask those with interest to please pose one question and one follow-up question, so we might allow everyone with interest the opportunity to participate. The presentation is being recorded. Thank you, Dan, and thank you for joining our call today. A few brief comments, then we move to Q&A. Macao's future is bright, remains the largest integrated resort market globally. Our commitment to investing in this incredible market is never wavered and with an unrivaled critical mass of world-class IRs as well as continued improvement in transportation infrastructure in the region. Macao will mature into a vibrant, diversified tourism market over the coming years. SCL's positioning and scale are perfect to capture the opportunity. Our diversified IR model with continuous investment in non-gaming segments, including MICE, hotel suites, live entertainment, retail, food and beverage, positions us well to capture the growth opportunity. Our diversity, scale and track record in non-gaming make us uniquely positioned to cater all segments of the market enable Macao to appeal to international tourists as well. The new concession is a win-win. We deeply appreciate the opportunity to operate one of those gaming concessions in the next 10 years. We are excited to deploy more capital to expand non-gaming offerings at SCL. The $3.8 billion commitment is just a baseline. We hope to invest more as the market continues to grow. The commitment to develop non-gaming is the core of our investment and operating strategy for the past two decades, whether it be MICE, entertainment themed attractions or destination sales and marketing in overseas markets. We view the investment commitments by SCL and the rest of the industry is positive for Macao. Over the past few weeks, travel restrictions have been lifted. It is too hard to tell the true measure of the underlying pace of recovery, but indications are extremely positive. We have seen significant improvement on property visitation, gaming volumes, retail sales and hotel occupancy. We remain positive on investments in, The Londoner and Four Seasons. Our investments position us well as the market recovers. The quality of our new products will also help drive high-value tourism from the region, especially the overseas markets. Turning to Singapore, our normalized EBITDA and gaming volumes are back now to the 2019 levels. Normalized EBITDA reached $386 million for the quarter. Rolling volumes are approaching 2019 level and mass win per day is now exceeding the level of 2019. We have also delivered strong performance in non-gaming across all segments, including retail, mall, hotel, F&B and MICE. Retail is especially noteworthy with a 26% increase in tenant sales per square foot versus 2019. Our [Indiscernible 0:03:45] casino renovation program is progressing. Renovated product will come online throughout the year. Looking ahead, Marina Bay Sands is poised for further growth as all of our markets recover and become free of travel restrictions and airline lift continues to recover. Thank you. Ladies and gentlemen, the floor is now open for questions. [Operator Instructions] And the first question is coming from Joe Greff from JPMorgan. Joe, your line is live. Hey, everybody, good afternoon. And good morning to those in Macao. My first question, obviously, is going to be on Macao, and Rob, Patrick, Dan, can you remind us what levels of mass GGR either on a dollar per day basis or as a percentage of 2019 levels, do you need to be at in order to be EBITDA breakeven? Obviously, the 4Q saw a narrowing relative to the 3Q. I'm presuming and would love for you to expand on it, I'm presuming what you're seeing thus far early in January is either at EBITDA breakeven or maybe more recently generating some level of positive EBITDA. So pessimistic, Joe. We're more than breakeven. A lot more than breakeven, doing just fine. I'll ask Patrick to give us some color on those issues, but I think we're past the breakeven. We're now in the positive territory moving towards very positive territory. Patrick? Thanks, Rob. So a couple of things to note. Mix is important here. So as you know, we're a mass and premium mass and really a large-scale tourism investment company. And I think the key thing to note is the market is open. Liquidity is in the market. This is going to be a premium led recovery. We invested significantly during the pandemic. And the benefit of that investment is on full display. We have new suite products. We probably have the -- what we think is the best new property we've had in a long time, opened up in Macao. That investment is really showing power in the market right now today. There's significant non-gaming scale and investment that we've made that is bearing fruit. And so it's great to see the recovery. It's great to see the volumes coming back. It's interesting, I think, Rob has talked a lot about pent-up demand over the years. He's witnessed it in other places earlier in his career. We saw it here in Las Vegas, and we experienced it fully in Singapore and now we're at a run rate that is really, really strong. And I think we're seeing that in Macao. I think the key thing is this is going to be a premium led recovery. Yeah. Joe, I think we can be confident, be very honest and direct. We are in very positive territory and keep moving upside. I think the one thing I would say to you is that no one ever questions the power the base mass market. I would remind you I was looking at our numbers, base mass in Macao in our building costs about 1,500 Hong Kong per hand as an opening bet. So it's a couple of hundred bucks a hand USD. That's the base mass business. The problem we have right now is you can't get a seat in the games in our buildings. We're running 95%, 100% occupancy in those games. And the same applies to slot ETGs. The big question everyone's thinking about obviously is premium mass. And I think you'll be pleasantly surprised when you can see the numbers coming out of the premium mass. And you'll see the liquidity, you'll see resilience in that segment. And it's been a very pleasant surprise. Grant, can you add some color to that? Yeah. Good morning and good afternoon. Yeah, I think the key thing we're seeing right now is that the quality of patronage is very high across all segments. So it's not just premium mass, it's also the base mass, it's in the retail segment. So we are seeing a very strong recovery in spend per customer. And again, that's not concentrated in any one segment. It's extremely broad based. And I think what you're seeing in the public numbers on presentation were recovered. I think for CNY against 2019, we're about 40% of where we were in 2019, Chinese New Year for the first three days. And we're seeing revenues and volumes outperforming that visitation recovery, which is natural, which is what we've seen in other markets. So things are looking extremely positive right now. Great color, guys. Thank you. And then maybe switching over to Singapore for my follow-up question. Obviously, your comments on mass gaming, Rob, obviously, very strong. Can you maybe talk a little bit about your comments that you believe on like forcing late December and thus far in January, there's been an inflection at least from the Mainland Chinese segment? Can you give us some perspective on the relative -- I don't know if you want to look at it on a revenue or EBITDA contribution looking at 2019 levels. And then where that was sort of more recently as a percentage of the total mix? Yeah, sure. I think the important thing to note is that there was this pent-up demand story in Singapore and now it's blossomed into full on bonanza. And so what we're really seeing is every segment is working. And so we had a lot of noise in this quarter because of the hold. We rolled north of $7 billion, which is pretty unbelievable considering where we came from. And the mass play was very, very strong. And so while we were doing this, we had almost 20% of our room inventory out. And so when you look at that 477 win number in mass and you look at the rolling volumes and realize we're out 20% of our rooms, there's a lot of leg room here. There's a lot of room for us to go. And so I want to be careful when we talk about margins and contribution because we're going to adjust that as we change mix, as we get rooms online as we go through the innovation, as we change our suite product, as we price up, as we yield up, and as we have access to higher value tourism. So this is really a forward-looking thing more than it is what happened in this quarter because we're going to continue to sort of adjust while we get our mix right. So what I would look to in this business is margin expansion over time, more rooms coming online, better product, better service and, of course, being able to capture a very strong component of both VIP play and mass play. Joe, I think we're missing -- to Patrick's point, we're missing -- we're in a great place. We're back to 2000 -- we're back to 1.6 run rate if you take out the abnormal low hold on the rolling. But the two drivers that we just thought -- there's a lot of drivers, but the two jump off the page or renewed tours throughout Asia and China in particular. That's yet to come. We haven't -- we're doing all this -- we're in 2019 with no China participation and or limited China participation. And as Patrick mentioned, a handicap physical plan, we are in a very, very fortunate position with MBS. I think it's going to become a property, a lot of growth. And I believe it's going to be a $2 billion business in the future. And I see nothing holding it back, except for our own renovations, which are extraordinary. I hope you get a chance to see it. And the reemergence of Asian tourism, including China back into the property. The only regret we have is Singapore. We just like to have more capacity because -- you'll see -- I think you'll see in this year the power of -- the earning power of MBS. It's an extraordinary product, and we're lucky to have it. And Patrick, just back to your mix and yield comment. Do we interpret that, at least if we look back to 2019, that, that China MBS patron was a -- had a positive mix on spend per trip or spend per day or gaming revenue per day? I think it's a combination of factors, Joe. I think, obviously, the China market is always powerful. But I also think there's cost issues in all these markets. There's this inflationary factors, undeniable, be it energy, wages -- I mean, there's a different world out there, and you've got to cope with it. But the thing about MBS that fascinates us is we believe we can drive revenues across the board. We're going to rethink our retail, rethink our table mix, our floor, our room pricing. We think we have a product that the demand will be close to insatiable for it, from the gamer and non-gamer perspective. And we're going to overcome margin cost -- margin by overcoming costs with higher revenues, a lot higher revenues across the board in every segment. That's the approach. We see MBS as a very unique product that's unrivaled in that part of the world. And we can just push pricing across the board, gaming pricing, ADR pricing, retail pricing, F&B pricing, it's just that good and that desirable. And let's face it, the market right now is using our favor. Singapore is very desirable from a lot of perspectives. Hey, everybody. Thanks, and good evening. Rob, or whoever wants to handle this, I was just wondering, in the brief time that China has more or less reopened, have you guys seen positive or negative, any change in behavior as it pertains to patronage at MBS? MBS, that's a good question. I think it's too early to say we're going to see that. I see us as getting plenty of trying of participation, both in Macao and Singapore. But it's really too early to say. It just happened so quickly and the turnabout was so rapid that I think it's too hard to predict. I think the way this is going to segment though is that we're going to get more than our fair share of the rolling business in MBS. That moves in that direction, and we'll get the premium mass customer to visit more into Macao. I think our business really is going to split in that direction. I think it's very predictable what's going to happen here, and we're okay with that. So Singapore will get the top of the top. But each of those places will get tons of premium mass demand from China and throughout the region. I also think people underestimate how powerful Macao can become as a desirable visitation place throughout China. It's got everything. It's got the rooms, it's got the access, it's got the -- one thing, it has beyond Singapore, it's has lots of capacity and lots to offer. So I think Macao is going to be a very strong international destinations ahead. We plan to be very aggressive trying to push people into Macao to see the property, all of our products. That makes sense, Rob. Thank you. And then just as a follow-up, and I understand kind of looking backwards at things that are Macao related is somewhat pointless in the environment that we're in right now. But it's just -- it does stand out a little bit when looking at your base and premium mass table revenues from the slide deck, your premium mass is representing, I think, 20% of 4Q '19 base mass kind of more like mid-teens, 16, something like that. However, the premium mass is down considerably year-over-year, whereas the base mass is reasonably steady year-over-year. Is that a whole dynamic on just lower than normal historical volumes? Or is there something else that's kind of made those 2 diverge more recently here, and then the fourth quarter specifically? No, I think it's just a visitation issue. It's not a whole issue. It's visitations sure. I think you're going to find that washes out. I wouldn't take those numbers too much to heart. I think when you look at Q1, I wish when you see January, when those numbers are out there for the market, I think it will all wash away quite nicely. It won't be -- it won't enter into your thinking, Carlo. It's a nonevent. I think you'll see a surprising strength in both those segments. I would say in Macao, we're going to be very strong, very represented in the base mass because we have the capacity. We're a scale player. And so we have the capacity in the gaming, non-gaming, retail, restaurant space to do extraordinary things in the base mass. And again, as I'll reiterate, base mass in Macao is a different animal than the U.S. It's a $200 base bet, $175 base bet. So pretty special customer. We are going to represent because of our scale. But on the other hand, with all of our suite product, et cetera, I think we'll also be the leaders in the premium mass business. So we have a very strong future ahead of us in Macao. I always chuckle, people, if you're looking for a negative commentary in the Macao market, you're in the rolling earnings call. Understood. And then, Rob, just quickly, if you could remind us, to the extent you guys are willing to share it, 2019, your direct VIP volume, your in-house VIP volume as a percentage of total, would you guys be able to share something like that? We could share it, we just won't. No, we're not going to do that. But Carlo, thank you. It's good to hear from you. So the visitation data for Chinese near looks like Hong Kong has been the bigger driver in the recent uptick in visitation. Is there any way to parse out recovery between Hong Kong and Mainland China? And any reason why spending behavior and recovery may be different between these source markets? Yes, you can see from the visitation numbers been published by the Tourism Bureau. The Mainland Chinese visitation is at about 30% recovery rate versus 2019 CNY. So obviously, with a 40% recovery for overall visitations, Hong Kong visitation recovery has been higher. Mainly, I think, as a result of just the ease with which they've been able to go. And obviously, Hong Kong has had a longer stabilized situation with, as it relates to the pandemic. So I think from a pure visitation point of view, it's just not unexpected. And bear in mind, the transportation support for the Hong Kong visitor only really opened up on the eighth of January. So this has been a very rapid increase in Hong Kong visitations. That said, I think we referenced back to the comments that Rob made earlier and I alluded to as well, I wouldn't get too stuck on the visitation recovery. I think in these types of reopening, we're going to see the premium customers come back first. The core customer coming back as a much bigger percentage than the overall visitation. So I think what we're seeing is the quality of revenues and the patronage from all regions that visit in Chinese New Year has been very, very high. So we are way outperforming the visitation recovery in terms of volumes and revenue. And indeed, I think if you look at our property visitations our recovery rate in visitations to our own property, is far outperforming the recovery in the overall visitation numbers in the market versus 2019. Steve, to Grant's comment just, again, we don't want to confuse visitation with GGR. There's not necessarily an easy way to make them work. I was recently in Singapore, I walked in one of our retail stores with our retail person and she told me the sales in the store were like $70 million. And I said there's nobody here, no one in the store. And she said, Rob, we only need the right people, not a lot of people. I think that's what's happening in Macao, we gained the right people showing up in mass, and it's reflecting in the numbers. You'll see that when the market numbers come out. I think the early adapters to the market are the right people for the market. And I think that's why there's a confusion in the visitation versus the actual revenues. Makes sense. And maybe as a related follow-up there, there's been a similar dynamic, stronger spend per visitor in the U.S. that ultimately drove much better margins. How are you thinking about the puts and takes to margins in Macao versus what we've seen in other markets? Yeah. I think first of all, our cost structure is in good shape. It's been -- unfortunately, we've had to spend extra effort in optimizing the cost structure over the past two or three years. So we've got a very lean cost base right now. In terms of gross margins on the revenue, I think a couple of things. One is our mix, obviously, is more favorable going forward just from a gross margin mix perspective simply because a vast majority of our revenues will be coming from the non-rolling and slot segments. And then secondly, the non-gaming, we expect to be growing, and that's obviously a much higher margin. We expect to be growing retail, hotel, F&B, actually all the non-gaming segments. So that's the structural framework for the margin. But obviously, the actual flow-through in the percentage margin we ultimately deliver from this very positive structure is really dependent on the rate of volume recovery. So we still need the top line to recover to a certain level before you get the flow through. And then to go beyond that, obviously, we hope and we all are working towards that, is for this market to continue to grow and, hopefully, at least in the mass segments and non-gaming segments glad to go beyond where we were in 2019. So if that happens, obviously, our margin structure should be very positive. So hopefully, that gives you a sense of how we think about the structure of margins going forward. Great, thanks. I wanted to ask, you've obviously always been very focused on the mass business there. But some of your competitors that have been more VIP focused, are you seeing them do things differently now that there's not the VIP market to go after in the same way there had been? Is that -- is it too soon to be seeing what changes that might mean? I would assume it is, but I'll defer to Grant since he's on the ground. I can't imagine we have any visibility into that at this point. But clearly, we have a new market here, which favors our asset base. And our approach for the last 20 years has been scale. As you well know, Robin, it's a mass story with premium mass and retail commencing, et cetera. So we don't have things like -- it's tailor made for what we do, this environment. Our competitors will adapt and have to change. But I don't know. Grant, any color on that? Yeah. I think, Robin, the competition for premium mass has always been very intense. And I think we'll continue to be, given the dynamics you just referenced. At the same time, I think as Rob says, we've got a footprint and scale advantage on our [Indiscernible 0:24:40] non-gaming asset facilities, I think really position us very well for all segments of mass. And then as Patrick referenced at the outset, the product that we've been developing for the last three years, especially, The London and the Grand Suites at Four Seasons, are really prime position to help us be more competitive the premium lifestyle segments up in market as well as, I think, hopefully, to drive overall high-value tourism to Macao over the coming years. And I do as to point about international tourism as well. I think our footprint to combine with our new products and our traditional strength in MICE, in international marketing network really position us very well to bring those high-value guests to Macao as well. Great. Thank you for that color. And then just for my follow-up question on Macao. Can you give us sort of a rough sense of that dollar commitment that you've made to invest over the next 10 years in Macao? Kind of roughly what percent of that might be new projects and what percent might be -- might kind of fall into the OpEx line, kind of like overseas marketing and things? Just kind of CapEx versus OpEx split, just ballpark? Thanks. Yeah. Sure. I think one thing that would be helpful. If you turn to Page 22 in the presentation, you'll see some details on that. So it might be best to refer to those pages because we do break it out, and there are several pages behind it that explain what our concession renewal commitments actually are. So it's there in the presentation. I apologize. I think the key thing here is that we're very committed to investing in the Macao market. We think this investment will drive additional long-term tourism value and diversification of Macao's economy. We're very excited to make these investments, and we think these are things that will really help achieve our goals in the goals of the government. So we're looking forward to it actually. Good afternoon. Good morning, Grant. So just high level, as you kind of look through kind of what you're seeing probably real time, could you give us just your latest thoughts on maybe the pace of recovery here? Do you expect things to be pretty linear or any chance of whether it's COVID or restriction-related setbacks or anything else that could change what you're seeing on the ground? And obviously, Chinese New Year is fantastic. But it would seem like the opening here is just going to continue. Any reason that, that would be kind of different from the reality? Or how are you seeing your bookings shape up and the patterns you're expecting to see over the next couple of months? I'd begin by saying, first of all, we're just thrilled to be open and making money and seeing demand like we're seeing. I don't think any of us have the aptitude or the insight to tell you what's going to happen -- they have post-change news. But I do think longer term, you have to have real strong confidence. And you see -- when you get to see these numbers that we are seeing that this is a market that's going to rebound. This market has a strong base mass, premium mass. And some of the fears be in the market about, it was liquidity like, what's resiliency, I think those fears will be pushed to the side. What's the trajectory and how fast it happens? I don't think any of us have the gumption to make venture a guess. I think it would be silly. We just feel fortunate we're open. We're operating. We think it keeps getting better, not worse. I don't believe COVID is going to be -- obviously, China has gone through a different trajectory than we did here in the U.S. But hopefully, that won't be a problem. Again, I don't want to speak anything that I can't speak for. But if things keep going like they're going, we'll all be in a very happy place in 2023, especially, I think, somewhere in the second half of the year. As normal travel patterns resume, Hong Kong gets back on speed, Mainland China. I think there's a lot of growth potential and a lot of good thoughts coming our way vis-a-vis the future. We are -- again, as I said earlier, we're not going to tell you that we don't believe in this -- we believe in this strongly very strongly. We believe in our assets very strongly. We believe in international tourism in Macao very strongly. So we're not going to predict when it happens, how it happens, how fast it happens. But we feel very positive about what's going to happen in Macao in the long term, very positive. And we're looking to investing money in there and getting back to where we were in the past in Macao. We couldn't be more positive on the can long term. Great. Thanks for that, Rob. And then maybe a little bit more specific one for Grant, if I may. But just wanting to dig in a little bit more on the labor and staffing side of what you're seeing in Macao right now. You talked about the margin structure high level. But are you fully expecting to return to levels of staff that you had pre-COVID? Are you already there? Will it be even above those levels? Kind of what's needed and what have you optimized? I know those people have -- many of them have found employment elsewhere, the market has grown since where we started. So kind of how do you think about maybe either FTEs or overall operating expense run rates relative to 2019? I think, Shaun, we've also become more productive and efficient through the past couple of years. So I think we'll have to rethink -- it wouldn't necessarily be referencing exactly back to 2019. And also a mix of product has also changed quite a bit through the Londoner. So to give you a bit more color, today, we are short of manpower relative to full operating capacity and relative to the demand that we're seeing. So we're not operating one of the Sheraton Towers as we speak. So we are minus 2,200 rooms from our operating capacity. And our newest hotel Londoner Court, which we soft opened in the past year, we're not at the full operating capacity for that high end all-suite hotel. We're still only about two thirds of the way through in terms of ability of manpower to operate the whole hotel. So both at the top end and at the mass end, we are still short of manpower to operate at full capacity. And we'll be progressively hiring to fill the gaps as we go through the recovery. And hopefully, within the next few months, we're going to be in a better place relative to our full operating potential because we clearly see the demand pattern, I think is going to urge the whole industry to staff up and to be able to operate, especially for these peak periods. And that's another part. We have no crystal ball as Rob says served on the post CNY. But clearly, the early indications of metrics like the demand for the hotels is telling you that, yes, the demand is staging a strong recovery. Hi, good afternoon. Thanks for taking my question. In the slide deck, you highlighted principal areas of development being Macao, which we just talked about, Singapore, which we talked about, and New York, which I was wondering if you could elaborate a little bit more on. But second part of that question is, I know in the past, you talked about other potential opportunities in Asia like a Korea or a Thailand, years ago we talked about Japan. Wondering if those are going quiet at this time. So I guess, firstly, on New York, and then secondly, potential Asian opportunities? Thanks. Chad, let's revert your mind, I'll reverse it just. I think we all know that Thailand has been discussions there, and we're certainly looking at Thailand. And that's no secret has been in the press that Thailand is a possibility. So we're certainly looking hard at Thailand. I would love to be -- have a presence there in the future. Japan, as you referenced, is not there. And Korea is nothing viable to speak of today. So we'll jump to New York, which is an extraordinary and unique opportunity. And I think for the winning bidder or bidders, it's going to be an amazing opportunity because of a very simple dynamic of a huge market with limited capacity. There's only a few casinos there. It's probably the only place in the U.S. where you can have millions and millions of people, and yet there'll be probably just a handful of casinos total. The win per units there will be exceptional. The lucky winner is going to do very, very well. I think the evidence of the market is clear just by looking at the three operating properties under the table games. And we really don't have much of a -- it's not a great product right now in New York as far as room capacity. It's still doing approaching USD 2 billion with just slot machines. So our approach is very much in LVS, it's anchored by an LDH historical approach, which is scale and quality. We're not looking to build a casino, looking to build not a regional casino but rather a truly large hotel with spa convention space, dozens of restaurants, a new theater, a huge entertainment feature, a transformational product, which will positively impact the community and grow tourism a powerful statement. We're not looking to be in this thing in a limited way. We'll be all the way in. And we think if we do it, it will be transformational for the county we're working in, very good for the people in the county and something they can be very proud of. And it will drive tourism -- outsized tourism into Nassau. Our bid is very much traditional on the thinking of LVS large-scale with numerous non-gaming assets, lots of meeting space, probably 400,000 square per foot new space. So I view New York very much very unique to the rest of the United States. It's not -- it's a population in the many millions to just a couple of casinos, very different here in Las Vegas. We've got a huge local market but dozens and dozens and dozens of casinos. There you'll be basically alone. And so it's going to be very -- it's an exceptional opportunity. It won't come along again. I think this is one and done. So we're trying very hard. And we've been trying to do New York for a number of years, but it looks like this is finally someone's opportunity. Hopefully, it's ours. Thank you very much, Rob. And then secondly, I just wanted to ask another one on Macao, now that you've had some more data in the market, Grant. It seems like there's an even bigger shift towards Peninsula -- or I'm sorry, versus to Cotai versus Peninsula than we've seen in the past. I was wondering if you could confirm that or if that's really just kind of a mix of a reflection of what we're seeing from the different modes of transportation. Wondering if that's a trend that could continue in '23. And then related to that, how are you thinking about your asset and the Peninsula there's CapEx opportunities? I know that's not part of the big CapEx plan. Thank you. I think I haven't seen any data on the split between Cotai and Peninsula. However, it stands to reason, I think, structurally, we see -- and we have always said that Cotai will become the primary hub. And I think even pre-COVID, we were already more than half of the mass revenues from Cotai. And I think that trend will continue. I think there's a lot of different reasons. But I think at its heart, the main reason is just the cluster of world class integrated resorts that you have on Cotai. And what this, I think, next generation of these lifestyle consumers are looking for from Macao as a destination, and all of the investments in non-gaming that are going into basically making these results even more desirable over the next 10 years, all of those structural factors are surely will continue to push the balance of revenues towards the Cotai side, and that's a structural issue that will continue to evolve over the long time. As regards to -- we obviously have one asset on the Peninsula, we do intend to reinvest in that asset. But it clearly the majority -- the vast majority of our capital will still be going towards our Cotai properties. Hey, everybody. Good morning. Thanks for taking my questions. Starting on Singapore. I was curious if you could compare the spend per visitor that you're seeing there to what we saw in Las Vegas in 2020 and 2021. If that's sort of holding up in the same way, if it's -- if the curve looks different quarter-over-quarter. And then if you want to throw Macao early days into that comparison, that would also be helpful. Yeah. I think it's really hard to compare between markets. The key thing to note is that it's really all about pent-up demand, consumer tourism experience and the products that we offer. And sort of the nature of those assets for high-quality tourism. So it's not really fair to compare between markets. The price points are different, the consumer behaviors are different. It really doesn't look the same. What is thematically similar is the pent-up demand story. And Rob -- as I said before, Rob's seen it in his career in other locations. We experienced here in Las Vegas in a very strong way. We saw it in Singapore in a very strong way, and it's still in effect and we're starting to see them in Macao now and it's coming on strong. So I think it's really the nature of consumer behavior as opposed to the specific price points in each market. It's part of the -- to Patrick's point, think about what Singapore is market GGR versus Macao, Macao could be a $25 billion, $30 billion GGR market has been higher historically. And Singapore just doesn't have the capacity. And then Las Vegas is much more of a -- it's got a gaming component, it's got a very strong non-gaming. So it's almost impossible to apples-to-apples. The driving force is the scale of people in Macao in Singapore -- in Mainland China, the accessibility to adjustable market is so huge in Macao. And so the product offering. To Grant's point, the Peninsula, versus the Cotai, it's got such enormous capacity and great product. It's hard to -- that market is so outsized when it just back at full capacity, it's hard to compare than anything. It's so powerful. Okay. Okay. Thanks for that. And then on Slide 22, the long-term commitments in Macao slide, on the capital, the left side of the slide, I was curious, looking at your plans for the next 10 years if you think you're going to be able to achieve return levels commensurate to recent projects that you've done in that market and you've enjoyed in that market? Yeah, we sure do. We forget, we -- you're talking to a bunch of people have been doing business in the count for 20 years, and we've seen the returns. We've seen what non-gaming can do. Our theaters, our retail, our entertainment has driven billions and billions and billions of dollars of EBITDA, and they will in the future as well. We have no concerns whatsoever about investing and getting a solid return on non-gaming commitments. All they do is drive more visitation to the market. They are additives to the market, certainly going to drive more business right now. We look at this as a 10-year starting commitment and going beyond that. Our commitment to Macao is as long as we can be there. And so we have no hesitation to invest or show the market a very, very considerable return. Just look we've done in the past. I mean, on our current assets, mostly non-gaming. The lion's share of our investment in Macao is non-gaming, the great majority. It's worked out pretty well for us. So we think next 10 years, we'll continue that trend, and we're very happy and very committed to Macao. Hey, everyone. Just a quick one for me. Historically, capital return has been really important to you guys. Obviously, Macao is just beginning to ramp, and there's a lot of areas to invest. But how are you thinking about the dividend these days? Is that still important? And if so, how should we think about timing of that? Yeah. If Sheldon were here, he would say, yay [ph 0:42:49], dividends. I think someone put us on hold in Macao. So as I was saying, if Sheldon were here, and we miss him dearly, he would be saying, yay, dividends. I think Las Vegas Sands is a growth company. We're back to growth. We're a development company. We do large-scale developments in key markets. But most importantly, we're also a returning capital company. And I think as our business returns and as we see normalization of cash flows, we're going to look to start the dividend again and be very shareholder friendly. But at the end of the day, we're very focused on the strength of our balance sheet of new development. And you heard Rob talk about New York, it's very exciting. There are other things that hopefully we'll get a chance to do in the near term. And opportunistically, I think we'll continue to deploy capital where the highest returns are. And as part of that, the dividend will be fundamental to our shareholder return strategy. But I think we're going to wait and see where operating cash flow ends up and we'll make some assessments at that point. Yeah, guys. Good afternoon. So Rob or whoever wants to take this, I mean, if we look at visitation in Macao over the last, let's call it, week or so around the start of Chinese New Year, it does seem like it has been pretty strong. And I guess, is there any commentary or color you could give us about the spending patterns of these folks that are coming to the market? Meaning, are these folks gambling as much as they did before? Or is that some of that spending being pushed more into the non-gaming side of the floor? And maybe it's just too early to tell. But I think with how high Chinese savings levels are right now. I'm just wondering if you can provide any color around that. Yes. Yes. Yes. They're spending in retail, they're spending in gambling, they're spending, as we may have referenced so Steve, it's just the right customers showing up. And I think this is historically how it's worked out in the recoveries where those who are the most aggressive gamers and retail spenders show up first. And we're seeing that strongly in Macao. It's a very good audience, a very strong audience. You'll see the market numbers then come out. It's really gratifying for those of us who wait along terrible three years to see these days return, and they returned. And I think the real question is these customers that are now the question is, how many more are coming behind them? Because to your point, visitation has been mediocre out of Mainland China, relative to what had been previously. We're not even there. We're getting some pretty big numbers coming out of Macao in the market. So we're very enthused about it. I don't think -- it's not necessarily choosing gaming or retail, I think they're doing both, and then they're eating and shopping and funding everything. So -- it's very typical of these recovery situations where the people who wanted most to shop there and they're buying their spending enjoying life again. I think the Chinese are no different to the Americans who came to the U.S. markets and enjoy themselves. And hopefully, a party continues is just getting started, and we've got a very encouraging start to this reopening after the last three years. No, I think it's just as you said. The nature of these reopenings, it will attract the high-quality customers first, and that's what we're seeing. And I think we saw that in Singapore in April as well. We had much stronger recovery in the Southeast Asian overseas spend in Singapore versus the recovery in the tourist arrivals. And I think Macao has also following something similar, except for the fact Macao has a much bigger advantage in being able to support visitation, not just by international airlift, regional airlift, but also by land and sea as well and domestic airlift then connecting through the Southern China as well. So I think it's -- let's see how -- what the pace of visitation recoveries like versus the revenue recovery. But so far, I think the pattern that we've seen in CNY does support that pattern. Yes, you're getting a much stronger revenue. I think you are in visitation. I think that last comment of Grant's, that's a great one, in that this is on the air dependent market like Singapore. You'll need the airlines. You can come other ways, access to Macao is mostly vehicular or both. So I think it's a huge advantage for Macao that as the population conquers, the virus situation gets more confident, there's nothing to -- no impediments to massive growth in visitation coming to Macao from China. That's a very positive point. But Steve, look, we just -- we are pleased we're seeing and they're spending in every direction. So we very -- we feel very fortunate. Hopefully, it just continues to ramp up from here. Hi. This is Cassandra on behalf of David. Happy Chinese New Year to everyone. Yeah, I think a lot of my questions have been answered already, so I hope it's not getting repetitive. You've mentioned cost issues in all markets, especially in energy wages. So could you discuss to what extent are those permanent? And where we might be run rating in terms of EBITDA versus 2019 level today? We're not going to discuss EBITDA at this point, except for what you've seen in Singapore. I do think energy is a vast thing. It does vastly. It doesn't go one way, as you well know, whereas wages, I think, worldwide are going to be an issue for everybody. And I think we'll deal with that. They're not -- I don't see them coming down a whole lot. Again, our resorts and our capacity constrained ability to price up -- the rating at our business is you can price up and retain your margins. That, I think, will be our strategy in Singapore and also in Macao. I don't think wages are going to decline greatly. I think Grant alluded to efficiencies, and then that's important. We have a large workforce, in the tens of thousands, in Macao. So more efficient and better doing what we do, that should be helpful. But I think we're all going to live with at this point in the U.S. and Asia, higher wages appear to be in the structure for now. Patrick? I think the key thing is that by the nature of our business, we have resiliency in the face of inflation. As Rob mentioned, we have a lot of flexible pricing, hotel rooms, gaming pricing, the way we operate food and beverage, that we operate all of our non-gaming amenities. These are not long-term contracts. We have the ability to go with the market. So while there are some structural increases around wages, around inputs that we use, at the same time, we have the ability to price because of the unique nature of our products the experiences we offer to be fair to the positioning of the products that we have. We've invested a lot over many years in both markets, the reason why they're so strong. So in our mind, inflation is a real thing. We have to take into account but we have the ability to work through it and actually grow the margins of our business over time. Great. Thank you. And shifting to New York, how do you share or disclose publicly what kind of investments you expect to make if you win the gaming license versus if you don't? Yeah, the current thought in our heads is about $4 billion to $5 billion. Again, this is not a regional casino. This is a full-blown resort. With MICE, entertainment, retail, restaurants, it's the real thing. It's not meant to be a small time investment. We're going all the way in and building something transformational that drives tourism. And we think will be the biggest, in terms of the casino business will be the biggest revenue generator. Thank you. And the last question today will be coming from Dan Politzer from Wells Fargo. Dan, your line is live. Hey, good afternoon, everyone. And thanks for [Indiscernible 0:51:23] I guess, first on Macao. I know VIP was historically about a quarter of your total business. I mean, to what extent, if any, have you seen this customer return and in what form has it been more of a credit, a direct VIP type customer? Or is this customer showing up in premium mass? So one thing to note is the VIP contribution was much lower than that. So let's call it, high single digits, low double digits historically. We've always been mass and premium mass driven. So it's -- on a contribution basis because the margins in premium and VIP and, to be fair, junket business, were always structurally much different than they were for our mass business. So we've always been led on a contribution basis by our mass play and our premium mass play. And you can tell that by our asset base and how we speak to our customers and the type of tourism we attract. That being said, I do want to turn it over to Grant for some additional comments. Thanks, Patrick. Not a lot to add. I mean, all of our rolling business currently is in the premium direct program. And I think the second point is premium mass is doing recovering much, much faster than premium direct. I think that's what we're seeing right now. Got it. And then just a follow-up on the New York investment, the $4 billion to $5 billion you mentioned, I mean, is there -- should we expect a commensurate return on that type of project that you've seen in your Asia-based investments or given the high density population, the spend curve per unit, is there reasonable to think that there could actually be upside to that kind of 20% historical return? I think for us, we're very focused on return on invested capital. So Rob and the rest of the team really looks everywhere that we can to try to best deploy capital in the highest return outcomes. And so we would be interested in New York, if we didn't think the returns were there. We think it's a very strong potential opportunity. And for us, it's going to be about the jobs we create, about the tourism we drive about the investment in the local community, the relationships that we have. In every market that we're in, we're typically the largest trade partner with small and medium enterprise. We're looking to develop deep community routes, so we can support the community and really show this industry is something that can benefit everyone. So we're very excited about it. We think the returns are there. Otherwise, we wouldn't be interested. Thank you. And ladies and gentlemen, this does conclude today's conference call. You may disconnect your phone lines at this time. And have a wonderful day. Thank you for your participation.
|
EarningCall_1145
|
Good day and thank you for standing by. Welcome to the BankUnited Fourth Quarter and Fiscal Year 2022 Earnings Call. At this time, all participants are in a listen-only mode. After the speakerâs presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. Thank you, Michelle. Good morning, and thank you for joining us today on our fourth quarter and fiscal year 2022 results conference call. On the call this morning are Raj Singh, our Chairman, President and CEO; Leslie Lunak, our Chief Financial Officer; and Tom Cornish, our Chief Operating Officer. Before we start, I'd like to remind everyone that this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that reflects the company's current views with respect to, among other things, future events and financial performance. Any forward-looking statements made during this call are based on the historical performance of the company and its subsidiaries or on the company's current plans, estimates and expectations. The inclusion of this forward-looking information should not be regarded as a representation by the company that the future plans, estimates or expectations contemplated by the company will be achieved. Such forward-looking statements are subject to various risks and uncertainties and assumptions, including, without limitation, those relating to the company's operations, financial results, financial condition, business prospects, growth strategy and liquidity, including as impacted by external circumstances outside the company's direct control. The company does not undertake any obligation to publicly update or review any forward-looking statements, whether as a result of new information, future developments or otherwise. A number of important factors could cause actual results to differ materially from those indicated by the forward-looking statements. These factors should not be construed as exhaustive. Information on these factors can be found in the company's annual report on Form 10-K for the year ended December 31, 2021, and any subsequent quarterly report on Form 10-Q, or current report on Form 8-K, which are available at the SEC's website, www.sec.gov. Thank you, Susan. Welcome, everyone. Thank you for joining us. So we announced earnings this morning. EPS for the quarter came in at $0.82; for the fiscal year, $3.54. Let me get quickly into the components, the key components that you will find in the release. Loans. Loan growth came in at $619 million. If you look at our meet and pay [ph] businesses, commercial and CRE, it actually grew $722 million. So very happy about -- what the lending teams were able to get done this quarter. Deposits, which are under a lot of pressure across the system, we actually grew deposits a little bit, $160 million, though NIDDA did decline given the rate environment and how Fed funds is. So NIDDA decline was $756 million. DDA now stands at about 29% of our total deposits. When we started this DDA growth journey in five, six years ago, I think we were at 14%. Just before the pandemic, we were at about 18% DDA. Today, we're at 29%. So feel pretty good about it. Despite the reduction in DDA that we saw this year, we're still in a pretty decent place. Margin expanded again, though a little less than in previous quarters, as we have highlighted to you. Margin came in at 2.81%. It was up from 2.76% in the prior quarter. So for the year, I think margin grew by 30 basis points, which is right in line with what we have guided to you at this call last year. Provision, before I talk about provision, let me talk a little bit about credit quality. Criticized, classified assets continue to come down as they have over the last many, many quarters. Our NPLs are actually now at 42 basis points. They were 64 last quarter, and this includes a guaranteed portion of SBA loans. If you back that out, NPLs are now down to 26 basis points. Just before this call, I asked Leslie to check for me what the NPLs were before the pandemic hit. And NPLs today in dollars are at $105 million. And before the pandemic hit, we were at $205 million. So NPLs today are half of what they were. And so from a credit quality perspective in the portfolio, the last two years, we've been sort of consciously and subconsciously been getting ready for whatever slowdown is coming, and we feel pretty good about where we are whatever comes our way. Having said that, we are more pessimistic about -- or more cautious about the environment than we were three months ago. So we did tweak our assumptions and increased our reserve. We took our reserve up from 54 basis points to 59 basis points. We, of course, had growth in the portfolio. All of that added up to a provision of just under $40 million. Also, the buyback continued as we have promised last time. We had bought back, I think, in the fourth quarter, $65 million. We'd already bought $10 million in the -- from this authorization in the previous quarter that leads to $75 million in this authorization, which we're continuing to -- we'll continue to execute as we see fit. Quickly, let me talk about the environment, and then we'll talk about guidance for next year. The environment, 2023, this is a year of the slowdown and possibly even a mild recession. That seems to be the consensus out there. The curve is inverted. As everyone can see, the Fed wants to take short-term rates up closer to 5%, and the 10-year certainly wants to go closer to 3%. So it's an inverted yield curve and it is expected to stay inverted all through this year, probably into next year as well. Last year, the Fed slammed on the brakes. This year, they're not slamming on the brakes. It looks like they still have some pressure on the brakes, and they'll probably take the foot off the pedal sometime this year, but it's unlikely at least based on what the Fed is saying that they will step on the gas pedal. The market disagrees and only time will tell eventually how things play out. We build all of our internal models and projections and everything based on whatever the future curve is getting us. Labor costs, while they were very high last year, I would say they are still higher than usual, but they are moderating somewhat, based on some weakness that we're seeing in certain sectors. So that is good news that labor costs start seems to be getting back to normal, but it's not back normal yet. On the other side, it is good news. Margins are better than we've seen. Lending margins, loan pricing is very rational. We're getting paid for taking credit risk, pretty much across the board from the safest to -- across the spectrum, any kind of asset you want to participate in, margins are 50, 70, 80, 90 basis points better than they were just nine months ago. And most importantly, Fed is succeeding in its mission of controlling inflation. That was very important. Three or six months ago, this looked like a pretty crazy place that the economy was in, but the Fed is finally having success. And eventually, that will also have an impact on this inverted yield curves are not good for bank margins. So, as the Fed finishes this tightening and get to the other side, it will be a better rate environment for banks. But right now, it's an inverted yield curve which is tough. Last year, we gave you guidance around loans, deposits, margins, and so on. We said loans would grow mid to high single-digits. It grew 6% in total, 13% for C& I and CRE, our main mega site bread and butter categories. Deposits, we said mid-single-digits, but starting in January of last year, nobody foresaw what the Fed was about to do. I don't think even the Fed foresaw what they eventually did. So, we missed on that. Margin, we said would expand, it did, at 30 basis points, came in exactly as we expected. Expenses, we said would grow mid to high single-digits and it did, 7.5% growth in expenses. And the end result was -- we also said we would buy back stock, and we did, a little over $400 million worth of stock. NII grew 15% based on -- actually, one of the metrics I asked this morning -- I also looked at 2019 as sort of a year to compare things to because 2021 were pretty messy years with large provisions and reversing provision and so on. And really clean year is 2019, and I often ask about, just like I said about NPL total, our NPLs at the end of 2019 versus today where they are. I asked about margin also and our margin has -- despite the difficult rate environment, our margin is significantly better than it was in 2019, which is sort of an end result of all the hard work that has gone into improving the franchise. Cost of funds, while it is elevated at 142 base cost of deposits, 142 basis points, it is 142 basis points in an environment of north of 4%. Fed funds rates would be get to 5%. So, it is -- a lot of progress has made on the balance sheet, whether you look at credit metrics or profitability metrics. Yes, there is a lazy part of the balance sheet still sitting there, very large securities portfolio, large resi portfolio, which will sort of wind its way down over time. But overall, I think the balance sheet is in a much better place than it was before the pandemic. This year, given everything I've said about the environment, I think we're looking at loans growing at mid-single-digits, deposits doing the same. Margins still expanding, though not as much as it did last year. And expenses, again, very similar to last year -- expense growth. Buyback will continue. We will get this $75 million done over the course of next few weeks. And all likeliness, the Board will authorize another $150 million after that. A quick reminder. It's been now nine months since we launched our Atlanta presence. I'm extremely happy with how that has panned out. We did open a branch in Dallas, but we did not truly acquire a team on the commercial banking side. We are in the market for that now. So Dallas will be the project for this year in terms of having full capability in Dallas, not just a branch. Atlanta is off the races. I'm very happy with that. And I think going forward, we will look to opportunities like Dallas, like Atlanta and continue to grow this, and this will become part of our ongoing strategy. So with that, I don't want to take away all the talking points here. I'll leave some for Tom. Tom, I'll pass it over to you, and then you can pass it to Leslie. Great. Thanks, Raj. So as Raj mentioned, total loans grew by $619 million for the quarter, C&I grew by $599 million and CRE grew by $123 million for the quarter. And overall, as we to continue to meeting the cadence analogy, the $722 million growth in those two lines of business was extremely encouraging for us. We felt great about it. And I think if we break it down a little bit and look at industry components and asset classes, it was really broad. You can see in the supplemental data that we generally provide, in the C&I side, we grew 11 different segments during the quarter. That really led to $600 million essentially of loan growth in the quarter. It continues on a strong C&I growth number for the entire year. So separately kind of our middle market and corporate banking business, it grew by 25% for the year. So it was just an outstanding year. I think that's reflective of both our own efforts, and it's also reflective of the fact that we're in great markets. Florida has performed extremely well. All of the major cities in Florida have done very well. We're blessed to be in great markets. As Raj said, we really couldn't be more delighted than we are with what we've been able to accomplish in Atlanta in a very short period of time, multi-hundreds of millions of dollars of commitments in that market, excellent relationships. And we are very enthusiastic about expanding into Dallas. We see Dallas is a very parallel market to Atlanta in terms of size of the MSA, in terms of depth of the economy and breadth across the number of industry segments that fit the kind of risk profile that we're looking for in terms of diversification. And so we're excited about that. Rest of Florida continues to do well. We saw good growth in the commercial segments in the New York market in the quarter and throughout the year. So I think both the combination of our efforts, the segments that we're in and the overall health of the markets that we're in were very important parts of the growth story in the quarter and throughout the year. Last quarter, we had a bit of a growth in CRE. We told you we have more, and we did. That's also, I think, a good, solid commitment to the fundamental parts of the business we want to grow. We had solid growth in the industrial and warehouse segment, again, which is really strong, particularly in the Southeast. We have committed a bit more resources to our construction lending efforts and saw the construction loan portfolio pick up a bit. And we're particularly active in the multifamily construction area, which is a strong growth area and virtually every market that we're in, multifamily units continue to trail the need for multifamily housing in most of the areas that we're in. So those things really led to what we feel really good about in terms of our growth story for the quarter and for the year. There's some other â other areas, mortgage warehouse, that environment remains pretty challenged right now. We're committed to that business. We think we'll see some growth in it. But right now, the overall housing market, as you know, is not robust. So, we're seeing utilization rates fairly low in that business right now. Pinnacle and Bridge continued to decline during the year. I think if the tax rates improve and pricing improves in Pinnacle that may be an area for growth. We continue to deemphasize the franchise lending and the equipment finance area, both from an overall quality and just return on asset perspective is not very attractive to us right now. Resi grew modestly in Q4. So looking forward into this year, we continue to see growth in the core C&I and CRE books. We see it across all of our geographies. As I said, we're committed to mortgage warehouse for the long term and expect to see some growth in that portfolio. Also, if the environment for Ginnie Mae and EBO business improves, there could be some growth opportunities there as well. We also continue to build sales teams, and bring on new producers in the market, and we're looking at some key hires even in this quarter as we start off the year, even beyond the Dallas expansion that we've talked about. On the deposit side, total deposits grew by $160 million for the quarter. That growth was in interest-bearing deposits. As Raj said, NIDDA declined for the quarter, which was not unexpected in the environment given the rising rates and tightening liquidity. We had finished the loan-to-deposit ratio at 90%, which essentially was flat from the previous quarter. Thanks, Tom. As we guided last quarter and as Raj said, we saw the NIM increased this quarter to 2.81% from 2.76%. The yield on investment securities increased to 4.33% from 3.12%. The duration of this portfolio stands at 1.94% at December 31. The yield on loans grew to 4.72% from 4.11% this quarter. That's all mainly attributable to the resetting of coupon rates on variable rate instruments and new production and securities purchases at higher rates. Total cost of deposits was 142 basis points for the quarter, up from 78 basis points last quarter. I'd refer you to slide 6 of the deck. While this is a story that is obviously still playing out, you can see on that slide illustration that the spread between the Fed funds target and the cost of deposits have grown quite a bit, compared to back in 2019, which is a testament, in my mind to the improvement that we've made in the quality of the deposit base. Total deposit beta to date this cycle is about 43%. At the peak of the last cycle, our total deposit beta was about 61%. We think it's going to go up from 43%, but we still don't think it's going to get to that 61%. With respect to the reserve and the provision, slides 9 and 10 give some details about the reserve. The provision this quarter was $39.6 million. The ACL increased to 59 basis points from 54 basis points. As Raj mentioned, in spite of the decline in our NPLs and favorable credit quality signs, we built reserves primarily due to an increasing level of uncertainty about the economy. And qualitatively, we weighted a downside scenario more heavily in establishing our reserve this quarter. We did a -- majority increase in specific reserves that you saw this quarter, which was another contributor to the reserve build related to one single loan that was charged off before the end of the quarter. And substantially all the charge-offs taken this quarter were related to that particular loan. There's not really much to comment on with respect to non-interest income and expense. I'll just reiterate that for the year, non-interest expense, if you factor out the hedge loss that we took in the fourth quarter of 2021, it was up 7.5%, which is really exactly what we've been guiding to since the first of the year. So we came in right where we've been telling you we would with respect to that. I don't think there's anything there particularly to comment on for this quarter. I will open it up for questions. I know there are 19 other banks that have released. So we will -- let's take questions. Operator, you can open up the line. I was curious, I just want to follow up on the guidance that was given. You said kind of the mid-single-digit loan growth and deposit growth. Was that correct? And then, kind of, thinking just the deposit perspective, with quantitative tightening and kind of fighting against the treasury curve, really, in terms of what else is available to depositors. I mean, when you look at year-over-year, your deposits are down. I was curious, is there any new action, or are you willing to go to price the market in order to garner some overall growth relative to peers? I mean, you guys aren't the only ones. I don't mean to pick on you, but deposits are down. I was just curious on what actions or strategy might be taking to get them up. Yes, yes. I think the big difference -- and we could be wrong on this, but the big difference from last year to this year is that we're not expecting that slamming of the brakes that we saw with the Fed, but a more gentle sort of slowdown, tightening of monetary policy and eventually ending that tightening. If the Fed continues to surprise us with very aggressive actions, then achieving the single digits will be hard. Of all the guidance I've given you, whether its loans, margin or deposits or what have you, the deposit guidance is the hardest one to really give. And some of this is also our desire not to let our loan-to-deposit ratio get to out of whack and get past 100 to 105. So you can't get the deposits. It comes down to price. So we're not -- loans, you can look at the pipeline and kind of guess, okay, here's where loan demand is, and this is what I know. Typically weâre able to close up the pipeline and so on. The deposits, it's much harder. But based on another 325 basis point increase and eventually slowing on rate hikes, I think if that's what happens, there is a good chance that we will end up at mid-single digits, if it's worse, if the tightening is harder and stronger and longer, then there will be it will be tough to get to mid single-digits. Ben, I would also add that one of the things that we look at is when you look at the creation of new relationships across the franchise, and you look at virtually all of the business segments that we're in, the overlying economic activity obviously impacts the balances that might be in any individual account. But we have very, very good trend line information in performance history this year as it relates to the number of new relationships being created by all of the sales teams. And that gives us some confidence that, that will continue as we look into the year. Got you. Yes. No, I'm probably thinking that you guys could get the deposits just really at what cost. And then kind of conversely to that, are you guys are expecting some margin expansion from here? So that's from just kind of squaring triple to some degree? But the latter question I had is more kind of the nuance probably for level. But when you think about the expenses, BKU has historically had some pretty clear seasonality, I guess, you could say from quarter-to-quarter, but that kind of has fallen off as of late. I was just kind of curious, should we still expect 1Q to be a little bit higher relative to Q3 and then fourth quarter is the highest in the year, or is that kind of gone to the waste side? I was just trying to look for some overall quarter-over-quarter expectations. I guess the whole year is around seven ballpark, but just quarter-to-quarter? Sure. We don't spend a lot of time obviously focusing on any one particular quarter. But typically, compensation expense is higher in the first quarter just due to the impact of certain payroll taxes and benefits and whatnot. But as we've been investing in people and bringing new sales teams and support people on to support growth of the business, you may have seen that trend move out a little more because those people tend to come on over the course of the year, and headcount may not be held constant. So again, don't spend a lot of time and energy trying to figure out what the quarter-to-quarter forecast is. I'm more concerned with the year as a whole. But you will see that spike in benefits, but the trend maybe smooths out a little bit by new FTEs coming on more evenly over the course of the year. Got it. Okay. That's helpful. Appreciate the time, everyone. You guys have done a great job kind of remixing the deposit side of the balance sheet. So it clearly sets you guys up in a much better position than where we were a few years ago. Thank you. Yes, so I wanted to step on the expenses first. Raj, just to clarify, you said expense guidance is the same as last year, which would be mid to high single digits, correct? Okay. And just as we think about the base was with -- that mid high single-digit growth of, is the right way to think about it to annualize the fourth quarter and grow from there, or is it really just cumulatively? Okay. Now that's helpful. Thank you. And then, Raj, I know you called out maybe one or two maybe non-recurring or one-time charges that happened in the third quarter. Was there anything similar that happened in the fourth quarter? I know there's still a fairly big pickup in expenses? Got you. Okay, great. Thank you. And then just moving to -- I appreciate all the great commentary of the allowance and the bumped-up linked quarter there. Just as it relates to the one charge-off you guys took, I was just hoping to get a little more color around that. I appreciate there were some specific reserves tied to that charge-off. It looks like maybe based on the way your NPAs moved, those CRE loan, but I was just hoping to get a little more color? So, that loan, it didn't work out. So, I have to be careful what I say. What I will tell you is in a situation where we lose faith in the financials of the company, the certified financial of the company, we intend to charge-off the loan. We basically write-off the target. This is a developing situation. It's only three months in terms of when we really found this out and a little more than three months into this. And we just took the most conservative stand, which is we can't -- we don't really know -- there's some -- it looks like there will be some regularities in financials of the borrower, and we're just going chalking off the loan, which is what we did. Now, there are recoveries that have come back. I'm hoping there'll be some recoveries, but not knowing that with any confidence, we just quite often talk about. It's a one-off situation. Is it -- the when you audited financials come into question, it's not about the industry. It's about just that one situation. Got it. Understood. Thanks. And then just thinking holistically, you have mid- to high single-digit expense growth year-over-year. I appreciate the guidance. So, you think that the margins still cause a little expansion from here? Just putting the two together, Raj, do you feel like you could still grow revenues over the mid to high single-digit expense guidance and still maintain some of your positive operating leverage as you move to 2023? Yes. Yes. Over time, I absolutely agree that that's what we're shooting for, and that's what we will get to. It may not be that literally every quarter. And it is a tough environment to try and achieve that in. But remember, we're making investments not for the next six months or for the next even 12 months. Some of these investments we're making are multiyear investments with multiyear payoffs. We had a lot of discussion this time around during the budgeting season as to -- this is a year of slowdown, possibly a recession. The curve is inverted. Should be pulled back on investments? And you really cannot take a very short-term view of investing. You have to take a longer term view. So, the things that we put into motion, we're not going to pull back because the next couple of quarters might be a difficult banking environment or there may be a recession in the second half of the year. You're hearing me talk about -- we launched a plant the last year. We're launching something in Dallas this year, possibly new markets next. These are all long-term investments, so are some of the technology investments. So, you can't yoyo your investing sentiment quarter-by-quarter or even year-by-year. You really have to stay the course. We have -- from an expense to asset ratio, we're one of the -- not just better, one of the best banks in the country. I sometimes argue that we're not investing enough, which is why our ratios are as low as they are. So investing on a steady pace is important. Revenue, unfortunately, it does get a little bit â it's more tied to the environment that we're in, and this is a tough year, but next year will probably not be. So but over a period of time, which you just said is our expectation revenue will grow more than expenses? Absolutely. Otherwise, why do it. But a modest amount of margin expansion next year. Obviously, as Raj alluded to earlier, the hardest part about that to predict is the deposit environment. Please standby for our next question. Our next question comes from Timur Braziler with Wells Fargo. Your line is now open. Maybe circling back to that last comment from you, Leslie, on margin expansion next year. I guess what's the rate environment or rate outlook that you're using that guidance? And then just looking at the deposit spot rates ending the year versus the average, it seems like there's going to be a headwind in the first quarter. Is that kind of back-end loaded that comment, or do you think there's enough happening on the asset side to offset some of the funding⦠I'm not that focused on what happens quarter-by-quarter because that's extremely hard to predict. But we're using the forward curve. So this has Fed funds peaking at 5% in the second quarter and dropping to 4.5% to 4.75% by the end of the year with an inverted treasury curve throughout the year. So that's the forward curve that underlies those estimates. But as I said before, the wildcard is the deposit environment, as Raj expressed, we're very confident that we can grow core deposits this year. Based on our geographic expansion, the growth of the Florida economy, the producers that we're adding, our business people are very confident that we can grow core deposits given the environment that we think we believe is going to play out. So the Fed's been on the brake harder, the environment will be more challenging than we think that, that margin prediction could come under pressure. Okay. And maybe just asking you to look at the deposit crystal ball over time. But on the way down or once the Fed stops at least hiking, what's the expectation for the deposit environment in your geography? I mean, I'm assuming it's going to remain competitive, but could you actually see deposit pricing continue to increase if the loan demand is still there, or do you expect it to kind of tail-off at a similar pace to what it did on the way up? You're asking about, not just in the next six or 12 months, but beyond that. And it's very hard for me to say what the deposit environment will be like. But there is a lag. On the way up, there is some line on the way down as well. And -- but it's really hard for me to predict what will happen when the Fed starts to pull back. I don't know what the loan demand would be like. I don't know what the economy will be like. Will we be in a recession or not? It is, I would say, the best â it will be hard actually for you to even go back at that last cycle and try and look at that â but last cycle was really weird. But we're not going to have a effect going to zero overnight kind of a situation. It's going to be a slow, slow drop, a very gentle decline is what I think will happen with effect. But it is very hard for me to say what will happen a year out. Yeah. I do think the more rate-sensitive part of the deposit portfolio will respond very quickly, either way on the way up or the way down. But with the more core portions of the deposit portfolio, I think you see a lag on the way up, but you also see a lag on the way down. And it is very difficult to predict. I wish I had that crystal ball more for you. And remember, it's even more complex for us, because a lot of our deposit business is in one way, shape or another tied to the â the real estate business, right, the refi business, which is dead right now, or even the purchase business, which is not doing that well. So, we could have a mini refi boom before you know it. I mean, if the tenure is floating with 3.35, that could happen and that could actually help that will help the warehouse business, but that will help the deposit business as well. It's a lot of pain that we felt this year was from the title insurance space. And that industry is a deep recession, so to say, if you talk to anyone in that industry. But that could come back. That's very risk sensitive. And that doesn't have to move too much. It's just the long-term rates keep doing what they're doing. You could have a significant pickup in activity. We're not counting on that, but we're very consistent of that sort of coil spring, if you were to say. Right. Okay. I appreciate that. And then just lastly for me, the C&I growth all year and in the fourth quarter was quite impressive. I'm just wondering, how much of that is increased utilization, if any? How much of that is new client growth? And then are you able to get deposit relationships with those new C&I clients that you're bringing on board? How much of that production is actually being self-funded? Yeah. I would say that, we saw a very little lift from utilization throughout the year. When we look at production in the C&I teams throughout the entire year, it was a very strong new client production, new relationship production. We are able to get significant deposits out of these, most our general focus is on relationship banking opportunities, and these tend to come with strong depository and treasury management type relationships. But we didn't see much lift at all in utilization rates throughout the year. So we'll see how that plays out into 2023. Originally, when we started the year, we thought we would see more lift. We thought we'd see maybe 500 basis points of lift. We didn't see that. It stayed pretty flat throughout the year. And if that were to pick up, that would help us as well. But what we did this year was really a lot of new relationship production this year across all of the C&I segments. My first question is on deposits. Can you talk about the decrease in non-interest-bearing deposits? What are your clients moving those balances to? Any color on whether it's moving internal or competition from T-bills or in other regional banks? Yes. So it's a laundry list of things. So there's still a slowdown in the real estate industry. We're seeing our title business average balances in those accounts from the smallest, the largest, everything declined. So it's an industry-wide trend. That is one. We saw people -- our clients use money for buybacks or dividends, just distributions. That was a fairly large category. Also, I'd say, as ECRs have moved up, they need to keep balances to avoid fees from the bank. That needed balance have gone down. So when that happens, capital frees up and it moves into money market or leaves the bank and goes, go out and buy treasuries. We don't have a wealth management business. So we're not seeing that. Corporate customers don't typically take money out the bank and buy treasuries, though some of that might be happening with whatever small retail business that we do have. So it's a mix of those things. But I'd say that the real estate industry suffering is still probably our largest driver, followed shortly with just people taking distributions and using money for either investments or buying properties or what have you. So there is -- money is not being left idle and people are much more corporate customers, commercial customers, they are much more aware that -- of the cost of idle money. Yes. Just, Alex, in 2021, there was a pretty substantial buildup in corporate deposit balances across really all industry segments coming out of the pandemic that has just been utilized. Thanks. And as a follow-up to that buildup, any sense of how much DDA is considered excess deposits per your customers before they get to like a core operating DDA level? We spend a lot of time trying to analyze that, but I don't -- I still don't think we know the answer to the question. Fair enough. And on the net interest margin guidance for expansion in 2023, any color in terms of the trajectory? Do you expect expansion every quarter, or at some point, do you expect a reversal of that, but still end the year higher? I think it's -- that's very difficult to predict. There's just too many external factors, particularly with respect to funding that are going to impact what happens quarter-by-quarter. I think, looking at the year as a whole, we can get a little bit better idea, but I'm reluctant to try to pinpoint what the NIM is going to be quarter-by-quarter. Got it. And just one last question on the other fee income line of $7 million. It was a little bit elevated this quarter compared to the rest of the year. Can you touch on what drove this? And if there's anything one-time in nature there? Thanks. It's just really a cats and dogs, Alex. There's no one thing. There's a lot of puts and takes in there. One of the things that's been kind of volatile over the last year or so has been BOLI revenue. I don't really know how to predict that, but it's no one thing. There's just a lot of puts and takes in that line item. So I don't think there's anything that I would necessarily regard as either something to call out specifically. I do think in terms of the core items that are in non-interest income, we'll see a steady increase, but all the little puts and takes can be episodic and volatile. I don't think there's anything material enough to call out in there. Please standby for our next question. Our next question comes from Stephen Scouten with Piper Sandler. Your line is now open. Thank you. Good morning everyone. Appreciate the time. The NIM guidance for next year is pretty encouraging relative to what we're seeing for most of the industry for the potential pace of expansion. Can you tell me, I guess, one, is that from the 2.81% fourth quarter level, or is that more from the 2.68% full year level? I mean, I was really, when I gave you the guidance, was referring to the full year level. I'm taking a look right now if I can find it just to see. I would expect it to expand from the 2.68% full year. I would also expect it to expand from the 2.81%. Having said those, with caveat, again, it's going to be a very challenging deposit environment. And if that doesn't play out the way we're forecasting, that you have to put some pressure on that. Understood. Understood. I'd still say that's encouraging, and it probably plays to an earlier point, maybe that, Raj, you said you feel like you're getting paid for your growth, getting paid for the risk you're taking. So can you talk to maybe what you're seeing on new loan yields? Because I'm presuming you're seeing some good expansion there even in light of the funding pressures. I think new commercial loans for the quarter, so higher at the end than at the beginning, but for the quarter, new commercial loans came on in the mid-6s on average. That's C&I and CRE and everything we did in the commercial space averaged together for the quarter. Okay. Great. Okay. And then maybe digging back into expenses really quickly. I just want to make sure, like if I look at expenses, it looks like they're up 12% year-over-year, 7.6% quarter-over-quarter, so just want to make sure if we're⦠When I -- yes, when I take total expenses for this year, total expenses for last year and I back out, once my math is wrong, which is possible, and on back out debt hedge termination loss we had last year, I'd get an increase of right about 7.5% year-over-year. Yes. Yes. I'm doing the same thing and getting like 12%. But I guess, either way, the expenses have gone up about $10 million a quarter, each of the last two quarters kind of in line with revenue growth. So do you think in 2023, that, that revenue growth can kind of outpace the size of expense growth? My comment, a couple of questions ago, long-term, that's what we're shooting for. It doesn't always happen every quarter, and 2023 is a tough year to actually achieve it. But that is certainly -- we're going to achieve long-term. I mean, our forecast would show that revenue growth will exceed expense growth next year, but it's a very challenging revenue environment, and there's a lot of things happening in the environment that we have no control over. Definitely. Okay. And then last thing for me is the big question I get from investors a lot is where is the margin for error at BankUnited, if we've got, what was ROA this year, 80 basis points, 67 basis points this quarter and then 1 of the lower loan loss reserves still at 59 basis points. So, I guess how would you speak to that and kind of a wage folks that might have concerns that if we do enter a worsening environment that there's just less margin for a given the lower profitability and lower reserves? I think our margin as well as our reserve levels are a function of the portfolio that we have. We have -- compared to a typical bank, we do have a much higher level of resi on that resi being government guarantees. We have investment-grade municipal portfolio. So, we have a lot of these loan portfolios that have lower margin and lower losses and lower reserve. I think that the point I made early on, that if you look at where our NPLs are at the absolute level at 26 basis points, excluding sort of guaranteed SBA loans, that is also alluded to the kind of portfolio we have. If you look at on a relative basis where our NPLs were, December 2019 to where we are today, our NPLs are half. So, the portfolio over the course of the pandemic has really become even safer, but we've been able to grow margin, not because we're taking more risk, but because we improved our deposit base. So, margin has improved significantly from 2019. NPLs have come down significantly from 2019. Deposits have improved significantly from 2019. So, sometimes just looking at a number at the top of the house without color behind why that number is what it is, is often where people get tripped up. Every bank is a little bit different. And over time, you really have to look at the composition of the balance sheet to really get good answers on why the numbers make sense or don't make sense. Steven kind of took my question, but I'll ask it a different way, Raj. What -- are you more pessimistic, or is this step-up in provision just out of caution, your cautious nature? And what is-- We think -- yes. the provision this quarter was pretty heavily influenced by the Moody's S2 downside scenario. So, I think we're well-positioned from a reserve perspective in the event of a mild recession. Obviously, if the economy totally goes off the rails and we have a severe recession, well, all bets are off for the whole industry. But I'm not expecting that to happen. So, I think we're very well-positioned. And I expect provisioning -- sitting here today, I expect provisioning for 2023 to really be mostly a function of production. Not in the quality, but in the quantity, we have seen some -- a little less robustness in the pipeline. And some of it is probably because we had a pretty good quarter, and we closed a lot of stuff. Nothing really spilled over into January. But some of it, I suspect, is also customers basically looking at the environment and saying, maybe I want to wait a little bit to make the next investment, build the next factory or the next payoffs. So some of that, when we talk to clients, I can see the intended effect that the Fed wanted to have, it's actually happening in the real economy. People are more cautious. People are thinking hard about their expansion plans and being, on the margin, a little more cautious. So that is also influencing our guidance we're giving you about loan growth that in next year, in which everyone is expecting a mild recession, you're not going to see some outsized level of growth. It would be responsible. Yes, I would add, you particularly see that in the real estate business where pipelines and investment is driven by -- there's a substantial amount of capital on the sidelines today in the real estate markets. But if people kind of read into what they think the curve is going to look like or at least what the curve looks like today, that towards the latter part of the year, people are thinking the cost of debt will be -- fixed rate debt will be less than it is today. So investment strategies are being paused a bit, particularly in the CRE markets. Okay. Okay. And then just one more on commercial real estate, the $30 million number last quarter. So maybe that's the number we're looking at. You guys don't have a single non-performer the way you categorize commercial real estate? Talk a little bit about what you're seeing in the quality of the portfolio. It's obviously on every investor's mind, but it looks like your portfolio is very, very clean. Are you seeing any roading? Are you being more cautious, or do you feel like this is more symbolic of your portfolio and maybe the industry is going to get a little bit worse? That's all I had. Thanks. Yes. I think it's a very detailed answer because it's not a portfolio, a lot of sub portfolios that add up to it. So I think where the industry needs to be cautious is obviously central business district office. That is, again, probably not as much of a deal in the next 12 months, but over the next 24 to 36 months, that's the asset class to really pay attention to. And it will be an evolving story. And we're spending a lot of time focused on whatever little of that we have. Now it helps us tremendously being in Florida, where everything is getting absorbed in Florida. But in markets outside of Florida, New York, for us, for example, and for other banks at the other part of the country, that's the asset class that you want to pay attention to in the medium-term. I think in the short-term, it's not really an issue. And -- but outside of that, retail has been a perpetual issue for banks. I think for the most part, banks have put that behind, and multifamily, warehouse industrial is still doing very well. Yes. I would add, we're super asset-allocation focused. When we think about the real estate portfolio, we've got a very disciplined approach to thinking about what sectors, geographies and asset classes we take exposure in. And even the broadest categories, as Rod said, really have multi-categories. So an anchor â a grocery store anchored center in Boca Raton is very different than retail that might be a Tom Ford store on Madison Avenue in 63rd Street. That's very different kinds of retail, but we think pretty highly of the quality of the real estate portfolio that we have. And I think when we look at exposures across the platform in areas where we think there could be some softness, we feel really good about what our exposure levels are in those categories. Hey, great. Thanks for letting me jump back on guys. Just a quick follow-up, I wanted to hit on the buyback. I know by our math, you guys had massive buybacks this year, somewhere around 12% of the company repurchased in 2022. Raj, if the stock kind of hovers around the current levels, do you plan to keep the gas on the buyback here? And then just as it relates to your capital, I know you guys don't look at TCE as much more so common actually, Tier 1 at the bank level. Did you have any internal targets or any internal threshold where you wouldn't want to see that ratio draw down to? Thanks. Yeah. So yeah, we are active. The price of the stock is at right now, it's a no-brainer from my perspective. And in terms of what ratios we look at, I'll actually got Leslie answer that. Yeah. Yeah. We are more focused on CET1. A couple of things we think about when we think about capital levels, we are very protective of the company's investment grade rating. So we're very conscious of the ratings agencies' view of buyback. We also want to be sure we're retaining sufficient capital to support growth that we see on the horizon. So, those are the two constraints we think about. Our Board is probably going to meet in the next month or so to improve our actual capital plan for 2023. That hasn't happened yet. Currently, I don't anticipate any changes in the way we think about capital targets, but I'm going to refrain from putting them out there until that capital plan gets finalized. But I don't think anything changed. I would not anticipate that the capital targets that we've laid out in the past have changed. But I don't know that with certainty until the Board meets. At this time, I show no further questions. I would now like to turn the conference back to Raj Singh for closing remarks. Thank you. Appreciate all your questions, all the back and forth. We're here. Leslie and I are both here, if you have any follow-up questions. But again, thank you so much for joining us. We'll talk to you again in three months. Bye.
|
EarningCall_1146
|
Good day, and welcome to the Old Dominion Freight Line's Fourth Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. Thank you. Good morning, and welcome to the Fourth Quarter and Full-Year 2022 Conference Call for Old Dominion Freight Line. Today's call is being recorded, and will be available for replay beginning today and through February 8, 2023, by dialing 1-877-344-7529, access code 2673176. The replay of the webcast may also be accessed for 30 days at the company's Web site. This conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including statements, among others, regarding Old Dominion's expected financial and operating performance. For this purpose, any statements made during this call that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words believes, anticipates, plans, expects and similar expressions are intended to identify forward-looking statements. You are hereby cautioned that these statements may be affected by the important factors, among others, set forth in Old Dominion's filings with the Securities and Exchange Commission and in this morning's news release. And consequently, actual operations and results may differ materially from the results discussed in the forward-looking statements. The company undertakes no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. As a final note, before we begin today, we welcome your questions, but we ask, in fairness to all, that you limit yourselves to just one question at a time before returning to the queue. Thank you for your cooperation. At this time, for opening remarks, I would like to turn the conference over to the company's President and Chief Executive Officer, Mr. Greg Gantt. Please go ahead, sir. Good morning, and welcome to our fourth quarter conference call. With me on the call today is Marty Freeman, our COO; and Adam Satterfield, our CFO. After some brief remarks, we would be glad to take your questions. The Old Dominion team produced fourth quarter financial results that allowed us to finish the year with company records for annual revenue and profitability. We extended our track record of success and delivered the 10th straight quarter with both an increase in revenue and improvement in our operating ratio. As a result, the fourth quarter of 2022 was also the 10th straight quarter where we produced double-digit growth in earnings per diluted share. Our team produced these results while facing many challenges during 2022, which were primarily related to the unexpected slowdown in the domestic economy. We entered the year anticipating growth in our volumes that didn't ultimately meet our initial expectations. But we made the necessary adjustments throughout the year that once again showed the flexibility and resiliency of our long-term strategic plan. We also maintained a watchful eye on the efficiency of our operations and continued with our disciplined approach to managing discretionary spending. Due to our confidence in our ability to win market share over the long-term, one thing that did not change in 2022 was our commitment to investing for the future. Capital expenditures, totaling $775.1 million in 2022, were a new company record. And we invested $299.5 million in real estate projects that further expanded the capacity of our service center network. We also continued to invest heavily in our OD Family of employees, with improvements in pay and benefits, as well as a company record contribution to our 401(k) retirement plan for employees. In dealing with the reality of slower than anticipated business volumes we also work diligently to protect the significant investments that we made over the past two years in our new employees. Thinking of new employees, I am proud to share that there have been over 1,300 new drivers that graduated from our internal truck driving school over the past two years. And in some cases, these driver school graduates that now have their CDLs are temporarily working on non-driving roles. While this comes at an increased cost to the company, we believe this bigger pool of licensed drivers will provide us with the strategic advantage once the freight cycle turns and additional volume opportunities become available to us. We said in our third quarter earnings call that we anticipated volumes could start increasing in the spring of this year. And we continue to remain cautiously optimistic that this will occur despite ongoing risk with the domestic economy. Regardless of the economic environment, I believe our 2022 results provide yet another example of why our long-term strategic plan will remain our focus for the foreseeable future. Consistent execution of this plan had helped us create an unmatched value proposition in our industry that led to over $1 billion of revenue growth for the second straight year, in 2022. I am confident that this commitment to our strategic plan will also continue after my retirement at the end of June, this year. Our long-term success is the result of a strong team and their combined commitment to maintaining a strong company culture. After working with Marty for most of my career, I can tell you that he lives and breathes the OD Family spirit, and will help take the company to new heights. I think the best is yet to come for Old Dominion. And I look forward to watching OD expand its long-term record of success. Thank you for joining us this morning. Thank you, Greg, and good morning. I would like to start today by thanking Greg and our Board of Directors for providing me the opportunity to lead this great company. It will be an honor to lead our team. And I can assure you that we will work tirelessly to keep producing strong profitable growth. Along those lines, I was pleased with Old Dominion's revenue growth of 5.8%, and the improvement in our operating ratio to 71.2% during the fourth quarter. The combination of these items contributed to the 21.2% increase in earnings per diluted share. These financial results reflect the ongoing strength and demand for our services as we continue to deliver value to our customers by providing superior service at a fair price. While our long-term strategic plan is centered on our ability to provide this value proposition, the real key to our success is our strong family culture and our people. We will continue to invest in our OD Family of employees as our employees are the foundation for building strong customer relationships. We are in a relationship business, and each employee plays a critical role to help deliver our industry-leading service. I am proud to report that our service metrics remained strong during the fourth quarter as we provided 99% on-time service, with a cargo claims ratio of 0.1%. We believe executing our same long-term formula for success will allow us to win market share in the future. And as a result, we will -- also will allow us to constantly advance to new capacity ahead of anticipated growth. Our capital expenditures for 2023 are anticipated to be $800 million, which will improve the average age of our fleet and further expand the capacity of our real estate network. We have invested approximately $2 billion in real estate expansion over the last 10 years, and increased our door capacity by approximately 50% as a result. These investments supported our ability to double our market share over this time. The ever-increasing cost of both real estate and equipment, however, will require us to maintain our pricing discipline. Our long-term pricing philosophy is designed to evaluate the profitability of each customer account, and then obtain the necessary increases to offset our cost inflation, while also supporting our ongoing investment in capacity and technology. As we have executed on this consistent strategy over the years, the resulting improvement in our cash flow has generally supported our ability to invest between 10% and 15% of our revenue into capital expenditures each year. Continuing with each of these priorities demonstrates our team's intention to remain focused on executing the same business strategies that we have created our unique position in this industry. We will continue to focus on our people, servicing our customers, and investing for the future. This commitment to the core principles have differentiated us in the marketplace, gives us confidence in our ability to further produce profitable growth, while also increasing shareholder value. Thank you, Marty, and good morning. Old Dominion's revenue growth, of 5.8% in the fourth quarter, resulted from a 16.7% increase in LTL revenue per hundredweight, which more than offset the 9.1% decrease in LTL tons. LTL revenue per hundredweight excluding fuel surcharges increased 8.7% and reflects the continued execution of our long-term pricing initiatives. Our consistent approach to pricing is supported by our ability to provide our customers with superior service and available capacity. We believe this value offering is becoming increasingly important to shipper, which is why we remain absolutely committed to executing on the fundamental elements of our long-term strategic plan. On a sequential basis, revenue per day for the fourth quarter decreased 2.4% when compared to the third quarter of 2022, with LTL tons per day decreasing 4.4% and LTL shipments per day decreasing 4.6%. For comparison, the 10-year average sequential change for these metrics includes a decrease of 0.6% in revenue per day, a decrease of 1.3% in tons per day, and a decrease of 3.3% in shipments per day. For January, our revenue per day increased approximately 4.2% as compared to January of 2022. This growth included a 13.1% increase in LTL revenue per hundredweight that more than offset the 7.8% decrease in the LTL tons per day. Our fourth quarter operating ratio improved to 71.2%, which is primarily due to an improvement in our direct operating cost as a percent of revenue. Within our direct operating cost, productive labor as a percent of revenue improved 170 basis points, which our purchase transportation costs improved 200 basis points. These changes more than offset the 260 basis point increase in operating supplies and expenses that primarily resulted from a significant increase in the cost of diesel fuel and other petroleum-based products during the quarter. Our overhead costs as a percent of revenue were consistent between the periods compared. Old Dominion's cash flow from operations totaled $361.3 million and $1.7 billion for the fourth quarter and 2022, respectively, while capital expenditures were $270.4 million and $775.1 million for the same periods. As Marty mentioned, we currently expect capital expenditures of $800 million in 2023. We utilized $199.9 million and $1.3 billion of cash for our share repurchase program during the fourth quarter and 2022, respectively, while cash dividends totaled $33.0 million and $134.5 million for the same periods. We were pleased that our Board of Directors approved a 33.3% increase in the quarterly dividend to $0.40 per share for the first quarter of 2023. Our effective tax rate for both fourth quarter 2022 and 2021 was 25.0%. We currently anticipate our effective tax rate to be 25.8% for 2023. Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Jordan Alliger with Goldman Sachs. Please go ahead. Yes, hi, good morning. Question, so on the salary expense side of the equation for the fourth quarter, I think the dollar amount was actually down year-over-year. Can you maybe talk a little bit to your thoughts around the drivers of that, just a lower incentive comp, I think I you had mentioned attrition? And then how do we think about the salary line going forward, whether it be on a wage inflation perspective or a growth perspective? Thanks. Sure. The overall dollars, obviously, we've been making adjustments as we've gone through the year. And I would say through the back-half of the year, in particular, we've been letting attrition take place, and just consistently adjusting our headcount and the hours worked by our people in relation to what the volume environment dictates to continue to give service by continuing to operate efficiently. And so, I think, overall, that helped drive the decrease in that quarter-over-quarter, those expenses, if you will. So, we continue to be focused, obviously, on managing those costs. That's our biggest cost element of our business is in the salaries, wages, and benefits. And so, it's certainly the biggest area of focus as we try to continue to run our network as efficiently as possible without giving any sacrifice to service. So, I do think that given the environment in the fourth quarter, I think we had, given the circumstance, is pretty strong revenue performance. So, I was pleased with the way our revenue and volumes trended. And that was probably one of the favorable line items, if you will, in comparison to the guidance that we had originally provided with respect to the operation ratio, was how the salary, wages, and benefits ended up coming in for us. Thanks. And just as a follow-up, is there a way to -- I mean, do you expect that type of control, at least for the first-half, until you get to that inflection, in the spring, in volumes? I mean, could we continue to see that trend line stay the same for the time being? Well, I think we're in a good spot right now with where our headcount is. And typically, we start seeing increases in volume. And certainly, we're not in a normal environment by any stretch. But our January volumes were slightly positive versus December, pretty flattish overall, really when you look at it from a shipment perspective. But we continue to anticipate that we will see volumes return to us in the spring. And I think we want to make sure that we've got all elements of capacity in place to deal with that environment whenever it inevitably comes. We're certainly very confident about what our future market share opportunities will be. And so, we want to make sure that we're in a position with our people, our equipment, and certainly our service and our network to be able to effectively respond when that does happen. Typically, the February volumes are a little bit higher than January. And it's March when we start seeing the increase coming. And so, I think that what we're trying to do is just, again, measure and manage all elements of capacity to ensure that we're in a good spot when that happens. So, again, I think that certainly a lot in the first quarter and probably the first-half of the year really depends on what the volume environment gives us. But we continue to believe that we are going to see some increase. We've certainly seen it in the past, even in down economic environments, whether you look at something as bad as the environment was in 2009. I think 2016 is another good example, where our second quarter volumes were higher than the first. And so, it'll be a little different situation, I think, playing out this year in comparison to 2022, when, beginning with April, our volumes were either decreasing or flattish on a month-over-month basis as we worked our way through the year. Certainly, we'd like to see volumes flowing into us as we transition and make our way through 2023. And hopefully start getting a little help from the macroeconomic environment as well. Okay, great. Thank you. Greg, congratulations on your retirement, and I think the $34 billion of shareholder value you've created since you've been CEO. Congrats on that. And Marty, you've got some big shoes to fill, but congratulations to you as well. Absolutely has been. So, I guess maybe if we could -- Adam, if you could maybe expand a bit on the January trends a bit more. You talked about January being up a bit or maybe even flattish versus December. Anything you feel comfortable sharing there in terms of January revenue trends and tonnage or shipments trends, that'd be helpful? And then, I guess, as you think about the operation ratio, first quarter versus fourth quarter, anything you can maybe share relative to normal seasonality would be helpful there? So, I'll turn it over to you, Adam. Yes, I guess from a volume standpoint on a year-over-year basis, January, our tons per day were down 7.8% that compares to December where we were down 12.3% overall. I would point out and obviously we will continue to give our mid quarter updates. We have a little bit easier comparison with the January year-over-year comp, and we had very strong performance in February of last year. So, that kind of gets a little bit more difficult there. And then, they obviously start getting easier. So, I guess be aware of that when we give that February update in a month or so. But nevertheless, I was pretty pleased with the way really going back through the fourth quarter. December came in a little bit stronger than what our normal sequential change is. And that's the month we kind of talked about I think on the last call in the fourth quarter in particular in some slower economic environment is where we have seen pretty hefty drop-off in our business levels. And the fact that we stayed pretty steady rather I think was a positive takeaway for me. I was hoping that we would see our sequential performance from a volume standpoint to be a little closer to our 10-year average trends. And certainly, it was. The fourth quarter volumes were down 4.4% sequentially, the normal changes of 1.3% decrease. But if we compare back to where we were in the second and third quarters relative to our 10-year average changes, I think, we are starting to trend back in the right direction, and whether or not we get back to the full 10-year average at least in the first-half of the year remains to be seen. I think we probably need a little bit stronger economy. But I do think that we are going to start seeing some increases like we mentioned particularly starting in March and then continuing through the second quarter. And then, we will see where things go from there. But I think that certainly that volume environment really will dictate what the operating ratio does typically just to give a little bit more color on the first quarter operating ratio. We typically have about a 100 basis point increase there coming off the fourth quarter. In this particular first quarter of 2023, we did have a favorable insurance adjustment. We have talked on -- and given the guidance for 4Q assuming that line held steady. There was improvement there. And I think that that will normalize back to around 1.2% of revenue in 1Q of 23. So, that's becomes a 70 basis point or so headwind for us. I think that we are going to continue to see a little bit of a headwind from depreciation as well. We have talked about this as we worked our way through last year that our delivery cycle was a little bit different than prior year. And so, we are probably going to see a little bit more headwind from here. So, on a normalized basis that probably puts us at about 200 basis point increase. So, we are where we just finished the fourth quarter. But -- so, that kind of puts us somewhat flattish if you will on a year-over-year basis if we were to hit that. And certainly, I think if we get better revenue performance, we have got the opportunity to be able to outperform that longer term normalized average. But I think the revenue environment will certainly control a lot of it for us. Following up on the waiver fees, your headcount was down about 3% sequentially. I think that's the biggest decline besides the COVID 2Q '20 jobs that you had since you began reporting this on a quarterly basis. You talked a little bit earlier in one of the other questions about feeling you are in a fairly good place. Can you elaborate a little more? Does that mean your headcount flat to up from here, or flattish and then trend with volumes from here? And just to help put a finer point on that, any commentary on productivity or the cost of heads -- I don't know, labor cost for employer, any other guidance you can get to help us kind of frame the cost piece of that in the expectation? Thank you. Thanks, Basc. And this is Greg. But I will take that and try to give you as much color only as possible. But obviously we made some adjustments where we felt like we needed to in headcount. And as Adam mentioned earlier, we talked about attrition. And we have kind of let attrition control some of these adjustments. But we have made some in other places where we needed to. Certainly, we haven't replaced openings likely typically would in a normal cycle where we are growing and what not. But -- and that will continue to be our efforts still thanks to our return of the other ways. So, we will see typically -- we will see a little uptick late February. Going into March, things really start to pickup. So, is that going to be the trend this year? We hope so, but just not absolutely certain. But I think we are in a good spot because as I mentioned in my comments earlier, we've got an awful lot of qualified drivers that we have got work on the platform and what not. They are not driving full time. So, I think we will certainly be ready when the increase does happen, you know, hope it's sooner than later, but definitely we will continue to make adjustments as needed. We talked about this on some of our prior calls. We have been able to make these adjustments in downturns in the past. I think we pretty began we can make adjustments when we need to. We have done it again. We feel good about where we are. We just have to continue to stay on top of it and react as the business dictates. I hope that helps. No, it's fairly helpful. To maybe cap that off, any thoughts on items that could impact kind of the cost per head this year? I don't know if there are some variables on incentive comp or other things that might make little bit lengthy versus what we would deem a normal trip based on history? Thank you. Not that I know of, Basc, and don't think so. I think it should be fairly normal from that standpoint. We certainly had some good experiences in the recent past with our benefit cost and those kinds of things. So, you just hope that those things continue to be consistent and don't turn the other way for some or no reason. Yes, good morning, and congratulations also to both of you Greg and Marty. And Greg, yes, just a remarkable run. So, congratulations on the great performance over time. Let's see -- I think -- I guess just in terms of the view on tonnage. I know you have a large customer base. So, maybe it's tough to pars it out. But what would you say about I guess dynamic in terms of volume from retail customers and volume from industrial customers? It seems like probably there has been a lot of weakness and focus on inventory reduction with retail customers. Maybe little less clear what's happened with industrial? So, just trying to think about is there potentially some weakness yet to come with industrial? Have you seen pretty big difference in the volumes from those two groups? And so, kind of any thoughts on that topic would be helpful. Thank you. Good morning, Tom. I would say during the fourth quarter we saw a pretty consistent revenue performance with both our industrial customer base and our retail customer base. I would say earlier part of the year we had seen a little bit stronger performance on the industrial side. And those two kind of converged, if you will, in the fourth quarter. Obviously, our customer bases leans more industrial than retail. We are still 55% to 60% industrial overall and 25% to 30% or so on the retail side. In longer term that retail business has been growing faster than the industrial. And I think that reflects some of the ecommerce trends and the effects of those on our customer supply chains. And we certainly continue to believe that that will be a longer term tailwind for us. And I think that as we start working through 2023. And we believe that we will start seeing customer's orders for their products picking up and some inventory rebalancing if you will. And I think that's why we've seen in some of the prior slow period that I spoke of earlier why you start seeing that orders and freight flows kind of leading the other macroeconomic indicator. So, we believe that the freight cycle will starting turning. And we will start seeing some pick up. And it's through these customer interactions and conversations that, that support our belief that we're going to start seeing freight flow, and again, as we get into March and into the second quarter. Yes, but it sounds like you haven't seen a big difference, maybe over the past, in 4Q or even 3Q, in performance from industrial and retail, and I guess looking forward, you think maybe both of them kind of bottom and improve at the same time. And maybe we start seeing retail outperform again, while I assume, and some of the industrial numbers look a little bit weaker, we start getting some of that retail performance as an offset, leading us out and eventually we'll start seeing the industrial picking back up again. Hey, thanks. Good morning. Yes, congrats. Absolutely to Greg and Marty, it's been a heck of a run, certainly, Greg. When I guess I wanted to talk a little bit about how you guys are planning for the potential improvement in tonnage that you may see in the spring, you guys have always been very good at being out in front of potential opportunities. But do you think that there are incremental costs that need to come on the network. Before that happens, are you fairly comfortable being able to sort of let tonnage lead you out of this to drive incremental margins, which obviously, you guys have performed quite well with over time? Yes, I think that, Chris, that some of the conversation earlier about headcount, probably on paper, we may be a little bit heavy now, if you just look at things statistically, if you will. But that's kind of the point of the, what we've said is, I think that we're in a good spot, with our headcount with our fleet, and certainly with the service center network to be able to let volume start flowing again. And when we talk about increases, just keep in mind that we're talking about sequential increases, and certainly with the year-over-year comps, particularly in the first-half of the year, we've got some tougher year-over-year comparisons there before we get back to, does being able to show year-over-year growth. But I think that'll be the important thing for us to continue to watch is, are we seeing those types of sequential increases? And certainly we've got a lot of flexibility within our workforce. And I think that, given the team that we have, and the current levels, we should be able to respond to growth when it starts coming at us and get some good leverage, as it does. But certainly we're looking at right now in the first quarter. Like I mentioned, with the January tonnage levels, we've got probably the volumes that are going to be the toughest comp, and certainly, overall, the fourth quarter we were down 9.1%. Our yield performance is still looking good. And we certainly expect to continue to push for core yield increases this year to offset our cost inflation, as well. But there could become some converging factors, if you will, that drive the top line, depending on what the overall fuel environment looks like, and so forth. But we're certainly going to continue to look and execute on the same pricing philosophy that we have in the past and look for cost plus increases to offset the cost inflation that we see in the business and to keep supporting these expensive investments that we're making in our real estate network and technologies that can both improve customer service, but also drive further operating efficiencies for us. So, a lot of things to kind of manage through it particularly the first-half of this year, but I think we're in a good spot to be able to handle the volumes if they do backflow our way. Yes, that's very helpful. I appreciate that, that color. On the point of pricing, just to follow-up, ex-fuel yield did accelerate, the year-over-year growth that accelerate in the fourth quarter, and I guess they're guiding the first quarter or roughly speaking to around flattish which may coincide with the worst tonnage, you're going to see from a year-over-year standpoint. So, when you take a step back and think about 2023, more broadly, is OR expansion on the table, given those circumstances is pricing good enough to be able to offset inflation as we go and tonnage potentially gets less worse as the year progresses? Well, I think that again, the revenue environment will have a lot to say about that, more broadly speaking, we've talked and kind of pointed everyone to our performance in 2016 and 2019, when we've been in a flatter revenue environment, certainly, given the planned investment of about $800 million in capital expenditures this year. And with some pressures that we'll see on depreciation, starting earlier in the year than normal, we will have some pressures, if you will, on those overhead costs. And we saw a little bit of that in the fourth quarter already where overhead costs as a percent of revenue were flat in 4Q '22 versus 4Q '21. But like we did in '16 and in '19, the focus when we're in a flat to a down revenue environment will be managing our variable costs flat, and we'd love to see improvement, but trying to hold all those costs flat. And then, any deterioration if there is anything would be in those overhead costs in particular, on the depreciation side. And so, I think that in '16, we certainly saw a little bit of a decrease in the operating ratio or an increase, rather depending on how you look at it. But I think our operating ratio deteriorated 60 basis points that year. And that was something that was right in line with the change in the depreciation line item. And then, '19 was the same thing, where we had 30 basis points deterioration there. So, we'll take it quarter-by-quarter, certainly, and we'll talk as we get to the end of next quarter's call about what we think we may be able to do in 2Q, but certainly feel like we're probably going to have a little bit more pressure on the overhead side this year if we are in fact a flat to slightly down revenue environment, but there's still a lot up in the air when it comes to the top line for this year. Hey, thanks. Good morning, guys, and again, congrats, Greg and Marty. I was wondering, can you give us some of the yields ex-fuel accelerated in Q4, is any color, is underlying pricing accelerating here? And then, Adam, I think you talked about 13% total yield growth in January, anyway you can just help us on the gross and on the net of fuel, I just want to understand that that net of fuel is continuing to accelerate? Thank you. Yes, net of fuel in January was about 8.5%. So, fairly consistent with what we just did in the fourth quarter overall. And we are starting to see a decrease in fuel. And we'll see how that continues to trend this year. And so, perhaps the yield with and without the fuel, those two numbers will maybe be a little bit more consistent. I think that fuel hold steady with where we are right now, it certainly becomes a headwind as we get into the later quarters of the year, but nonetheless, I think that certainly there's always mix changes that can drive that number, higher or lower. But I think it's pretty consistent with what our long-term philosophy has been. We certainly dealt with higher cost inflation on a per shipment basis in 2022 than then what at least I initially expected I thought we would see some cost moderation as we got into the back-half of the year, which obviously did not happen. So, we just continue to execute on that same consistent philosophy that we always have. And I think that's why we saw that the yield performance that we did, but I believe that call should be a little bit more favorable versus the last couple of years. And 2023 are certainly that's our hope. And we'll continue to build our cost model around what that cost inflation expectation is and then continue to try to achieve 100 to 150 basis points of positive spread above that inflation to again support the investments that we're going to make. So, I think overall, if you did sort of roll out typically the first quarter our yield metrics are up about 0.5% over the fourth quarter. We'd expect to continue to see if mix is constant. Those numbers increase sequentially quarter-after-quarter, but certainly that some of that, that growth if you will may start to moderate a bit but again you're going to see that same type of moderation or should, what the costs. But nonetheless, the overall philosophy stays the same, and we'll continue to look for cost plus pricing. Very helpful. And just because you mentioned the fuel, and maybe the surcharge revenue and flex negative, how does that impact your thoughts on the question earlier about operating ratio improvement this year? Well, again, it's just it's one of the drivers on the top line, that is a change that we will deal with. And I think overall, it would be a positive for the economy and something that would be good to see. But I don't know anybody that would like showing up at the pump and seeing that bigger number. And certainly, that's been a big cost driver for what we've seen. I think it's better to for just cost inflation and other line items. I think the increased cost of fuel is driving inflation and about anything, whether it's a product or service that we're buying. And so, I think a decrease there certainly helps. But as we look back 2015-2016 were the timeframes that we last went through a bigger decrease in average fuel prices. And I think we continue to try to manage, just like we did in those periods, and continuing to manage the different components that go into building out our rates with customers, whether it's base rates, fuel surcharge, or as is oils managing all the revenue inputs with the cost inputs and trying to account for whether or not fuel goes up or down. So, it's just something that our pricing and costing teams and our sales teams have got to work through is we're working through renewals with our customers every day, and just looking at and seeing where we are and what we feel like we need to keep driving improvement in our customer specific pricing and profitability. Hi, good morning. I just want to ask about potential customer attrition, just given some of the freight challenges out there and certainly your customer focus on costs. Are you seeing any sort of attrition as customers try to tray down obviously, quality but prices low or the dynamics may be a little different this cycle, just any thoughts there? Yes, good morning. This is Marty, I'll take that one. We aren't seeing anything like we saw back in '08 or '09. We have customers in here every week, and our larger customers, contract customers coming in. Its business is usual. They're coming in and asking for contract renewals, additional services and so forth. So, we're not seeing anything out of the ordinary for the economic circumstances, no major price cutting or anything like that. So, I feel pretty confident that the end is probably near what we're going through. Thank you. Good morning. Marty, since we have you, as you're entering, you're already there. But you're entering the head seat and the best mousetrap in the industry probably on the precipice of breaking the 70 OR basis. You've already laid out your CapEx for this year. But as you think strategically over the next few years, anything you're thinking about differently as it relates to growth, as it relates to the labor et cetera or is it just kind of ride the cycles of what you've had and continue to get incremental productivity out of that mousetrap? Well, one of the reasons we've been able to grow like we have over the last years is because we continue to build capacity even during slow times, and I don't see us moving away from that focus. So, we'll continue to do that. We'll continue to buy new equipment and hire employees as needed. So, I don't see any change from what we've been doing, this made us successful in the past. Thanks. Good morning everyone. Congrats Greg and Marty and Marty, yes, please don't change the thing, just do -- in that seat and anything. A couple of follow-ups here, do you feel like you have a better ability to capture that spring inflection in growth if it comes versus peers given how much free capacity you have? And do you have a sense of your ability to grow into that volume relative to peers? I don't know about relative to peers, but certainly, we feel confident about our ability to grow. And I think you look at things in the past, we've certainly have been outgrowing the market relative over the last 10 years, in particular, year in and year out. When we're in up cycles, that's when our business shines the brightest. And certainly, our service is what wins us share and have an available capacity to respond to customers when they need us the most. That's kind of our hallmark. And so, we're sitting in a very good spot right now to be able to respond to that growth when the phone calls come, we're going to be picking them up. Got it, sounds good. And maybe as a follow-up kind of on the fuel topic, I mean, there's been a lot of speculation in the investment community about like fuel and kind of how much is driven earnings. And I think a lot of you -- I mean, you and your lot of your peers have been saying that, hey, there's a new algorithm when it comes to fuel pricing and it's stickier than you think, et cetera, et cetera. So, how do we think about how fuel becomes a headwind in the back-half of the year kind of there's any way to quantify that? And also kind of how much of that fuel can be sticky and kind of convert the base rate over time, do you think? It's something that's -- we certainly faced this question before when fuel changes. I think that we got a pretty long period where we were at low fuel prices kind of going back to when that final decrease happened in 2016. And I'd say we had pretty good results between 2016 and 2020 when we were in a lower fuel environment. And again, I think that it's something that maybe people on the Street, it's hard to understand if you're not negotiating with some of these types of contracts. But for us, it's all about having a good cost model, understanding our cost and knowing what the revenue and the cost inputs are going to be whether fuels at $5 a gallon or $3 a gallon, it's just something that we've got to manage through. In some environment, some customers may want more or less and increase coming through, a base rate type of change, some may want more exposure to that variable component of pricing that would be the fuel surcharge. And there's ways to increase yields by driving productivity with customers as well, where we can obtain the same objective by just looking at the operational factors underneath, and having all of our systems tied into our cost model allows us to have those types of conversations with our customers as well. Ultimately, it's just about driving customer-specific profitability improvement and work in our continuous improvement cycle so that we can continue to purchase real estate and expand our network. So, customers have got that to leverage within their own supply chains. We're effectively buying capacity on behalf of our customers. So, I think we got to just continue to execute on that front. And I think that we've shown in terms of going through prior cycles that we'll be able to do so. Great, good morning, and again congrats, Greg, on your tenure, and Marty, on the new role. Just a quick clarification, I guess, on that spring pickup you've talked a bit about. Is that just comp based? Or is there a commentary you're hearing from customer comments or just I guess on showing up inventories? I just want to understand why the -- I guess, the confidence in that given the market and then my question is on depreciation. You know the depreciation is going to be higher. Last year, you targeted, I think it was $485 million on equipment at the beginning of this year -- at the beginning of the year. This year, you're doing $400 million on equipment. Is that because the delivery schedule was slower? Is -- what's your view on getting that equipment? And does that still allow you to stay at that 20%, 25% excess capacity that you typically target? Thanks. Yes, Ken, this is Greg. I think so on the -- I'll take your revenue question first, but we typically always pick up in the spring. So, certainly, we're hopeful that we get back into a more normal cycle than what we've certainly been in really since COVID. We've kind of been off cycle, if you will, if that makes sense. And the normal numbers and sequentials that we compare with all over the years, they're just been different in the last couple of years. So, certainly, getting back to a normal cycle would be one reason we are somewhat hopeful. Some of the things that we've seen, heard and read, inventories are starting to get low compared to where they were back, say, a year or six months ago. So, I think there are some things that lead us to believe that we could be coming out of this thing, plus we've been through many, many cycles over the years. And typically, they're a year, 16 months, so we kind of think that that's what we've been in this one. So, yes, we're hopeful, got our fingers crossed that we will come out of this thing as we get into the spring and later on in the second quarter. As far as the equipment, yes, it's been kind of funky. The deliveries that we -- cycle that we've been on this time. We certainly didn't get everything back last year like we typically would. Typically, we would have all of our orders in the early fall. We had everything in place that wasn't the case this year. We're actually still taking some equipment that we should have gotten back last year. So, it's been a little different. So, we'll just have to see how the business develops, and I think that's going to determine where that $400 million that we talked about number, where that goes this year. So, we'll just have to see, and it will certainly be based on our business conditions and the numbers that we see as we get on into 2023 as to how that $400 million develops this year compared to last year. Thanks, Operator. Hi, everyone, Greg, hearty congratulations on the retirement; and Marty, looking forward to working with you as well. I guess I wanted to ask about pricing. I know pricing discipline is good, so it's not really about that, but I guess we've seen a lot of LTL companies in recent months announced general rate increases. I guess what's surprising to me is some of the ones that have even a little bit weaker service that may be more tempted to lean into price have also announced big price increases. And I wanted to understand like the reaction from the customers because, in the typical cycle, a customer would maybe trade down to regional lanes with high-quality carriers. Maybe you lose 20%, 30% of your lanes or two or three lanes or whatever it is, that doesn't seem to be occurring right now where shippers are not moving to other high-quality, but regional lanes. And I want to understand, one, why you think that might be like what's the psychology of your customers in terms of how they think this cycle is going to play out? And then second, how does that impact your ability to bounce back? Because I would assume as there's a big seasonal pull in March and April, May. You don't have to win back lanes, you don't have to win back customers so you can kind of see it first in terms of that upswing. So, sorry for the long-winded question, but hopefully that was clear. I don't know if I can explain the psychology of our customers, but I did take a psych class in college one, so I'll give it a shot, but I think that we've talked a lot about this that since going through COVID, there's been so much disruption to customer's supply chains and missed revenue opportunities, incremental cost added to production lines just because of all the supply chain challenges that many of our customers have been dealing with over the last couple of years. So, I think, for that reason, we've seen a little bit of change in customer behavior. I think customers have been sticking with us. And certainly, over the last year, as Marty mentioned earlier, despite the weakness that we've seen in the economy, we've seen good customer trends. We get periodic reporting from our national account sales teams. And we just -- we have not been losing customer accounts. I think customers have been keeping us in place because they inevitably know that one that many are still dealing with challenges. A lot of the conversations that we continue to have are more around challenges within the supply chain. And I think two is that they know that we are probably closer to things turning and orders picking back up for our customers' products. And they want to make sure that they have got capacity that's available as needed. There are a lot of competitors that had embargoes in places and communication to customers saying I am keeping you up today. But I can't pick you up tomorrow. And we were able to respond in particular in 2021 to a lot of those customers that called on us needing capacity. And so, I think that that's strengthened the relationships that we have with our customers. And we have got a lot of continuity within our customer base anyway. So, I think those -- everything that's happened over the last couple of years has really strengthened those customer relationships. So, I think that one of the things you said as part of your questions though gives us a little confidence in terms of when those orders for our customer product start picking up again in the sense that in prior cycles like 2016 or 2019 where we may have lost a few lanes or lost a customer account, we were always confident that the business would return to us in many case because the customer told us that they wanted to bring this back in when they could. But we had to wait until the next bid cycle before we got that opportunity. Customers are keeping us in place. They are keeping their contracts current, pricing terms updated. And so, I feel like that whenever those orders start picking up, we may be getting three shipments instead of two at every pick up. And volumes should return to us quicker than perhaps they have in prior down cycles. Great. Thanks. Good morning, everyone. And, congrats Greg, it's certainly been an impressive run that you have, and congrats also to Marty on some big shoes to fill here. So, I wanted to ask about you guys have talked about for some time the ability to get the OR into the 60s. I understand obviously there are different puts and takes on kind of economic uncertainty, maybe some cost inflammation, but also talking about this inflection that's expected for second quarter, it seems like there is some optimism there around the ability to perhaps improve OR year-over-year which would certainly suggest that you are kind of bumping up against that ability to get the OR to the 60s. I just want to get your updated thoughts kind of given the progression of OR improvement that we have seen over the last couple of years, do you think that OR in the 60s is achievable whether it's 2023 or into 2024? Well, again I think we were saying earlier, certainly 2023 just given the environment it's certainly going to be a little bit more challenging. And we are continuing to keep our eye for the future. We are investing or planning to invest $800 million in capital expenditures this year when the economy is certainly soft right now. And we may end up being in a flattish type of revenue environment. So, revenue will certainly dictate a lot. But I think that just given the comparison to the two years that we have talked about, you can make your own assessments into what you think revenue may end up being for us this year. But if we are in a flattish revenue environment, then certainly we have seen the operating ratio increase slightly in those years. But the positioning that we are going through is to make sure that we are in a great position to be able to respond when that inflection does happen and we get back to a revenue growth environment. And we've averaged to 11% to 12% of revenue growth per year over the last 10 years. And we think of ourselves as a growth company. But, we are certainly going to be disciplined in periods where the economy is softer. And we have seen flattish type of revenue in those environments in the past when the economy has been slower. So, I think certainly a lot of depends on that. But, we had many type of OR degradation in the short run. I mean just for this year, the positioning in the recovery year is usually pretty doggone strong. And so, we continue to stand behind our goal of wanting to get to a sub-70% operating ratio. We didn't put a timeframe behind that when we laid it out last year, at this time, for this sole reason; we don't want to be beholden to something that's, in the short-run, that may jeopardize our opportunity for producing strong profitable growth in 2024, '25, and beyond. And I'm confident that we'll certainly be able to get to sub-70% for the year. We certainly did it for two quarters this year, in the second and third quarters. And so, I think we've shown that it can be done. And just to be clear, we continue to say that that is our next goal, but it will not be the final goal. We think that we can continue to go further from there, but we're going to keep that goal in sight for now. And once we achieve it, then we'll lay out where the next stop might be in this long-term OR journey. Got it, understood. And then I wanted to ask also, as I think about the conditions that you've kind of been describing for 2022, where volumes have been a little bit softer than what you would have hoped for. Obviously, we've seen the headcount come down. And yet, your earnings growth was obviously strong this year, at 35%-plus. To what extent, when you're going out and talking to customers who maybe were a little bit squeezed on capacity during COVID conditions, as supply chains normalize, does that put a little bit of a headwind on your ability to go to customers and ask for rate increases? Or conversely, do they push back and say, "Look, we gave you rate increases when capacity was really tight," but now the supply chain's kind of normalized a little bit, are they pushing back any more on some of the rate increases relative to what they were over the past 12 to 18 months? I think the answer to that is yes. They push harder when they know they -- either they are in a position to do so. And certainly with the conditions being soft like they've been, yes, they're pushing us for not as big of an increase, and that kind of thing. But you got to remember, we don't necessarily go into a customer and start talking about price. We talk about the value that we provide that customer, and that's what we will continue to sell them. We sell them value. And many times, value and price are pretty darn close, if you know what I mean, because if you're not getting value, what does the price matter? So, that's what we'll continue to sell. And thankfully, I think our customers have seen that, and in what OD has delivered over the years. And that's a huge reason for the success that we've had. So, we'll continue to focus on selling value, and not price. And honestly, try not to have those conversations. I wanted to thank our sales team who does a fantastic job of sharing our costing with our customers, especially our large customers. We're an open book; we actually show them what we're paying for equipment, how much it costs not to put -- freight, pick it up, sort and flag it, whatever the cost may be. And once you explain to them what our costs are, it's a lot easier to swallow a general rate increase. So, I think most of our customers understand what our costs are. And we try to explain that to the best of our ability. Thank you very much. And I'll also echo congratulations, Greg, and congratulations, Marty. A lot of my questions have been answered at this point. Just a real quick one on fuel and the potential headwind that you were talking a little bit about, for '23, if I just look at this quarter, fuel surcharge revenue up $97 million incrementally, fuel expense up $48 million incrementally, so -- or $49 million. So, that the net of that was a positive $48 million. Total operating income was a positive $58 million. So, I guess part one is, is the math that simple, that of the $58 million operating improvement, $48 million was the fuel differential. And then I guess, if so, as I look at '23, given where fuel is right now, can you put or quantify what the magnitude of that headwind would be, say, the fuel surcharge component coming down, which you alluded to in the January data, versus fuel expense? Yes, the short answer is that the math is really not that simple. Going back to prior comments, fuel is just one of many elements that get negotiated as part of a customer's rate each year. So, it could be that we get more fuel surcharge in one particular more, more base rate in another. And so, trying to look out and measure what the surcharge revenue piece is versus what the potential expense might be is not really a one-for-one comparison in that regard. The surcharge, if a customer has decided to take on more variable exposure to that fluctuation in fuel is covering many more cost elements than just the cost of fuel and other petroleum-based products. Certainly that's what it's designed to cover, but that's not everything that is covered by that variable component of pricing. So, again, I think the -- if you want to look back into a declining fuel environment, I would point people to look at 2015, and 2016. In '15, the average price of fuel was down 30% that year. Of course, we had volume growth, it was a little different macro environment, and so as a result we were able to improve the operating ratio that year. In '16, the average price of fuel decreased further. It decreased about 15% that year, and that was one of the years, as I mentioned earlier, that we had a 60 basis point increase in the operating ratio. That the overall macro was a little softer, volumes were certainly flattish that year. And so, a little bit different top line makeup, if you will. But so, that's probably a little bit more relative comparison, is looking back at how some of those revenue changes quarter-to-quarter, and cost changes progressed in that year. But we're certainly managing through it. And we're looking at -- we've got contracts that turn over every day, and they progress through the year. So, if fuel stays where it is today, then we're looking at a contract with a base rate of a fuel at $4.58 a gallon versus, last year, we were looking at it and it would have been $5-something per gallon. So, you just always got to look at what the current environment looks like, and then try to risk-adjust for do you think fuel prices may go up? If they do, again, how does the top line for each individual customer account change, and what do the cost inputs change? If fuel goes down, you do the same thing, and you try to make sure that those fuel scales, as they work on each customer account, that we're still effectively getting paid for the service that we're providing and, like Greg said, the value that we are offering. And so that's what we stay focused on. And it's less important for us to look at the profitability of each customer account. All right, thank you for the clarification. But math for the fourth quarter would be fair at face value, but there's more uncertainty, to your point, looking to '23. Is that the right way to think about it? Well, it -- certainly there is uncertainty with respect to what fuel may end up averaging. We had -- we have seen it declining a little bit more, and then it kind of reverted back and had a little bit of an increase over the last couple weeks as well. But certainly, if it holds steady from here, then maybe we see fuel prices that are down 10% or so this year. But I think it's better for the U.S. economy if we get back to a lower fuel environment. And certainly, we will deal with that from a company standpoint, it's not going to change our long-term objectives, and we're not changing our operating ratio, goals, just because fuel may ultimately decline. Those are certainly built into what our longer-term forecasts are. We think that it should decline overall, and hopefully we get back to a lower fuel environment. This concludes our question-and-answer session. I would like to turn the conference back over to Greg Gantt for any closing remarks. We thank you all for your participation today. We appreciate your questions. And please feel free to give us a call if you have anything further. Thanks, and have a great day.
|
EarningCall_1147
|
Good day, and thank you for standing by. Welcome to the Fourth Quarter 2022 Capital One Financial Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakersâ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that todayâs conference is being recorded. I would now like to hand the conference over to your speaker today, Jeff Norris, Senior Vice President of Finance. Please go ahead. Thank you very much, Victor. And welcome everybody to Capital Oneâs fourth quarter 2022 earnings conference call. As usual, we are webcasting live over the internet. To access the call on the internet, please log on to Capital Oneâs website at capitalone.com and follow the links from there. In addition to the press release and financials, we have included a presentation summarizing our fourth quarter 2022 results. With me this evening are Mr. Richard Fairbank, Capital Oneâs Chairman and Chief Executive Officer; and Mr. Andrew Young, Capital Oneâs Chief Financial Officer. Rich and Andrew will walk you through the presentation. To access a copy of the presentation and the press release, please go to Capital Oneâs website, click on Investors and click on Quarterly Earnings Release. Please note that this presentation may contain forward-looking statements. Information regarding Capital Oneâs financial performance and any forward-looking statements contained in todayâs discussion and the materials speak only as of the particular date or dates indicated in the materials. Capital One does not undertake any obligation to update or revise any of this information, whether as a result of new information, future events or otherwise. Numerous factors could cause our actual results to differ materially from those described in forward-looking statements. For more information on these factors, please see the section titled, Forward-Looking Information in the earnings release presentation and the Risk Factors section in our annual and quarterly reports, which are accessible at Capital Oneâs website and filed with the SEC. Iâll start on slide 3 of tonightâs presentation. In the fourth quarter, Capital One earned $1.2 billion or $3.03 per diluted common share. For the full year, Capital One earned $7.4 billion or $17.91 per share. Included in the results for the fourth quarter were two adjusting items, which collectively benefited pretax earnings by $105 million. Net of these adjustments, fourth quarter earnings per share were $2.82 and full year earnings performance share were $17.71. On a linked quarter basis, period-end loans grew 3% and average loans grew 2%, driven by growth in our domestic car business. This loan growth coupled with net interest margin expansion drove revenue up 3% on a linked quarter basis. Noninterest expense grew 3% in the linked quarter, driven by an increase in marketing expenses while operating expenses were largely flat. Net of the adjustments I mentioned earlier, operating expenses were up 2.4%. Provision in the quarter -- provision expense in the quarter was $2.4 billion, driven by net charge-offs of $1.4 billion and an allowance build of about $1 billion. Turning to slide 4, I will cover the changes in our allowance in greater detail. The $1 billion increase in allowance in the fourth quarter brings our total company year-end allowance balance up to $13.2 billion, increasing the total company coverage ratio by 22 basis points to 4.24%. Iâll cover the changes in allowance and coverage ratio by segment on slide 5. In our Domestic Card business, the allowance balance increased by $795 million, bringing our coverage ratio to 6.97%. Three things put upward pressure on our card allowance. The first factor was the continued credit normalization in our portfolio. The second factor was a modestly worse economic outlook than our assumption a quarter ago. And finally, we built allowance for the loan growth in the quarter. The impact of the fourth quarter loan growth on the allowance is more muted than typical loan growth given the seasonal nature of these balances. These three factors were modestly offset by a release in our qualitative factors. In our Consumer Banking segment, the allowance balance increased by $129 million, driving a 20 basis-point increase in coverage to 2.8%. The build was primarily driven by continued credit normalization in our auto business, including lower recovery rates. The second factor also putting upward pressure on our allowance is the impact of a modestly worse economic outlook. These two factors were modestly offset by a release in our qualitative factors. And finally, in our Commercial business, the allowance increased $73 million, resulting in a 9 basis-point increase in coverage to 1.54%. This was largely driven by reserve builds for our office portfolio. Turning to page 6, Iâll discuss liquidity. You can see our preliminary average liquidity coverage ratio during the fourth quarter was 143%, well above the 100% regulatory requirement. Total liquidity reserves increased by $14 billion to $107 billion. Strong consumer deposit growth throughout the quarter drove cash balances higher and allowed us to pay down prior FHLB borrowings. Turning to page 7, Iâll cover our net interest margin. Our net interest margin was 6.84% in the fourth quarter, 24 basis points higher than the year-ago quarter and 4 basis points higher than the prior quarter. The 4 basis-point linked quarter increase in NIM was driven by higher asset yields and a balance sheet mix shift towards car loans. This impact was mostly offset by higher deposit and wholesale funding costs. Turning to slide 8, I will end by discussing our capital position. Our common equity Tier 1 capital ratio was 12.5% at the end of the fourth quarter, up about 30 basis points relative to last quarter. The $1.2 billion of net income in the quarter was partially offset by growth in risk-weighted assets, dividends and share repurchases. We repurchased approximately $150 million of common stock in the quarter, bringing the repurchases for the full year to $4.8 billion. We continue to estimate that our longer term CET1 capital need is around 11%. Iâll begin on slide 10 with fourth quarter results in our Credit Card business. Year-over-year growth in purchase volume and loans, coupled with strong revenue margin drove an increase in revenue compared to the fourth quarter of 2021. Credit Card segment results are largely a function of our domestic card results and trends, which are shown on slide 11. In the fourth quarter, strong year-over-year growth in every top line metric continued in our Domestic Card business. Purchase volume for the fourth quarter was up 9% from the fourth quarter of 2021. Ending loan balances increased $22.9 billion or about 21% year-over-year. Ending loans grew 8% from the sequential quarter. And revenue was up 19% year-over-year, driven by the growth in purchase volume and loans as well as strong revenue margin. Both the charge-off rate and the delinquency rate continued to normalize and were below pre-pandemic levels. The domestic card charge-off rate for the quarter was 3.2%, up 173 basis points year-over-year. The 30-plus delinquency rate at quarter-end was 3.43%, 121 basis points above the prior year. On a linked quarter basis, the charge-off rate was up 102 basis points and the delinquency rate was up 46 basis points. Noninterest expense was up 12% from the fourth quarter of 2021, which includes an increase in marketing. Total company marketing expense was about $1.1 billion in the quarter. Our choice in domestic card marketing are the biggest driver of total company marketing. In our Domestic Card business, we continue to lean into marketing to drive resilient growth. Weâre keeping a close eye on competitor actions and potential marketplace risks. Weâre seeing the success of our marketing and strong growth in domestic card new accounts, purchase volume and loans across our card business and strong momentum in our decade-long focus on heavy spenders at the top of the marketplace continues. Slide 12 shows fourth quarter results for our Consumer Banking business. In the fourth quarter, we continued to see the effects of our choice to pull back on auto growth in response to competitive pricing dynamics that have pressured industry margins. Auto originations declined 32% year-over-year and 20% from the linked quarter. Driven by the decline in auto originations, Consumer Banking loan growth continued to be slower than previous quarters. Fourth quarter ending loans grew 3% compared to the year ago quarter. On a linked-quarter basis, ending loans were down 2%. Fourth quarter ending deposits in the Consumer Bank were up 6% year-over-year, and up 5% over the sequential quarter. Average deposits were up 4% year-over-year and up 3% from the sequential quarter. Our digital-first national direct banking strategy continues to get good traction. Consumer Banking revenue was up 10% year-over-year as growth in auto loans and deposits was partially offset by the year-over-year decline in auto margins. Noninterest expense was up 13% compared to the fourth quarter of 2021, driven by investments in the digital capabilities of our auto and retail banking businesses and marketing for our national digital bank. The auto charge-off rate and delinquency rate continued to normalize in the fourth quarter. The charge-off rate for the fourth quarter was 1.66%, up 108 basis points year-over-year. The 30-plus delinquency rate was 5.62%, up 130 basis points year-over-year. On a linked quarter basis, the charge-off rate was up 61 basis points, and the 30-plus delinquency rate was up 77 basis points. Slide 13 shows fourth quarter results for our Commercial Banking business. Compared to the linked quarter, fourth quarter ending loan balances were down 1% and average loans were flat. Ending deposits were down 1% from the linked quarter. Average deposits grew 7%. Fourth quarter revenue was down 23% from the linked quarter. The decline was primarily driven by an internal funds transfer pricing impact that was offset by an equivalent increase in the other category and was therefore neutral to the Company. Excluding this impact, fourth quarter commercial revenue would have been down about 6% quarter-over-quarter and up 2% year-over-year. Noninterest expense was up 2% from the linked quarter. The Commercial Banking annualized charge-off rate was 6 basis points. The criticized performing loan rate increased 74 basis points from the linked quarter to 6.71%, and the criticized nonperforming loan rate was up 17 basis points from the linked quarter to 0.74%. In closing, we continue to drive strong growth in card revenue, purchase volume and loans in the fourth quarter. Loan growth in our Consumer Banking business was slower compared to previous quarters as we continued to pull back on auto originations. Consumer deposits grew. And in our Commercial Banking business, ending loans and deposits were roughly flat compared to the linked quarter. Charge-off rates and delinquency rates continue to normalize across our business and were below pre-pandemic levels. Total company operating expense net of adjustments was up 2.4% from the linked quarter. Our annual operating efficiency ratio for full year 2022 was 44.5% net of adjustments, a 15 basis points improvement from full year 2021. And we expect that the full year 2023 annual operating efficiency ratio net of adjustments will be roughly flat to modestly down compared to 2022. Pulling way up, we continue to see opportunities for resilient asset growth that can deliver sustained revenue annuities. We continue to closely monitor and assess competitive dynamics and economic uncertainty. Powered by our modern digital technology, weâre continuously improving our proprietary underwriting, marketing and product capabilities. Weâre focusing on efficiency improvement and weâre managing capital prudently. As a result of our investments to transform our technology and to drive resilient growth, weâre in a strong position to deliver compelling long-term shareholder value and thrive in a broad range of possible economic scenarios. Thank you, Rich. Weâll now start the Q&A session. As a courtesy to our other investors and analysts who might wish to ask a question, please limit yourself to one question plus a single follow-up. If you have any follow-up questions after the Q&A session, Investor Relations team will be available after the call. Victor, please start the Q&A. Thank you. One moment for our first question. Our first question comes from line of Mihir Bhatia from Bank of America. I wanted to ask about just the vintage seasoning or growth math as you talk -- as I think weâve talked about in the past. Weâve added a lot of loans here in last year. And as these loans season, I was just trying to -- wonder if you could maybe talk about just how you see that flowing through into your loss rates and what that does to your delinquency and loss goes here over the next 12 to 24 months? Thank you. Yes. Thank you. Let me just start with a reminder of what we mean by growth math. As a general rule of thumb, losses on new loans tend to ramp up over a couple of years and then peak and then gradually come down. When we accelerate growth and especially when those new loans are added to a seasoned back book with low losses, it can increase the overall level of losses of a portfolio. We grew rapidly -- for example, just looking back at when we talk a lot about growth math, we grew rapidly in 2014, 2015 and 2016, and had a particularly visible growth math effect in the wake of that growth. At that time, the large front book was adding to a back book that was unusually seasoned because it had survived the Great Recession. Given our recent rate of growth, I think itâs likely weâll see some growth math effect again over the next few years. But I think the general normalization trend will be the bigger driver of our credit trajectory. One other thing thatâs different about growth math going forward is CECL. Under the CECL accounting regime, the allowance impact of new growth are pulled forward significantly. We havenât seen this effect for most of the pandemic, even as we have accelerated our growth because of the offsetting favorable factors in our allowance. But as our growth continues, a portion of our allowance builds going forward are intended to support that growth. Okay. Thanks. And then just maybe on your reserve. Just trying to understand just some of the assumptions underlying the reserves. Maybe you could just talk about what youâre assuming for unemployment whether you have a recession built into the short term. Any additional color you can help us with there? Thank you. Sure Mihir. As I said in the past, we are largely consumers of economic assumptions. In this particular case for unemployment, we are assuming something thatâs a little modestly higher than consensus estimates for where we will land in the fourth quarter. I think consensus is somewhere around 4.8. Weâre -- our baseline forecast gets up to around 5% in the fourth quarter. But itâs important to note thereâs a lot of other things that go into the calculation of the reserve, things like unemployment -- sorry, changes in the unemployment rate, inflation, home prices, wages, all of those factors matter as well, but our unemployment assumption is to be around 4% in the fourth quarter -- sorry, around 5% in the fourth quarter. So Rich, maybe I can ask Mihirâs -- one of Mihirâs questions in a slightly different manner. So, competitors in the industry are talking about reaching pre-pandemic loss levels by year-end or maybe even overshooting those levels. Can you maybe just talk a little bit about how you think about the pace of normalization or maybe even overshooting those? And maybe just talk a little bit about normalization versus parts of the portfolio if youâre actually seeing any deterioration. Thanks. And I have a follow-up. Okay. Thanks, Ryan. So consumer credit metrics remain strong. And of course, as weâve seen, theyâve been normalizing steadily through 2022 and are approaching pre-pandemic levels. At first, normalization was more pronounced in some segments more than others. It was -- of course -- and by the way, this is always the case that front book, new originations tend to be higher. So, that would have been shocking, had it been different. But the other thing we also said and talked to investors about it was more -- normalization was happening everywhere, but it was more pronounced at the lower end of the market. More recently, weâve actually seen more uniform trend of normalization across businesses and segments, so, for example, across various FICO ranges and also across income levels. When we index them on credit metrics back to where they were before the pandemic, the sort of rest of the credit spectrum and rest of the income spectrums caught up to the, very recently in the last few months, to the lower end. So really, if I pull on that, it looks like the normalization is pretty consistent across the board. And -- yes, go ahead, Ryan. So, you asked various competitors are forecasting or talking about different times at which things cross 2019 levels. I think at Capital One, weâre not making specific predictions on that. But I think the key thing I would have you look at is the delinquency metrics. Delinquency metrics are the best single predictor of where things are going to go in the near term. And in fact, if we look at flow rates, we can see that very early flow rates into delinquency buckets are pretty normalized. So, weâre not giving specific guidance. But we would say, look at the credit metrics, look at the dynamics across other metrics, but we feel this is -- itâs clearly normalizing as we see it. Got it. And then, Rich, maybe to follow up on the comments regarding the efficiency being flat to modestly down. I think last quarter, you were talking about modest efficiency improvements. There have been headlines about the firm reducing some headcount. So, Iâm just curious, has anything changed in terms of your expectations for efficiency improvement? I guess given the pace of revenue growth thatâs expected and contemplated, is there any acceleration in investments thatâs taking place to drive the stable to modestly efficient -- improving efficiency? Thank you. Yes. Ryan, our efficiency outlook is exactly the same as it was last quarter. If you recall, actually, we guided to the -- for full year 2022 for efficiency to be flat -- basically kind of flat to 2021, and then modestly down for 2023 relative to 2021. What happened is that â22 came in a little bit lower. So, our guidance of flat to modestly down, itâs the same outlook as we had before. And so, thereâs not big investments behind that. Itâs a continued journey of Capital One to lean into our opportunities to continue to invest in the tech opportunities that we see and the opportunities to create breakthroughs in the marketplace and continue to transform how we work. But pulling way up the sort of story if you kind of pull way back on operating efficiency, the journey that where weâve driven 440 basis points of improvement from 2013 -- well, through 2019. And then we had the whole pandemic thing. But if I pull way up the gradual operating efficiency improvement is what we are continuing to drive for through the leveraging of our tech transformation even as we continue to invest. So two questions. One, just as we think about the margin and the net interest margin, interest margin outlook, -- can you give us a sense as to how youâre thinking about deposit betas and how thatâs likely to grow here over the course of the year. I noticed you talked a little bit earlier about deposit growth was really strong. Maybe give us a sense as to which types of deposits youâre really leaning into at this stage. And then help us understand how asset yields are likely to trend given -- forward curve, Iâm assuming is the base case, but tell me if you have a different point of view on that. Thanks. Yes. Betsy, Iâll start with your last question first, which is we are following the forward curve, assuming 50 bps here in the first quarter and holding flat throughout â23 before coming down in â24. With respect to how weâre thinking about beta and asset yields as components of NIM, as we get into the latter part of this rate cycle, lagged deposit rates really have a bigger impact than the asset yields that reprice more quickly and did so over the last couple of quarters as the Fed was moving rapidly. And so, thereâs a bit of that sequential dynamic going on. In terms of thinking about overall deposit beta and product mix, roughly 85% of our deposits are in consumer. Itâs where our focus lies. And so if you just look at the cumulative deposit beta for the total company, itâs around 35%, was low-20s last quarter. But if you look at the last increasing rate cycle, I think the terminal beta was around 41. So, I could see a terminal beta being somewhere above that, just given competitive dynamics in the marketplace at this point. So, I would say the net of all of those factors is likely to be a modest headwind to NIM. We talked last quarter about balance sheet mix -- and we are largely back to a pre-pandemic balance sheet mix from where we were a year ago. And frankly, our NIM is roughly in a similar spot. So, I would say balance sheet mix over a multiple quarter period isnât likely to be a big driver, unless we just see outsized growth in the higher-margin card business. And then, the other factor that could prove to be a tailwind to potentially offset a little bit of the modest headwind that probably comes from the beta dynamics that I described is we could also see a bit of an increase in card revolve rates from where they are today. So, all of those things are -- just to leave you with kind of a net impression that there are headwinds and potentially some tailwinds. But the one thing I will just note as we look ahead to the first quarter, as a reminder, in the way we calculate NIM day count has an effect. So, the one thing we know for sure is weâll have a 14 basis-point or so headwind in Q1 due to having two fewer days in the quarter. Okay. Thatâs super helpful color. As a follow-up, I just wanted to get a sense as to how youâre thinking about the outlook for marketing, obviously, a critical driver of growth, and I know itâs been something that youâve been very successful with in generating that top of wallet customer. But just wanted to see how we should think about that investment as we go into the next year with this NIM headwind, et cetera. Thanks. Betsy, yes, we continue to -- I feel very good about the traction that weâre getting in marketing. Of course, most of the marketing that we do is in the card business. We continue to see attractive growth opportunities across the business for new account origination. We have continued to expand our products and the marketing channels that weâre originating in. We see evidence all over the place of the benefits of our tech transformation thatâs giving us some extra opportunity. So, we feel very good about that. You mentioned, of course, how do we feel about leaning into this in the context of the potential looming downturn. And what we do is we just continue to look all around the edges of our originations and look for places that either we would think might be particularly likely to have a challenge or be vulnerable or things that we see having any kind of performance issues, and we sort of trim around the edges. Thatâs what weâve been doing for three decades at Capital One, and we continue to do this. So thereâs a little bit of trimming around the edges. But really, the net impression I would lead you on the card side is we continue to lean in. Now, of course, thereâs the marketing that we do just the -- to originate accounts directly through all the direct marketing media. We, of course, have our continued investments on the brand side, we -- the heavy spender investments, which are particularly heavy in terms of marketing costs. We continue to get very good traction on the spender side, our growth as you sort of look at each sort of range of spenders, the -- we are getting the most growth at the higher end. So, that continues to be a good sign for us. And so, weâre leaning into that. And then the other thing on the marketing side, of course, is the national bank marketing. Youâve seen some of the success weâre having there. Everybody in banking is sort of leaning into the deposit growth side in the context of changing interest rates, and some deposits leading the banking systems. So our marketing venues to get very good traction there. So pulling way up, we continue to feel good about the marketing. We like the traction that weâre getting. And we have, of course, a very vigilant eye on the economic environment that weâre moving into. Rich, I wanted to follow up on your commentary around delinquency metrics. At the current pace of normalization, is it reasonable to expect that we could see DQs get back to pre-pandemic levels by the mid-2023 time frame? And then from there, does your outlook suggest that you expect delinquencies to flatten out, or are you conservatively expecting DQs to drift higher and are prepared for some degree of modest worsening in credit that perhaps goes a bit beyond normalization? Well, what we have said, Bill, is there are lots of metrics to look at, and I can even talk to you about a few -- some of the others weâre looking at as well. But number one, that we would point our investors to look at is delinquency. And delinquency entries and individual delinquency flow rates have -- we see the normalization happening there, as I mentioned earlier. And we think the there continues -- itâs interesting the -- when you look at the delinquencies themselves and most of the credit metrics, they continue to just keep on moving toward what weâre calling sort of normalization. Normalization, of course, is not any precise point. But there are also a number of other things that we look at that I think show sort of the strength of where this thing is headed. And one is on the vintage curves from new originations. They continue to be pretty flat month after month. Theyâre, of course, lagged by several months, but pretty flat. And in -- when we compare individual segments to where they were back in the pre-pandemic period. Itâs pretty much on top of each other. So, that is a good sign. We continue to look at our payment rates, which continue to be elevated. We like elevated payment rates that weâve assumed theyâre going to normalize part of the way down to where they were before. But of course, thereâs been some mix shift towards more spender within Capital Oneâs portfolio. But payment rates continue to be strong. The percent of customers making just the minimum payment is still below pre-pandemic levels. The percent of customers making full payments is above pre-pandemic levels. Revolve rate is roughly flat relative to last year and remains below pre-pandemic. So, these are all things that are positive indicators. But I do want to say also, again, thereâs been some mix change in our own portfolio with a bit of a shift toward the heavier spenders. So, many of these metrics may not fully get back to where they were pre-pandemic. But if we pull up on this, what we see is -- nothing we see is surprising. It would be consistent with a consumer coming off of some of the extreme stimulus and some of the extreme pullbacks in the pandemic and returning to more normal behavior. And I think the delinquency metrics are certainly leading indicators of that trajectory. Thatâs very helpful, Rich. Thank you. If I may, as a follow-up, separate topic. Can you give us an update on Capital Oneâs strategy for reducing friction at checkout with different electronic consumer wallet solutions. There have been some recent press reports regarding partnerships with other digital wallet providers. It would be helpful if you could just share your latest thoughts. So, a phrase that Iâve often used is the tip of the spear in the transformation of banking is payments, both on the consumer and the commercial side. And the reason I say this is that first of all, itâs very prone to significant changes in technology, and also, itâs not as heavily regulated a space as much of banking is. You donât have to be a bank holding company to be doing a lot of those things. And thatâs actually the area that we have seen certainly a lot of traction in -- by some very successful tech company. So, Capital One has -- we continue to support the various technology players who have developed payment innovations, and we continue to develop innovations of our own. There were some news out about in the news today, in fact, about potentially a new wallet coming out. We are 1 of 7 co-owners of EWS. And weâre one of the thousands of banks that use EWS. But on that one, we really donât have any specific comments to get ahead of the EWS management team on that. Rich, I was wondering if you can talk a little bit about your thoughts on auto credit. And then, as a follow-up, what youâre seeing on credit card spend, in particular, heavy spenders and whether or not they can sustain for travel and spend numbers. Okay. Thank you, Don. In auto, letâs talk a little bit about the auto business and maybe a little bit of a comparison to the card business. Just to talk about -- auto as many of the very same trends. It is all the same general trends going on with the consumer and the normalization that we have been talking about. The auto business also has some other things that are unique to it. Auto recoveries, for example. Auto recoveries inventories are unusually low because of the very low charge-offs that weâve had in the past few years. The past charge-offs are basically the raw material for future recoveries. So, the generally good news that has been in the auto industry of robust used car prices actually puts upward pressure on our overall loss rate as recoveries inventory build. So, we also, in terms of the credit metrics, we have seen more degradation in the very, very low and mostly below where we play in the auto business, but we have trimmed a little bit around the edges at our own low end. But basically, we continue to feel very good about our originations. From a credit point of view, the biggest issue in auto is the margin pressure that has come from the rising interest rates that have not been fully passed through by the competition. So we continue to feel really good about the auto opportunity, but our pullback is really not a credit-driven pullback so much as it is a margin-driven pullback. But we certainly do see the -- we can see the normalization in the auto business. Okay. And then on the credit card spend, same story. Are you seeing moderation? And can you talk about heavy spenders trends? Yes. We -- youâll notice our own spend growth numbers moderated quite a bit this quarter. We are seeing spend per account per customer moderate across our portfolio, moderating the most at the lower end, but we see the moderation. We see it the least in the very heaviest spenders, but the moderation that you see in our spend growth metrics are driven really by whatâs happening per account, we continue to get nice growth of accounts. So that is a phenomenon that -- and then we kind of ask, well, what should we be rooting for? I think youâre seeing a very rational response by consumers to the environment. There was a big surge in spending. I think itâs moderating somewhat, particularly at places other than the very highest end of the marketplace. So, I think itâs basically a sign of consumers being rational. Thank you. Andrew, first question for you on share repurchases. Maybe you could just help us think about the pace of share repurchases as we move forward because I know you guys slowed them down, but youâve been building capital. Maybe you can just help us with that first. Sure, Sanjay. In terms of thinking about the capital that we have moved down over the course of the last couple of years from -- in the 14 to we hit a low point of 12.1, a couple quarters ago. But as we sit here today, weâre just looking at the actual and forecasted levels and the earnings and growth and in particular, economic conditions, and thereâs some pretty wide error bars around those factors, particularly with respect to growth and economic uncertainty. And so, we feel like at this moment in time that itâs good to be a little bit more on the conservative side with risk management of managing that capital. But clearly, we have the flexibility around our capital decisions under SCBs. And so -- and I donât know, Rich, if you wanted to make any comments about repurchases as well. Yes. Well, we -- I think we just continue to generate a lot of capital. And we -- a central part of our strategy is the return of capital through share repurchases and dividends. Lately, weâve dialed back a little bit on that just really as a measure of prudence in an unusually uncertain time like this. I think thereâs -- Iâve never met anyone who sort of says that they had too much capital in a downturn. So after very strong levels of buybacks, weâve moderated here in this environment, but the strategy of Capital One continues to be the same. And we believe that return of capital is an important part of the economic equation for investors over time. Yes. Sanjay, weâre just going to manage it dynamically based on what we see in the marketplace and the factors that I described before. So, at this point, youâve seen what weâve been doing over the last handful of months, roughly $50 million a month. But again, we have flexibility, and as we have a bit more certainty of how the coming quarters will play out, thatâs going to inform our actions. Maybe you could just talk a little bit about the level of marketing growth for the year. You had a bit of a step up, Iâd say, in 2022 and the growth rates there are obviously showing a lot of traction in most of your metrics. Is there essentially kind of a bit of a slowdown but still have the ability to continue to grow and get into the opportunity on the card side? Yes. Arren, yes, marketing -- the marketing story has several components to it. One is just the -- and an important part of that is the sort of real-time response to the opportunities that we see. And we continue -- and especially talking about card and of course, card is where most of the marketing is. But, we continue to see attractive growth opportunities really across our business and are leaning into them. So that -- and itâs corresponded with some expansion in opportunities that are just a byproduct of our tech transformation, and itâs just more access points, more channels, more better credit models that give a little bit deeper and wider access to opportunities and more granularity. The more granularity that we get from our models, actually, the more we can separate the attractive customers from the less attractive and it allows us to lean in more. So, the marketing -- the pursuit of the real-time opportunities we see is an important part of the marketing, and that is going very well. The second important driver, of course, is the continued traction weâre getting in our really 10-year journey to drive more and more upmarket with focus on heavy spenders. And I think back to when we launched the Venture card in 2010. And -- but of course, this journey -- and weâve been declaring for years that the pursuit of the top of the market is not something that is an opportunistic one of in and out. And it is much more about working backwards from what it takes to win with heavy spenders and then investing to be able to do that. And thatâs about great products with heavy reward content, great servicing, exceptional digital experiences but also more and more of the experiences that are consistent with the very high end lifestyle and so on. So, there have been a bunch of investments there. Most of that -- not all of it, but a lot of that shows up in marketing. That also has a significant upfront component in terms of not only the direct marketing and the brand building, but also the early spend bonuses that go right through the marketing line when we -- at the early stage of these accounts. So, thatâs something that weâve been growing and sustaining over the last number of years. We love the traction that weâre getting. And so, we continue to lean into that. And then again, the national bank, where I just want to comment, we are really pleased with the national bank that weâve built. This is a -- we are the really only kind of full service national bank that is -- doesnât have a national quest to -- through acquisition to continue to grow. In other words, of all the banks our size or even smaller, the realistic path to growth is to do that through mergers and acquisitions, our path is an organic one. Weâve invested quite a bit to create full digital capabilities for almost everything you can do in a branch to be able to be done by a customer digitally. And so that our growth story is not just about savings accounts, but itâs very much about checking accounts as well. And this is our quest weâve been on for some number of years to build a national bank. That also is -- thatâs physical distribution light and marketing heavy. So a bunch of things kind of come together to create the pretty big marketing levels that we have now, but we feel very good about the traction that weâre getting. Andrew, youâve made the comment talking about the reserve rate on the card portfolio and reflecting the seasonality of the increase in spend and balances from spend-driven accounts. As we move into Q1, should we assume that with normal portfolio runoff but a mix shift that that allowance coverage ratio will actually pick up then because youâre going to get a mix shift? Well, thereâs a number of factors, Rick, that will play into coverage ratio. So, why donât I just pull up and lay out the key pieces and forecast assumptions of our allowance. And I will get to your kind of seasonal balance point in a moment. But I think itâs important to lay out all of the component parts rather than just talk about one individual one since all of them will affect where coverage goes from here. So, the first part of the allowance is weâre using models to estimate the next 12 months of losses. And the early period of this forecast is generally more accurate because, as Rich was talking about earlier, we can look at the existing delinquency inventories and flow rates, beyond those months we incorporate in the economic assumptions, they become a more significant driver of expected loss content. I referenced that in the answer to the first question that was asked on the call, but the error bars around the loss content widened the further we go out over the course of the year. The second factor impacting the allowances, we start from the year one exit rate for losses and then assume a reversion to a long-term average over the following 12 months. And then, the third thing is we net forecasted recoveries against the loss estimates for all of those periods. And so, on top of all of those assumptions, we then put qualitative factors in places where we believe modeled outcomes have limitations. And so, we end up putting all of those pieces together to evaluate the allowance. The open-ended product of credit card is different than closed-end loans as we go through those mechanics because with closed-end loans, weâre reserving for estimated loss content for the account. But in a revolving product like card, weâre only able to reserve for the loss content related to the balances that are on the books at the end of the quarter as opposed to the projected loss content for the account. So getting to your question then, when we have elevated seasonal balances in the fourth quarter, we expect a portion of those balances to pay down very quickly. And therefore, those specific balances are likely to have very, very low loss content given the life of the balance is far shorter than the life of the account. So all else equal, the coverage ratio in the fourth quarter has a bit of natural downward pressure from that elevated denominator as you suggest. But looking ahead, thereâs a bunch of factors that can impact where the allowance goes from here beyond that single effect. In periods where future losses may increase we would replace the low loss content of the current quarter with the projected higher loss content in a future period. And for what itâs worth, those assumptions also then carry into that reversion period. As we have growth with seasonally adjusted balances, Rich mentioned this before, CECL significantly pulls forward that allowance cost of growth. And then the third factor is coming out of a period where we have unusually low losses like weâve experienced, over the last couple of quarters, you have lower recoveries to offset the forecasted loss content. So, all of those things can put upward pressure on allowance but we can also have revisions to our economic assumptions, to delinquency flow rates, to just our overall loss content. And so, thereâs pressures in the other direction. And so, I appreciate your bearing with me for a long-winded complex answer, but I think we all saw the complexity and pro-cyclicality of CECL play out during the pandemic when we had to make a bunch of assumptions as the pandemic played out, we built a sizable allowance only to release virtually all of it over the subsequent quarters. And so, itâs just a very difficult thing to predict given all of the assumptions at play, which is why we are trying to focus you on Mako [ph] and having delinquencies as a leading edge indicator of Mako because that is ultimately where the real economic cost is felt. Got it. No, itâs a great answer, and Iâm glad to bear with you. Iâll probably read it in the transcript about 7 more times. And I was hoping to talk a little bit about marketing. I mean, Rich, you did mention that you were primarily in card and primarily in the upscale customer. But could you just talk a little bit about, number one, what you might be doing kind of in nonprime and how we should think about whether that total marketing spend given what you see is likely to be higher in â23 or not? Yes. So Moshe, Iâm glad you asked the question because I would not want the net impression to be -- I think what you were saying is that, is our marketing primarily just in the upscale customer segment? Differentially relative to years ago, weâve certainly had a shift to the higher end in terms of our marketing. The marketing is also so expensive at that end. And then, also the marketing at the higher end tends to, in some sense, lift the boats across the franchise. So, the marketing at the higher end is carrying a lot on its shoulders, Moshe. But, we do a lot of marketing in the mass market of the card business, including in the higher end of the subprime segment of the market. This is -- our strategy here is -- well, it changes all -- we tweak it around the edges all the time. Weâve been doing this for pretty much approaching three decades now, at the lower end of the market. And the marketing there is direct marketing, stimulus response, very information based. And so, the marketing machine that weâve built, which has been enhanced by technology here is definitely leaning into that opportunity. And I do want to say that the -- we continue to get good traction in the subprime and prime parts of the marketplace, even as we certainly relative to 10 years ago, have a lot more marketing going on at the top of the market. So, thereâs quite a bit going on, and we feel good about the traction there. Got it. Maybe just to kind of -- as a follow-up, what would it take for you to see, either in the portfolio or in the market for you to do less marketing? Yes. The way this tends to happen is it happens in one little segment, one micro segment at the margin in response to things that we see going on there. I use this phrase a lot, trimming around the edges. And youâve heard me use that for many, many years. And this is something that we always do or something weâre expanding around the edges. The net feel of these days is weâre doing more trimming around the edges than expanding around the edges, but it is -- so itâs less about at the top of the house saying, we just believe we should do -- obviously, at the top of the house, weâre looking at all the macro things, but weâre linking what we see in the macro level to what weâre seeing right there in real time or the earliest we can see from our credit metrics. And then, using the technology weâve continued to invest so heavily in to have a more and more granular diagnosis. And at an earlier time than ever before diagnosis of where anything is deviating from the trajectory that we would expect. And then one is sort of the diagnosis of deviation. And the second thing, of course, is trying to get sort of a root cause, understanding of what may be driving that. And this is something that we continue to put a lot of energy into and it has led us to trim some -- there are some things that we have seen degrade a fair amount around the edges. Theyâre fairly small in the overall size of things, but weâre certainly glad when we see them. And then, what we try to do is to link data that we see to behavior that -- excuse me, to sort of an explanation of whatâs going on from a customer and credit dynamic to be able to be -- it makes total sense. So therefore, as things play out, itâs less likely -- and letâs say, we go more into a downturn, itâs less likely on the card side that you would see a big pullback. The kind of things youâd see is more trimming around the edges, more reduction of the credit lines that are given, and that would be more how it would play out. On the -- regarding the reserve build in terms of the drivers of the reserve build this quarter, I know you cited loan growth, you cited the macro backdrop, and you sited credit normalization. Is there any way to help parse out how much of the build of $1 billion is attributable to loan growth versus macro versus credit normalization? Yes. John, we donât break out those components in part because some of them are actually related to one another. For instance, how we think about qualitative factors and how we think about our base forecast is tied into one another. And so, thatâs why we just wanted to lay out that quarter-over-quarter when you look at consensus estimates for things like unemployment, looking ahead at 2023, from where we were as of the end of the third quarter to where we were at the end of the fourth quarter, looking ahead on some of those metrics, we saw a degree of worsening. And when you couple that with shifting forward one quarter and replacing a much lower loss content in the fourth quarter with continued normalization, as I referenced it heading into 2023, those are factors that go into it. But actually not even really able to break out the component parts because theyâre tied with one another with all the assumptions. Okay. No, I get it. Thatâs helpful. The normalization point, if I could just ask one more thing on that, was there anything about the normalization? And I appreciate the color you already gave. But is there anything about the normalization that youâre seeing that is kind of faster than expected, or any change like that that necessitated the size of the build this quarter? No. And I think Rich touched on some of these in one of his earlier responses, but what weâre seeing in terms of normalization is playing out as we expect. Itâs part of why I wanted to highlight the fact that the mechanics of the reserve though only take into account that 12-month model period and revert from there. And so, weâre only allowing for the content -- the outstandings content at the end of the quarter as well. So, even if things play out exactly as we expect, we could see allowance build, just like we saw this quarter. It just depends on a whole host of factors. And I think that concludes our Q&A for the evening. Thank you for joining us on the conference call today, and thank you for your continuing interest in Capital One. Investor Relations team will be here later this evening if you have any further questions. Have a good night.
|
EarningCall_1148
|
Good afternoon, and welcome to Arthur J. Gallagher & Company's Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions].Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statement and risk factors contained in the company's 10-K, 10-Q and 8-K filings for more details on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce Patrick Gallagher, Chairman, President and CEO, Arthur J. Gallagher & Company. Thank you. Good afternoon, and thank you for joining us for our fourth quarter '22 earnings call. On the call with me today is Doug Howell, our Chief Financial Officer, as well as the heads of our operating divisions. We had a terrific finish to cap off an excellent year. During the quarter, for our combined Brokerage and Risk Management segments, we posted 16% growth in revenue, 11.7% organic growth. GAAP earnings per share of $0.83, adjusted earnings per share of $1.86, up 24% year-over-year, reported net earnings margin of 9%, adjusted EBITDAC margin of 29.6%, up 120 basis points. We also completed 17 mergers totaling more than $140 million of estimated annualized revenues in addition to announcing our agreement to acquire Buck, another fantastic quarter by the team and our best fourth quarter in decades. Let me give you some more detail on our fourth quarter performance, starting with our Brokerage segment. Reported revenue growth was 16%. Organic was 11%. Doug will explain it does include a point from our Annual 606 review, Brokerage organic and double digits is outstanding. Acquisition rollover revenues were $107 million, and our adjusted EBITDAC margin was 31.3%, up 120 basis points and in line with our December IR Day expectations, another excellent quarter for the brokerage team. Focusing on the Brokerage segment organic, let me walk you around the world and provide some more detailed commentary starting with our P/C operations. Our U.S. retail business posted 8% organic, our new business was a bit better than last year offset somewhat by less nonrecurring business, client retention and the combined impact of rate and exposure were both similar to last year's fourth quarter. Risk Placement Services, our U.S. wholesale operations, posted organic above 9%. This includes more than 12% organic and open brokerage and about 7% organic in our MGA programs and binding businesses. New business was strong and retention was consistent with last year's fourth quarter. Shifting to outside the U.S. Our U.K. businesses, both retail and specialty combined posted organic of 17% benefiting from excellent new business production, strong retention and the continued impact of renewal premium increases. Australia and New Zealand combined, organic was 12%. Net new versus loss business was consistent with last year and renewal premium increases were above fourth quarter '21 levels. Canada was up nearly 9% organically, reflecting solid new business and retention. Moving to our employee benefit brokerage and consulting business. Organic was 3%, consistent with our December IR Day expectations. New business was similar to last year's fourth quarter and retention remained excellent. And finally, to reinsurance. Our legacy reinsurance operations crushed it with some hard earned new business wins and quarterly organic well into double digits. And recall that December was the first month our newly acquired reinsurance operations were included in organic. And while off a very small revenue base, they too had a spectacular organic growth for the month. So combined, Gallagher Re team continues to deliver outstanding results. So again, Brokerage segment, all in organic double digits. And with our outstanding fourth quarter finish, full year organic came in at 9.7%. That's our best full year Brokerage segment organic performance in decades and even more impressive when you consider we grew on top of the 8% organic we posted in '21. Next, let me give you some thoughts on the current P/C market environment starting in the primary insurance market. Overall, global fourth quarter renewal premiums, that's both rate and exposure combined, were up more than 9% that's consistent with the 8% to 10% renewal premium change we have been reporting throughout '22. Fourth quarter renewal premium changes by line of business were broadly consistent with the first 3 quarters of '22 with 1 exception, which is D&O. D&O continues to be the one area where rates are flat to down slightly, but in some cases, our customers are using the weaker pricing to purchase more limit. Exposures also continue to be consistent with the first 3 quarters of '22, indicating continued strength in our customers' business activity. In fact, fourth quarter midterm policy endorsements, audits and cancellations were better than fourth quarter '21 levels. Looking ahead, these trends appear to be holding. Thus far in January, midterm policy endorsements and audit adjustments are trending higher than last year's level and global renewal premium increases are consistent with the fourth quarter. But remember, our job is to help clients mitigate premium increases and provide an appropriate level of risk transfer that fits their budgets. Shifting to reinsurance and the important January 1 renewals. As we discussed in our 1st View Market report published earlier this month, it was a very late and complex reinsurance renewal season. Not surprising, U.S. peak zone property cat reinsurance saw some of the largest price increases. But it's worth noting 4 additional trends within property cat: First, attachment points were raised broadly; second, reinsurers pushed to remove prepaid reinstatements from some contracts; third, reinsurers, in some cases, were able to reduce coverage to named perils only; and fourth, top layers of many programs saw the largest percentage increases as reinsurers sought to push up minimum premium rates. On the casualty side, prices were up in the single to low double-digit range for most programs, while terms and conditions were more stable. Despite the tough market backdrop of higher prices, lower capacity and tightening terms, the reinsurance team was able to deliver favorable outcomes for our clients. Looking forward, the challenging reinsurance market conditions will, no doubt, put pricing pressure on the primary market during '23, and that's on top of our primary carrier partners dealing with catastrophe losses in secondary perils, including convective storms, floods and wildfires, high replacement cost inflation from raw materials to shortages in labor, social inflation, combined with the easing of the judicial system law , escalating medical cost trends and ongoing geopolitical tensions. So there's good reason to expect continued price increases and cautious underwriting for the foreseeable future. And as I mentioned before, we are not seeing any signs of exposure contraction. Rather, it seems our clients' business activity remains unchanged from the past few quarters. Within our employee benefit brokerage and consulting business, the backdrop for '23 is also broadly favorable. Employers continue to add jobs and wages are growing. So demand for our services and offerings should remain robust. So as I sit here today, '23 could be another fantastic year with brokerage organic growth nicely in the 7% to 9% range. Moving on to mergers and acquisitions. We had a really active fourth quarter completing 17 new tuck-in brokerage mergers representing more than $140 million of estimated annual revenues. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. For the year, we completed 36 mergers, representing annualized revenue of about $250 million. Additionally, we announced an agreement to acquire Buck, a very complementary business providing retirement, HR and employee benefits consulting and administrative services with estimated annualized revenues of $280 million. We expect the transaction to close during the second quarter and look forward to welcoming our new colleagues. Moving to our merger and acquisition pipeline. We have nearly 45 term sheets signed or being prepared, representing more than $300 million of annualized revenue. We know not all of these will close. However, we believe we will get our fair share. And before I conclude my M&A comments, let me give you a quick recap on our reinsurance acquisition now that we have a full year in our books. We had a fantastic '22, thanks to strong client retention, the expansion of existing client relationships, some great new business wins and excellent growth in our pro rata business. The team is fully assimilated, is delivering for clients and there's a lot of momentum. I believe we're on track for an even better '23. Needless to say, reinsurance continues to be an exciting story. Moving on to our Risk Management segment, Gallagher Bassett. Fourth quarter organic growth was 15.6% as a strong finish to the quarter pushed organic above our mid-December expectation. Core new arising claims increased during the quarter, driven by recent new business wins and continued growth from existing clients. And fourth quarter adjusted EBITDAC margin was great at 19.3%. So putting it all together, Gallagher Bassett finished the year with an adjusted EBITDAC margin of 18.5% and 13.3% organic benefiting from increased claim activity coming out of the pandemic and some really nice new business wins. Looking forward, full year '23 organic should be pushing 10% and adjusted EBITDAC margins should be around 19%. That would be another fantastic year. And I'd like to conclude with some comments regarding our bedrock culture. It's a culture of teamwork, client service and excellence, captured and celebrated in the Gallagher way. It is the culture that drove full year '22 results for our combined Brokerage and Risk Management segments of 24% growth in adjusted revenues, 10% all-in organic, 25% growth in adjusted EBITDAC, adjusted EBITDAC margin in excess of 32% and 20% growth in adjusted EPS. We have a culture that our people believe in, embrace and live every day. It's a culture that will continue to drive us forward. That is the Gallagher way. Okay. I'll stop now and turn it over to Doug. Doug? Thanks, Pat, and hello, everyone. A fantastic fourth quarter to close out another outstanding year. Today, I'll start with our earnings release, touching on organic margins and the Corporate segment shortcut table. Next, I'll walk you through our CFO commentary document, point out a few items for the next quarter and also provide a first look at our typical modeling helpers for '23 then I'll finish up with some comments on cash, M&A capacity and capital management. Okay. Let's flip to Page 3 of the earnings release to the Brokerage segment organic table. All in brokerage organic of 11%, above the 9% to 9.5% that we foreshadowed in December. Two drivers of the upside. First, as Pat just discussed, we had a really strong finish within our P&C and reinsurance brokerage operations. Second, our annual update of 606 assumptions added about 1 point to our headline organic. Recall under ASC 606, we must routinely update our assumptions related to the amount of services provided before and after the placement of an insurance policy. Based on our most recent operational analysis, metrics and time studies, more of our services being provided at the time of placement and more of the post placement service is being handled faster in our lower-cost centers of excellence. This causes less of our revenue to be deferred and thus, we recognized an additional $15 million of revenue in the quarter. That is a small amount relative to our total deferred revenue balance nearly $435 million, but it does cause an additional point of organic. So we're the call out today. From an expense perspective, our updated 606 assumptions also caused some additional compensation expense to be recognized during the quarter. The punchline of all this, our fourth quarter organic revenues, EBITDAC and net earnings got a small boost and adjusted EBITDAC margin was not significantly impacted. So 11% headline organic, 10% controlling for 606 and 120 basis points of margin expansion, that's a terrific quarter. Looking forward to '23, we're currently not seeing a slowdown in our clients' business activity. We're not seeing signs of price moderation from the carriers, and we still have loss cost inflation and labor market imbalances. Add that to our client for sales and service culture, we are still seeing '23 organic in that 7% to 9% range, as we stated during our December IR Day. Same with our margin outlook for '23. We are still comfortable with our December commentary. We think we can deliver about 50 basis margin expansion at 6% organic and fiduciary investment income could be a nice margin sweetener provided there isn't a surge in wage and cost inflation. One other [indiscernible] heads up for '23. On December 20, we announced our acquisition of Buck. The business operations operates at an adjusted EBITDAC margin around 20%, so please make sure a portion of your pick for future M&A revenues reflects that versus what you might pick for our other mergers. Moving on to the Risk Management segment and the organic table at the bottom of Page 6. You'll see 15.6% organic in the fourth quarter and full year organic in excess of 13%. Some of that growth this year comes from our clients' business activity still rebounding out of the pandemic and getting back to levels they saw before the pandemic. Accordingly, for '23, we're seeing organic revenue approaching 10%. Flipping to Page 7. The Risk Management adjusted EBITDAC margin of 19.3% in the quarter and 18.5% for the full year. We see a nice step-up in '23 with margins around 19% even as we continue to make investments to enhance the client experience and in analytics and tools to drive better claim outcomes. Another year of double-digit growth and margin expansion would be another terrific year. Turning to Page 8 to the Corporate segment shortcut table. In total, adjusted results were at the favorable end of our December IR day forecast. You also see 2 non-GAAP adjustments this quarter. First, our M&A transaction costs of $5 million after tax, mostly related to Buck and a little relates to Willis treaty. And second, as we discussed previously, you'll see a $31 million after-tax gain related to legal and tax matters. Now shifting to our CFO commentary document we posted on our IR website, starting on Page 3. As for fourth quarter, you'll see most of the brokerage and risk management items are close to our December IR day estimates. On the right-hand side of the page, we're providing our first look at '23. A couple of things worth highlighting: First, FX. With last year's midyear strengthening in the U.S. dollar, you'll see some volatility in how FX will impact our brokerage and risk management results in first half versus second half of '23. Please make sure to consider these impacts as you're planning your models. Second, our adjusted tax rate. With the U.K. corporate tax rate increasing to 25% effective April 1, we're providing our current estimate for full year '23 tax rate. More of an impact to our Brokerage segment than it is to our Risk Management segment, given the size of our U.K. retail London specialty and reinsurance brokerage operation. And one other thing. The left side of this page might be a nice reference when making your picks for quarterly margins given our quarterly seasonality. And finally, when you do make your margin picks, recall we were still in the Omicron portion of the pandemic during the first quarter of '22. So we're not expecting as much margin expansion in first quarter as we are in the second, third and fourth quarter of '23. Okay. Moving to Page 5. This page is here to highlight the incremental cash flows from our clean energy investments over the coming years. And remember, those come through the cash flow statement, not the P&L. You'll also see that we have $773 million of available tax credits as of December 31, '22. And that we forecast using about $180 million to $200 million in '23 and that should step up a bit in '24 and each later year. That's a really nice cash flow boost to help fund our M&A. The way I look at the math, it might say that an additional $773 million of free cash, combined maybe another $70 million of recurring EBITDAC at that 10 to 11x multiple, which would then have a nice arbitrage for our current trading multiple. Moving to Page 6 on the rollover revenue table. For the fourth quarter, rollover revenues came in higher than our December IR day guidance. Most of all of that came from reinsurance. Over the last 3 weeks, cedents have been closing their books for '22, and we're getting updated ceded premium figures. That translated into additional commission revenue for '22. For the sake of clarity, nearly all of that upside is excluded from our organic results because it likely relates to pre-December 1, '22, which marked the first year anniversary of the acquisition. And no -- also, please note that not all of that hits the bottom line because of production and incentive comp expense on that additional revenue. That said, it's terrific to get the bump-up. Staying on Page 6, but moving down to the bottom table. That table shows our actual reinsurance acquisition results. In a transition year, the team overperformed our pro forma expectation. That's impressive and terrific work by the team. So now let me move to some final comments on cash, capital management and future M&A. At December 31, available cash on hand was about $325 million. Our current cash position, combined with strong expected cash flows and incremental borrowing positions us well for our pipeline of M&A opportunities. In total, we estimate towards $3 billion to fund potential M&A opportunities during '23, which would include paying for Buck. And also yesterday, our Board of Directors approved an increase in our quarterly dividend by $0.04 per share. That would imply an annual payout of $2.20 per share. That's a 7.8% increase over '22. So with a strong organic outlook, margin expansion opportunities and an ever-growing M&A pipeline, from my vantage point as CFO, we are extremely well positioned for another fantastic year in '23. I'd like to thank the entire Gallagher team for another great quarter and outstanding year. Back to you, Pat. So my first question is on the reinsurance market and the growth you saw there. It's obviously really strong end of the quarter. And I think you've talked about high single-digit growth there for 2023. So did the end of the year kind of change how you think about that level of growth? Or how should we be thinking that going into next year? I think we are definitely going with some nice momentum. I wouldn't bank on some incremental big jump. But what I like about the momentum is when you come through a time like we did in this fourth quarter, it's interesting because you actually become much more valuable to your clients. And it's not an easy time when you're tussling back and forth with the cedents and the reinsurers trying to get these things done, terms are changing. Attachment levels are changing. But in the end, as I said in my prepared remarks, we got the placements made, and I think we are in a very strong position going forward, number one, with those clients, but also with the opportunity to pick up some new business. Great. And then my second question within brokerage as well. I noticed the compensation ratio as a percentage of revenue dropped pretty materially. And I think you'd called out some back-office saves, lower benefit costs, offset by some hiring. Is there a way you can call out how much each of those had an impact? Or where I'm trying to go with the question is how much additional leverage do you have to kind of bring that lower in 2023? All right. Let me see if I can break that out from memory here. I don't have it in front of me exactly, but when you're talking about being down was at 180 basis points, something like that. Yes. Is that right? I'm just going from memory, Sorry, I'll look it up here. Probably 1/3 of that is due to the continued efficiency that we bring by being able to push work into our lower-cost centers of excellence. I think that we've had some technology wins in that area, too, to help us make our workforce more effective on that and didn't have to put on additional heads as a result of that -- those technology investments. And then I think that when it came to -- the other 1/3 is kind of escaping you right here. Got it. Is there any change to the compensation structure that you make in this market, too? I know there's some changes just, I guess, higher organic accounts, things like that. No. We're pleased to pay our people for what they do. And we haven't messed with that compensation arrangement with our production force, in particular, in well over a decade. I want to follow up on the almost 10% 2022 brokerage organic results. Would you mind giving us some more color as to how pricing and exposure and net new business drove that year-over-year acceleration in organic. And then from where you sit today, how do you see those drivers changing in 2023? So are you asking for the quarter? Are you asking for the full year? Sorry, just so I've got the baseline. For the full year, right? So when I look at rate and exposure, as I did, our new business, we had a terrific new business here. So I'll say that our net new business spread was about 4 points and the rest of that is probably rate and exposure, remember between that. So maybe, again, you think about it, 1/3, 1/3, 1/3 net new business over loss business is 1/3, rate was 1/3 and exposure unit growth was 1/3. Got it. Okay. And then as a quick follow-up, do you have any comments on the degree to which fiduciary investment income will impact margins next year, kind of thinking about that 50 bps of expansion on 6% organic, how much that move from fiduciary investment income? I think the -- when we give the guidance of 6 points, if we grow organically, 6%, we think we can show about 50 basis points of margin expansion on that. Investment income would be a sweetener to that. to a certain extent. But I don't have a clear line of sight yet on the size of our raise pool and our hiring needs going into next year. We understand our budget. So I can't give you a specific number on it, but you give me a pick on what you think wage inflation is going to be next year to take care of our folks, and I can probably give you that number, but I don't think we're ready yet. I might be able to give you some more of that in March. I'm going to stick on the margin commentary. In your press releases on Page 4, you talked about the operating expense ratio and some of the pressures on that. So when you -- in your guide the 50 basis points or so of margin expansion provided 6% organic, how do we think about those factors affecting your ability to expand margins? And then just on the margin expansion, can you break it out based on business unit like is it going to come in international that you're going to get margin expansion or is it going to come into the employee benefits business, you get margin expansion? Or can you source where you think that's going to -- where that -- where the improvement is going to come from? Right. A couple of things. On the operating expense ratio, it was up in fourth quarter versus '21 fourth quarter, was up about 30 to 40 basis points, let's call it, 40 basis points on that. I think the footnote on that is explaining where it's coming from, mostly travel and entertainment, some consulting use and investments in technology. So I'd say it's probably half of that increase is investments and half of it is just the inflation that we're seeing in travel and consulting costs on that. When you're -- I think the next question was how am I seeing that vis-a-vis next year. Remember, we were still in the omicron portion of the pandemic in the first quarter. So we are going to see a little more travel and entertainment expense return in our first quarter, but we don't see it being up significantly in the second, third and fourth quarters. So we're looking at 50 basis points of expansion next year. Most of that will come in the later 3 quarters than the first quarter. And what was there was another piece of your question, Greg? It was just when I think about within the Brokerage business, the different business units, the employee benefits, the international the retail RPS, when you look at it that way, where do you think the opportunity is for margin expansion in the context of that 50 basis points or so guidance? Yes, it's pretty much so across all of them, Greg -- there is no standout in there anywhere that's a laggard in there. Makes sense. Okay. And the other -- just the other sort of cleanup question on Buck consulting. Can you give us -- is there any sort of cadence in terms of how the revenue flows and how the margins are. I mean is it heavier in the first quarter, either revenue or margins? Or any sort of color you can add as we -- and just as a follow-up, I assume that's also going to get folded into the Brokerage segment, correct? Yes. So it will be part of our Brokerage segment and our Employee Benefit operation. Greg, we don't think we're going to close that in the first quarter. We think it's more of a second quarter close at this point. I don't really have a good quarterly spread that I would feel comfortable giving on the call today for that because we have to apply our study on conforming the accounting principles to theirs, apply our 606 assumptions to it. So I need a little more time to work through that. And we just signed the deal 30 days ago, and I just need to until March to give you that quarterly spread. We heard, I guess, one of your peers about -- talk about programs participants pushing back on capacity or trying to restructure commissions. I was wondering if you're seeing something similar. Okay. Second one, I guess I was wondering, your deal spend has kind of accelerated over the last few months. It seems hoping you could maybe discuss the drivers behind that. And maybe talk about how you see 2023 playing out in this regard? We have definitely seen a change in the competitive environment vis-a-vis mergers and acquisitions in the last 60 days. I'm not going to sit here and say it's not still competitive, it is. But I would say that the number of bidders is reduced, and we are seeing maybe, what I would call, a more attentive seller to exactly who the buyer is, what the culture is, the strategic value of that buyer that maybe existed 12 months ago. Yes, we usually see a little bit of an uptick in the fourth quarter as people push to get things done by the end of the year, sometimes that's driven by tax or other financial planning that the sellers want to get done. But if there is a noticeable change in the market. I would say that we feel very good about our pipeline right now. There are some names on there that are really nice to have looking at us. So a little bit of an uptick in the fourth quarter, naturally, change in market competitiveness a little bit. But I also think it's going to be pretty strong in the first couple of quarters of the year relative to what we saw this year, in particular. Maybe sticking on the M&A point. You guys seem pretty optimistic with the pipeline, and you have announced a good number of deals of late. But if I look on the CFO commentary sheet, you also write the multiples you're seeing on deals went up 1x, right, 10 to 11x from 9 to 10, what are you seeing, I guess, in the market that's driving up multiples a little bit? I think it's mix right now is what we're seeing is -- I think that you're seeing some pretty high performing names on the list where the growth factors are a little bit bigger than maybe they were in the past. But one turn on that, it wouldn't overly react to it one way or another. And then with your margin guide for kind of the 50 to 60 basis points of expansion, are you assuming any wage inflation embedded within that guide? Yes. We're assuming that we're paying raises this year about similar to what we have for the last 2 years. So that's in the numbers. Also in that, I did a little -- I did a small vignette during the December IR Day. If you really look underneath that, there's probably 10 or 15 basis points as we toggle to Software as a Service that might be against that 50 basis points, too. So maybe it's more like 60 basis points, but in the accounting of where that expense gets charged does influence that a little bit. You and I talked about that in December, I think, too. And then on the reinsurance side, strong into the year, great rate increases we saw at January 1, but also we've seen higher retentions by primary companies. And I don't think we've really been in a similar environment, right, where you have 40% price increases with perhaps less premium to the market. So when you put that all together, does '23 feel like an environment where you could show double-digit organic growth within your reinsurance business? My first question is on the U.K. retail and specialty organic of 17%. Obviously, very strong. And I was just wondering if you could talk a little bit about what's driving that growth. Yes. As we said, a very, very strong new business in specialty with tenant rate increases. And as we've talked earlier, there were some term changes and the like. But also our aviation specialty team just crushed it this quarter in the U.K. And our retail operation across the United Kingdom did extremely well also. But I just think the whole London-based specialty team, reinsurance aviation just is set phenomenal close to the year. That's great. And just a question on the labor market. A number of companies are instituting layoffs. I'm just curious what type of unemployment rate is embedded in your organic guide of 7% to 9%. And if we did start to see some erosion there, at what point in the year do you think we would start to see that impact potentially in your organic growth? Well, let me just back up to our prepared comments again. It's very, very interesting. First of all, we don't play that much in the high-tech Employee Benefit business, and it's not that big a segment for us in terms of the layoffs you're seeing that are making the newspaper. And as I've said in previous quarters, we're already in the same papers, right? And we all see the same news reports. However, our middle market, core business is doing -- our clients are doing extremely well, and we keep reporting our -- what we're seeing in our midterm endorsements and changes to policies and as we see both our renewals and the audits going forward, our middle market, retail, property casualty benefits business, these people are doing very, very well. Truck counts are up. Our trucking business is very strong. Our work comp renewals in terms of payrolls are not being diminished. Now that doesn't mean that if there is, in fact, a global recession that it won't impact us, of course, it will. But at this point in time, we're not seeing that. So if you ask me where do we see an impact on that type of growth as we go forward this year. I'll tell you, our plans at present don't count on any recessionary pressure. And that could be wrong. This is Andrew on for Yaron. Just looking at head count in Brokerage, it looks like there's been a pretty good pickup year-to-date and in the quarter specifically. Can we kind of talk about what's going on there? And roles you're hiring and the degree to which those hires have been reflected in organic yet? Yes. Well, a lot of that -- remember those numbers are impacted considerably by our M&A program. So as we close the year out strong on M&A, those numbers would be in the December numbers and not in last year's December numbers, and that would impact the quarter 2. And I would want to comment on that as well. We are not undergoing an organic surge in new hiring. We have a very strong internship. We bring on a very strong number of young people every year. Of course, we're always looking for good solid production hires, but you are not seeing our organic head count surge beyond the M&A activity that Doug just mentioned. Great. And as we think about supplemental and contingent commissions, I suppose a part of that is based on underwriting profitability of those programs. So when you think about '23, is there kind of a loss trend that you bake into forward guidance there? Or maybe more broadly, what is your view on loss trends over the course of the next year? Supplementals are not subject typically to profit-sharing arrangements, our contingents are. And to date, I'd say we probably factored nothing in, in terms of having significant increases in our operating loss ratios. Another P&C CEO suggested he didn't see as much increase in property rates in the fourth quarter as you might have expected in light of the reinsurance market dynamics, but maybe that's something that builds up as the time goes by is the higher reinsurance rates do directly impact the carriers. Would you share that observation? Do you think property could get firmer on the primary level? I think property could get a lot firmer. I would say in the fourth quarter, it was very firm, in particular, in anything that had to do with Coastal, any area that was exposed to wind and fire. This market in terms of property is very difficult as it exists. And, yes, the changes to reinsurance at 1/1 will filter additional pressure onto the retail buyer. And we are out early telling our retail buyers about this. And it is going to get more difficult in what is already a very extremely difficult situation. Yes. If you think about -- remember, our fourth quarter, Ian hit right at the beginning of the fourth quarter, there were replacements that were done in October and November that hadn't had the full impact of the $70 billion loss. Yes. Yes. And then, Pat, last quarter, you mentioned a potential spillover effect on casualty. I don't know whether you updated your commentary on that this quarter, but do you think the reinsurance market, how much of an impact, I think, it's having on casualty, ? Mark, I don't have a number on that yet. I just think that it's possible that in order to pay for some of these property increases, other lines are going to have to be tagged. And I think I'll be able to feel that since it maybe have a better number around that at the end of the first quarter. And I may be wrong on that. At this point, I'm not being told by our carriers that that's happening. I just had a quick follow-up maybe on Elyse's question and the potential for double-digit growth in reinsurance. Just wondering if that's kind of -- if we should think about that as being achievable with current capacity or if incremental capacity might need to come to the market in order to get there? I think that it will be achievable with existing capacity. I was very pleased -- our reinsurance people were telling us in late November and December, early December that they were very fearful some of these placements just weren't going to get done. And that is a nightmare on all sides of the equation. And in fact, really, really pleased and proud of the team that did the work to bring the programs together for our clients as January got going here. So I think on existing capacity, of course, the largest renewal season is now winding down. It's not over, but it's winding down. And so I do think the increases going forward could come off existing capacity. However, having said that, any additional capacity would be very welcome and will be utilized quickly and would add to that. All right. Then let me just add a few comments as I wrap up. I want to thank you again for joining us this evening. Obviously, I'm very pleased with our '22 financial performance. I am still very excited about our future. I want to thank our clients for their continued trust, our 43,000-plus colleagues for their passion, hard work and dedication. And finally, I need to mention our carrier partners. They do play an integral role in meeting our clients' insurance and risk management needs. And we look forward to speaking with you all again at our March IR Day. So thank you for being with us, and we'll talk to you then. Thank you. This does conclude today's conference call. You may disconnect your lines at this time. Thank you for your participation, and enjoy the rest of your day.
|
EarningCall_1149
|
Good morning. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the Fifth Third Bancorp Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions] After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] Good morning, everyone. Welcome to Fifth Thirdâs fourth quarter 2022 earnings call. This morning, our President and CEO, Tim Spence; and CFO, Jamie Leonard will provide an overview of our fourth quarter results and outlook. Our Chief Credit Officer, Richard Stein; and Treasurer, Bryan Preston have also joined the Q&A portion of the call. Please review the cautionary statements on our materials, which can be found in our earnings release and presentation. These materials contain information regarding the use of non-GAAP measures and reconciliations to the GAAP results, as well as forward-looking statements about Fifth Third's performance. These statements speak only as of January 19, 2023 and Fifth Third undertakes no obligation to update them. Thanks Chris and good morning everyone. To start, I would like to thank our employees for the job they did, supporting our customers, communities and shareholders in 2022. You really held true to our core values and our vision to be the one bank people most value and trust. JUST Capital and CNBC recently released their annual study of America's Most JUST Companies, a comprehensive ranking that recognizes companies who do right by all stakeholders has defined by the American public. Fifth Third ranked 23rd out of the roughly 1000 companies covered in the study and was the highest ranked category four bank. It's a great achievement. Thank you for it. Earlier today, we reported financial results for the fourth quarter and full year 2022. The strength and quality of our franchise are evident in the numbers. We generated record full year revenue of $8.4 billion, up 6% over the prior year. We managed expenses down 1% year-over-year, producing positive operating leverage of 700 basis points and an efficiency ratio of 56%. Net charge-offs for the year were below 20 basis points. As a result, we achieved a full year return on tangible common equity ex AOCI of 16.5%, which places us in the top quartile of our peer group. Just as importantly, we did what we said we were going to do. We have a culture of accountability Fifth Third, and it makes me proud that our full year results exceeded the guidance we provided you last January in every major caption, including total revenue, expenses and net charge-offs. As a result, PPNR increased 18% compared to our original guide of 7%. We also made important progress on our growth strategies in 2022. We grew consumer households at a peer leading organic growth rate of around 2.5%, led by our Southeast markets at 7% and surpassed last year's record for new quality relationships in our Commercial segment. We opened 18 new branches in the Southeast in 2022, bringing our three-year total to over 70 new branches in those markets. During the year we also made meaningful progress in our technology modernization initiatives and enhanced our peer leading, digitally enabled treasury management managed services, and our momentum banking product offerings. You may have seen that most recently we extended momentum's early pay feature to include income tax refunds. Our FinTech platforms, dividend finance, and provide continue to scale and achieve top national market shares with dividend ranking third and provide ranking second in their respective markets. Our fee generating businesses are better diversified than most peers and continue to be a key focus for investment. Strong performance in our capital markets business related to helping client hedging activities, mortgage servicing and treasury management, all helped to offset market headwinds that all banks faced as did continued net AUM and flows in our wealth management business. During 2022 we remained focused on delivering stable long-term results instead of chasing short-term earnings. We maintained our discipline in our credit underwriting with continued focus on granularity and diversification. The outcomes of this are evident in our NPA, NPL and early stage delinquency ratios, all of which have remained well behaved and well below normalized levels. Our balance sheet management approach remains centered on providing strong and stable NII performance across various rate environments. We extended our advantage in our securities yield by waiting to deploy excess liquidity until we were able to earn positive real yields and we added derivatives to provide hedge protection through 2031. These actions will provide significant long-term benefits in the event of a lower rate environment. With respect to capital, given our strong PPNR growth and benign credit losses, we exceeded our target CET1 ratio in the fourth quarter and resumed share repurchases. Our capital priorities for 2023 are to maintain a 9.25% CET1 ratio and support organic balance sheet growth, pay a strong dividend, and continue our share of purchase program. We expect repurchases to steadily increase each quarter for a total of approximately $1 billion during the year. Jamie will provide you with the detail on our financial outlook for 2023, but it is a strong one that is consistent with our priorities of stability, profitability and organic growth. We expect to produce another year of strong revenue growth and operating leverage with full year PPNR growth in the mid to high teens, a return on tangible common equity ex AOCI exceeding 17% and an efficiency ratio below 53%. We will continue to invest in organic growth and efficiency initiatives. We'll add another 30 to 35 branches in our Southeast markets, including our first three in Charleston, South Carolina, and several more in the Greenville, Spartanburg, South Carolina corridor. We'll continue to increase investments in marketing and product innovation to accelerate household growth and we'll invest in scaling dividend and provide. Lastly, we'll make significant progress on our tech modernization journey and begin to realize savings and improve the client experience by leveraging these investments to drive automation into our most labor intensive processes. You have my commitment that we will continue to make decisions with the long-term in mind to invest where we can strengthen the value and resiliency of our franchise and to hold ourselves accountable for doing what we say we will do. With that, I'll now turn it over to Jamie to provide additional detail on our fourth quarter financial results and our current outlook for 2023. Thank you, Tim and thank all of you for joining us today. Our quarterly and full year financial performance reflect focused execution and resiliency throughout the bank. We generated strong loan growth in both commercial and consumer categories and generated record revenue. NII was positively impacted by higher market rates as deposit repricing has lagged the repricing of our earning assets, combined with the benefits of fixed rate asset generation at higher rates. Fee income has remained resilient despite the market related headwinds and expenses were well controlled while we continue to reinvest in our businesses. We achieved a full year adjusted efficiency ratio of 56%, which improved throughout the year with the fourth quarter adjusted efficiency ratio below 52%. Our fourth quarter PPNR grew 12% compared to last quarter and 40% compared to last year. Net interest income of approximately $1.6 billion was a record for the bank and increase 5% sequentially and 32% year-over-year. Our NIM expanded 13 basis points for the quarter. While interest-bearing core deposit costs increased 64 basis points to 105 basis points, reflecting a cycle to date interest-bearing core deposit beta of 24% in the fourth quarter. Total non-interest income increased 9% sequentially driven by our TRA revenue and commercial banking fees. That growth in commercial banking fee income was primarily driven by higher M&A advisory revenue and client financial risk management revenue, and it was partially offset by softer results in mortgage banking origination fees. Non-interest expense increased just 1% compared to the year ago quarter. This expense growth was driven by our acquisition of Dividend Finance during the year combined with continued investments in Provide compensation associated with our minimum wage hike, as well as higher technology and communications expense, reflecting our focus on platform modernization initiatives. Excluding the impacts of Dividend and Provide, total expenses would've been down 1% year-over-year. Moving to the balance sheet. Total average portfolio loans and leases increase 1% sequentially. Average total commercial portfolio loans and leases increased 1% compared to the prior quarter, reflecting an increase in C&I balances. Growth was led by our corporate bank and robust in almost all of our industry verticals. Among our verticals, production was strongest in energy, including renewables, which increased over 50% year-over-year. Healthcare growth was led by Provide with Provide balances up 150% year-over-year. The period end commercial revolver utilization rate remains stable compared to last quarter at 37%. Average total consumer portfolio loans and leases increase 1% compared to the prior quarter, led by Dividend Finance as well as growth in home equity. This was partially offset by a decline in indirect secured consumer loans. Average total deposits increased 1% compared to the prior quarter as an increase in commercial deposits was partially offset by a decline in consumer deposits. Period end deposits increase 1% compared to the prior quarter. After the deliberate runoff of surge deposits in the middle of the year, we have achieved solid deposit outcomes throughout the second half of 2022 reflecting our strong core deposit franchise. Moving to credit. As Tim mentioned, credit trends remain healthy and our key credit metrics remained well below normalized levels. The MPA ratio of 44 basis points was down two basis points sequentially, and our commercial MPA ratio has now declined for nine consecutive quarters. The net charge-off ratio increased just one basis point sequentially to 22 basis points within our guidance range. The ratio of early stage loan delinquencies 30 to 89 days past due also increased only two basis points sequentially and remains below 2019 levels. From a balance sheet management perspective, we have continually improved the granularity and diversification of our loan portfolios through a focus on high quality relationships. In consumer, we have focused on lending to homeowners, which are 85% of our consumer portfolio. We also have maintained the lowest overall portfolio concentration in non-prime consumer borrowers among our peers. In commercial, we have maintained the lowest overall portfolio concentration in CRE. Across all commercial portfolios, we continue to closely monitor exposures where inflation and higher rates may cause stress and continue to closely watch the leverage loan portfolio and office CRE. We have focused on positioning our balance sheet to deliver strong stable NII through the cycle. Our strong deposit franchise, our investment portfolio positioning, and our cash flow hedge portfolios will provide protection against lower rates well beyond just the next few years, as well as the addition of the fixed rate lending capabilities from both Dividend and Provide should continue to support our strong through the cycle outcomes. Moving to the ACL. Our ACL built this quarter was $112 million, primarily reflecting loan growth. Dividend Finance loans contributed $96 million to the ACL build. As you know, we incorporate Moody's macroeconomic scenarios when evaluating our allowance. The base economic scenario from Moody's assumes the unemployment rate reaches 4.2%, while the downside scenario underlying our allowance coverage incorporates a peak unemployment rate of 7.8%. Given our expected period end loan growth, including continued strong production from Dividend Finance, we currently expect a first quarter build to the ACL of approximately $100 million, assuming no changes in the underlying economic scenarios. Moving to capital. Our CET1 grew from 9.1% to 9.3% during the quarter. The increase in capital reflects our strong earnings generation, which was partially offset by the impact of a $100 million share repurchase completed in December. Moving to our current outlook. We expect full year average total loan growth between 3% and 4% compared to 2022. We expect most of the growth to come from the commercial loan portfolio, which is expected to increase in the mid single digits in 2023. We expect line utilization to be stable in the first half of 2023, but then decline slightly to 36% as capital markets conditions improve a bit in the second half of the year. We expect total consumer loans to increase modestly as an expected increase from Dividend Finance and modest growth from home equity and card will be mostly offset by a decline in auto and mortgage reflecting the environment. For the first quarter of 2023, we expect average total loan balances to be stable sequentially. We expect commercial loans to increase 1% reflecting strong pipelines in middle market and corporate banking, and assuming commercial revolver utilization rates remain generally stable. We expect consumer balances to be stable to down 1%, reflecting lower auto and residential mortgage balances, partially offset by dividend loan originations of $1 billion or so in the first quarter. From a funding perspective, we expect average core deposits to be stable to down a 1% sequentially, reflecting seasonal factors before resuming modest growth in the subsequent quarters of 2023. We expect continued migration from DDA into interest-bearing products throughout 2023 with the mix of demand deposits to total core deposits ending the year in the low 30s. Shifting to the income statement. Given our loan outlook and the benefits of our balance sheet management, we expect full year NII to increase 13% to 14%. Our forecast assumes our securities portfolio remains relatively stable from the second half of 2022 levels and reflects the forward curve as of early January with Fed funds increasing to 5% in the first quarter and the first 25 basis point rate cut occurring in the fourth quarter of 2023. Our current outlook assumes total interest-bearing deposit costs, which were 112 basis points in the fourth quarter of 2022 to increase in the first half of 2023 before settling in around 2% or so in the second half of 2023. Our outlook contemplates an environment of continued deposit competition, which would result in a cumulative deposit beta by the end of 2023 of around 42%, given the two additional rate hikes in our forecast over our October guidance. The future impacts of deposit repricing lag combined with the dynamics of our loan portfolio should result in our full year 2023 net interest margin, increasing five basis points or so relative to the fourth quarter of 2022 NIM. We expect NII in the first quarter to be down 1% to 2% sequentially reflecting the impact of a lower day count in the quarter combined with stable loan balances. We expect adjusted non-interest income to be relatively stable in 2023, reflecting continued success taking market share due to our investments and talent and capabilities resulting in stronger gross treasury management revenue, capital markets fees, wealth and asset management revenue and mortgage servicing to be offset by the market headwinds impacting top line mortgage revenue and higher earnings credit rates on treasury management, as well as subdued leasing remarketing revenue. If capital markets conditions do not improve, we would expect to generate improved NII and lowered expenses in the second half of 2023. We expect our fourth quarter TRA revenue to decline from $46 million in 2022 to $22 million in 2023. Our guidance also assumes a minimal amount of private equity income in 2023 compared to around $70 million in the prior year. We expect first quarter adjusted non-interest income to be down 6% to 7% compared to the fourth quarter, excluding the impacts of the TRA, largely reflecting seasonal factors. Additionally, we expect to continue generating strong financial risk management revenue, which we expect will be offset by slowdown in M&A advisory revenue and the impacts of higher earnings credits and software top line mortgage banking revenue given the rate environment. We expect full year adjusted non-interest expense to be up 4% to 5% compared to 2022. Our expense outlook includes a one point headwind each from the FDIC insurance assessment rate change that went into effect on January 1st, the mark-to-market impact on non-qualified deferred compensation plans, which was a reduction in 2022 expenses and the full year expense impact of Dividend Finance. We also continue to invest in our digital transformation, which should result in technology expense growth of around 10% consistent with the past several years. We also expect marketing expenses to increase in the mid single digits area. Our outlook assumes we close 25 branches in the first half of 2023 that will deliver in year expense savings and also add 30 to 35 new branches in our high growth markets, which will result in high single digits growth of our Southeast branch network. We expect first quarter total adjusted non-interest expenses to be up 6% to 7% compared to the fourth quarter. As is always the case for us, our first quarter expenses are impacted by seasonal expenses associated with the timing of compensation awards and payroll taxes. Excluding these seasonal items, expenses will be down approximately 2% in the first quarter. In total, our guide implies full year adjusted revenue growth of 9% to 10%, resulting in PPNR growth in the 15% to 17% range. This would result in a sub 53% efficiency ratio for the full year, a three point improvement from 2022. We expect 2023 net charge-offs to be in the 25 to 35 basis point range with first quarter net charge-offs in the 25 to 30 basis point range. In summary, with our strong PPNR growth engine, discipline credit risk management and commitment to delivering strong performance through the cycle, we believe we are well-positioned to continue to generate long-term sustainable value for customers, communities, employees, and shareholders. Thanks Jamie. Before we start Q&A, given the time we have this morning, we ask that you limit yourself to one question and a follow-up and then return to the queue if you have additional questions. Can you share with us, Tim, when you talk to your business customers, it seems like there's a real disconnect between everybody's outlook for loan loss reserve building. We understand, of course, at CECL, and you're going to be proactive life of loan losses. And you and your peers are building up the reserves, but then you look at the spreads in the high yield market, they're coming in. One of your competitors yesterday pointed out that the commercial loan spreads haven't widened out. Where is the disconnect? Or are we just going to fall off a cliff possibly in the second half of the year? But can you share with us what are your commercial customers seeing in their day-to-day business? And are they seeing the weakness that everybody is projecting that will happen later this year? Yeah. Sure, Gerard and thanks for the question. I don't think we're going to fall off a cliff in the second half of the year. That's certainly not consistent with what I hear. I was out and went and looked at the calendar the other day. I got to get into eight of our 15 markets in the fourth quarter of this past year. And I think I probably saw 40 or 50 clients while I was out there. I mean, here's what I hear. Like if you look at the manufacturing clients as an example, they're all feeling much more optimistic about moderation as it relates to raw materials. And I think by and large, they solved the supply chain issues that they were facing either through inventory builds or through restructuring the supply chain or because the overseas suppliers that they were relying on to come back online or there isn't an issue in the ports or otherwise. I think the issues they're running into are twofold. One, labor continues to be a challenge and it's labor cost, but it's also just labor availability. Two, because they solved their supply chain challenges through building inventory. When you think about lower inventory turns, you add in rising interest rates, now debt service costs to revenue or higher proportion. And so, while they got the costs associated with raw materials through this last year in price increases, they're all looking to the next 18 to 24 months to try to figure out how they pass on just this sort of continued slow grind on labor, and debt service costs. The services clients are having no problem pushing through costs, which I think is like evident in the inflation data and personally to anybody that took a vacation over the holidays this year. And they continue to be optimistic because demand has remained strong. I think what I hear more than anything else is that we're going to have a little bit of a slow grind down here in terms of growth, and that if anything, the thing I'm more worried about is not do we end up with plus 5%, 0.5% GDP or minus 0.5% GDP, but rather that the market may be overly optimistic about how quickly the Fed is going to be able to bring rates down. And that the byproduct of that is from an operating standpoint, you have to be thinking a lot more about how you position the balance sheet for the next three to five years and for more tepid growth and higher rates than worrying about the next, call it, 12 months in terms of the outlook. Very good. Very helpful. Jamie, circling back to you on one of your favorite topics, AOCI. Can you share with us two things? One, what does the accretion look like coming into 2023 for the AOCI number? And second, in your securities portfolio, I think you showed in your release that the taxable securities are yielding 3% today. What are you guys seeing in new yields as you put money to work? Yeah. Thanks Gerard. And yeah, I knew when we put you in the queue I was going to get an AOCI question, so, thanks for living up to that. In terms of the AOCI, if you look at year-end levels with the 10-year at roughly 387, the AOCI, earns back with our duration at 5.4. It earns back pretty evenly across that time period. So, a billion or so of TCE earn back per year. Obviously, no capital impact given that we're category four. If you fast forward to today and where the 10-year is, certainly we've had a significant improvement in the AOCI just in the first 19 days of January. So that would be helpful to the TCE as well. In terms of the securities yields, obviously, we're very pleased with how the portfolio is positioned at a 3% yield. I would expect that what's going to happen with the investment portfolio is that it will continue to grind higher each quarter and finish the year at a 310 level. So, the average for the year is probably in the 305 range, because as we're reinvesting cash flows or seeing opportunities on new investments we're looking at entry points in that 475 area right now. Hi. I know you guys walk -- I think it was your phrase that how the maturity securities were like being in the ROTCE motel, if I got that right. And you have hard -- what it's like hardly any securities held to maturity, which gives you flexibility and I'm not sure how much that matters. And maybe just gives you more flexibility as you look ahead, but you're also one of the few banks that are -- if you take the midpoint of your guidance, you're guiding for higher NII off fourth quarter levels. And I'm -- is there a connection between how you're managing your securities book and that guidance, or are they separate? But really the question is, NII guide as it relates to your securities. Yeah. Mike, it's Jamie. Yes, I did reference the ROTCE motel few quarters back. And I guess today's theme, it's -- the held to maturity is more like a hide the maturity. And it certainly helps having that flexibility to reposition as environments change. But really there's no one thing that's driving the strong NII outlook and NIM expansion for us. It really is the result of years of hard work of deliberately positioning the balance sheet for really what is a range of outcomes that still could play out given all of the uncertainty. And it really is a total company effort. And that comes from the household growth, new commercial relationships, product innovation, the FinTech acquisitions, and ultimately sales execution both on loan pricing and deposit generations. So that's really what is giving us the ability to grow NII during the course of 2023, as well as expanding NIM at the same time. And I think it's one of those capabilities of Fifth Third that we've proven over the past decade that's perhaps underappreciated by the market. And like you said, the securities are certainly going to be a higher level of gross income over the course of 2023, in part because we were patient in deploying the excess cash that we had and not buying securities when the 10-year was below 2% or even below 1% like some of the other banks. I think one of the bigger differentiators for us will be the fixed rate loan businesses that we have in our ability to emphasize or deemphasize those businesses. And right now, we have a little bit of an emphasis on auto being able to generate roughly $6 billion this year. And then dividend where the gross income on dividend will exceed over $200 million of growth in 2023 relative to 2022. And so really when you package it all together with an investment portfolio that's in a net discount position of about $1 billion, a dividend portfolio that by the end of 2023 will have unamortized fees, that will roll through NII of about $1 billion. We've got a lot of downside protection and a core franchise that with its ability to grow loans and deposits really is helpful. And within all of this guide, we do not assume spread widening. So to the extent that were to happen is, Tim mentioned, that would only be upside to our guide. And then, Tim, just a broader level. I mean, do you see a recession based on your bottom up analysis based on all the markets you're visiting, based on the clients you're talking to? I mean, we hear so much recession talk and then we hear about your loan growth and everything else. What do you just think from a high level standpoint? And then what are your assumptions for reserves in terms of unemployment? Yeah. I'll let Jamie fill the question on the specific assumptions on reserves, Mike. But I probably lost my crystal ball when I moved offices earlier this past year. So, I have to rely on what I hear from clients or what we get from our friends at Moody's and otherwise. If you asked me today, I would tell you we're going to have a shallow recession, I think. But I don't know that there's a big difference between a half a percent of growth and a half a percent of GDP decline in particular, given the amount of derisking that's been done inside the banking sector and certainly inside Fifth Third over the course of the past decade. I think the more interesting dynamic really is going to be this question about the duration of a recession if we see it, and what happens if we don't get a typical recovery, right? If you have several years of below trend growth and inflation that sits above the historic, certainly above the historic 2% target. Yeah. Mike, as you know, we used the Moody scenarios of -- their baseline scenario, and that drives 80% weighting and we maintained our weightings at 80.10% with the upside, and the S3 their adverse scenario or 10% probability scenario. So in the adverse, the unemployment gets -- almost up to 8% in the baseline unemployment ratchets is up to 4.2%. And then we blend those scenarios together to drive the ACL. So, I think it meshes well with what Tim's comments were of a shallow or mild downturn in the economy and then a recovery. 10% on the upside, which is the upside scenario is that the Fed delivers a soft landing, so unemployment stays in the high threes. So 10% in the high threes a baseline at 4.2% peak, and then a downside at 10%, at a 7.8% unemployment. Good morning everybody. Thank you for taking the question. Jamie, I guess it doesn't -- based on what you said, it doesn't feel like you would get there anytime soon. But in the past, you talked about sort of the 330 margin floor in the event of low rates. Just curious, given all the sort of the ebbs and flows we've had in expectations and just the own -- pardon me -- the moves you've made with your own balance sheet, how are you thinking about that lower bound kind of as we go forward in that 330 level? Yeah. We feel very good about the ability to have a floor on the NIM at that 330 level and a 200 down scenario should that play out, given all the work we've done on the investment portfolio with the bullet locked out cash flows along with being in a fairly sizable net discount position and the duration that we have combined with the fixed rate loan origination platforms with auto, Dividend and Provide, those should all provide yields. And then as we've talked in the past, we've layered in $15 billion of received fixed swaps that will also provide additional protection from 2025 through 2032. And that may be one other differentiator for us relative to peers is that we've been focused more on protecting that downside over a longer period of time and therefore, the duration of our swap book as well as our investment portfolio maybe a little better positioned should that downturn occur at the end of the decade. Perfect. Thank you. And then switching gears just a bit. Maybe some thoughts on kind of the trajectory of fees as we go through the year. You guys always have the seasonality that helps fourth quarter -- hurts the first. But it will be, I think a pretty substantial ramp up starting in the 2Q. Just curious, I think you alluded to capital markets kind of normalizing or recovering in the second half of the year. Just maybe your thoughts on main drivers as the year plays out. Sure. Thanks. When it comes to the fee income, we did say relatively stable over the course of the year and probably is helpful to look at it from two components. The first would be a category I'll call the factors in our control that do deliver nice growth, both from a strong customer acquisition perspective as well as overall fee generation from a combination of the branch network, our wealth business, the commercial business. That will drive both credit card income as well as wealth and asset management fees in the mid single digit area and top line fee equivalent growth in the treasury management area in the high single digit area given our strong product lineup. From there, transitioning to mortgage, that's actually going to be the largest growth item for us in 2023. And it really goes back to all the work that we put into growing the servicing business in 2020 and 2021 when levels were more depressed. It was a good buying opportunity. And so, given our strong mortgage servicing platform, we'll increase those fees from $125 million in 2022 to the $160 million area. So that's a growth of almost 30%, whereas top line mortgage should be relatively stable off very low levels. So, we feel good about those items. Capital markets, certainly the wildcard in our guide, given that we do expect mid to high single digits growth in the first half of the year relative to the first half of 2022. And then we assume a little bit of additional growth in the back half of the year under the assumption that the capital markets disruption should abate once the Fed reaches its terminal Fed fund level. And again, as I said in the prepared remarks, if that were to not happen, then we would expect a little bit better loan growth, a little bit better NII and lower expenses. So, in terms of PPNR on a relative basis, I feel confident in that should the capital markets improvement not occur. And then the other category when it comes to fees, it would be the headwinds facing us. So, they're really environmental given the increase in interest rates, and that's on the earnings credit. We're managing earnings credits to about a 20 beta, which is a little bit better than what we thought as we entered the cycle. But even with that, service charges ultimately will be down mid single digits for the year, which more than offset that strong top line fee equivalent growth. On the consumer overdraft and NSF side, we probably do a little bit better relative to peers, just given that we move sooner on some of those fee and structural changes. But overall, the first half of the year will be a little bit softer as we lap those changes that occurred mid year 2022. And then as we said in the prepared remarks, the TRA will decline in 2023 as well our expectations on lower private equity income so that other fees will be down 20%, 25% or so. I think if there's one thing I might add there, it's -- while we expect capital markets to improve this year, I would not say we expect them to normalize or recover with the investments that have been made in that business. A full recovery in capital markets would result in a substantially larger business and revenue footprint than we're anticipating this year. We just don't expect it to be as bad or as locked up as we saw in 2022. I was wondering, can you just walk through the puts and takes around deposit growth in 2023? I mean, it seems like the expansion in the Southeast is definitely a tailwind here. So, how are you thinking about deposit growth, especially given the more challenging macro backdrop? Yeah. This is Bryan. Certainly, we feel good about our franchise and the improvements that we've made over the years. We have a very strong new customer origination engine, both across consumer and commercial. We've got strong new consumer household growth, strong in QRs from a commercial perspective. We have a very high performing treasury management business that provides a lot of deposit support as well as growth. And as you mentioned, our Southeast branch expansion, obviously, is going to create a tailwind for us as well. And finally, we have proven and analytically driven customer offers that have done a really nice job through the cycle and driving the balances when we need them. So, we continue to maintain a lot of confidence in the environment that we're going to be able to deliver and gain our fair share of deposits as the environment changes. Obviously, we can't grow in all environments, but we are cautiously optimistic and well positioned. Yeah. And just to put a number on the -- narrowly on the Southeast, like we grew consumer deposits by over 6% in the Southeast this past year to Bryan's point. That is anti [indiscernible] has been a tailwind for us. Got it. Helpful. And then, maybe the flip side of that is the wholesale funding. We saw you had some wholesale funding earlier in the year. So, are those balances where you'd like them to be for now? And how does that fit into the overall funding strategy? Yeah. We're very comfortable with where we are from a wholesale funding perspective. We continue to have very significant contingent liquidity sources that help us manage through uncertainty in the environment. If we see decent deposit growth, we could see those wholesale funding balances come down over time. But we have a lot of flexibility across our funding base to help us manage through both liquidity needs as well as net interest income. Good morning. I guess, I just had one follow-up question on the credit comments earlier, Tim. You mentioned about the resiliency of the bank. But when you think about your scenario of higher for longer rates, do you think that begins to weigh on your customers when you look at either on C&I or on the CRE book that the longer the Fed has to stay at the five-plus rate, their cost of equity, capital is going higher, demand is falling off? And does that lead to a lot more pain on credit, maybe not in later in the year into 2024 absent Fed rate cuts? Yeah. Let me give you the quick answer, and then I'll let Richard comment. Absolutely. I think that is our view is that it's more of a slow growing dynamic here than a cliff, right, as Gerard mentioned earlier. And that the longer that we go with rates at elevated levels, the more pressure that it places on business -- commercial borrowers, in particular. I think our consumer borrower is a little bit different because such a significant share of our consumer lending is done to homeowners that they've had the ability to inoculate themselves a little bit from inflation because they locked in these historically low fixed rate cost of housing. Yeah. Ebrahim, I think there's a couple of things here. To your question specifically, clearly higher interest rates for longer is going to put pressure across the board. And I think that's, frankly, by design from a Fed standpoint to get things to slow down. The biggest impact is going to be in the leverage lending portfolio. We're starting with higher levels of leverage. Clearly, higher interest rates impact free cash flow. One of the things that we do is when we do our underwriting, and frankly our quarterly monitoring is we will go back and look at the rate curve. And in fact, we look at -- we underwrite the rate curve, forward curve plus 200 basis points to make sure that there's enough cushion in free cash flow so that when we're underwriting and taking on these loans, we can -- we believe these borrowers can withstand the pressure of higher rates through their margins and free cash flow. I think the other thing we're watching for, and as we think about the economy and Tim referenced labor, both cost and availability that in certain segments continues to put pressure on margins, particularly for those industries that have a mismatch between the revenue management and their expense management. So, maybe they've got long-term fixed price sales contracts they've got to manage through with short-term labor. And probably the most acute example of where this is happening is in pockets of healthcare, senior living. We've talked about not-for-profit hospitals, which have low margins. The cost to deliver care and service has gone up pretty dramatically. You can look at nursing availability and wages is a really good example. And there's a lag there in the revenue cycle in terms of reimbursement rates, whether it's public or private, where these companies -- for these companies to maintain margins, profitability. And so, in those cases, we're looking at other things the quality of the balance sheet, liquidity and liquidity burn rates. But no question that the higher -- as rates are higher for longer, it puts pressure on businesses. I think the last thing, and this is part of client selection is understanding the ability of our borrowers to adapt and the resilience to these things. So, it's not just a situation where rates are higher, and companies don't adapt or consumers don't adapt. And it's part of the relationship model and part of the way we go to market in terms of the advice and counsel with our customers, understanding what's happening, looking for alternatives, finding new ways to finance these customers. So that resilience through the cycle will continue to endure. That was helpful. And I guess, just one quick follow-up, Jamie, on Dividend Finance. About $100 million of provisioning. Anything else around Dividend Finance in terms of growth outlook this year versus last year that we should be aware of? Are things picking up or slowing down as we think about just the underlying growth in the business? Yeah. We feel very good about the business that Dividend is doing, especially on the solar side of the aisle. And for us, we're expecting roughly $4.5 billion of originations in 2023 with a weighting of 90% solar, 10% home improvement. Home improvement we're less enamored with. But again, it's a good product offering for other points in the cycle. So, it's being deemphasized, and solar continues to do incredibly well. And if anything, there's perhaps a little bit of upside to our NII guide on Dividend for 2023, just given the strength of the business as well as the pricing power. On the credit front, I know you gave us really good detail on delinquencies and non-accruals. Do you have what criticized assets did in the quarter? And what areas of criticized they have migrated negatively? Yeah. This is Richard. Thanks for the question. Criticized assets were flat for the quarter, both nominally. I think we had a little bit loan growth, so about three basis points of commercial improvement across the board. I would also point out that in addition to credit [ph] being stable, delinquencies 30 to 89, 90 and above, NPAs charge-offs were all down for the quarter on the commercial side. I think the things we're watching, and I hit on it a little bit, healthcare, specifically not-for-profit hospitals and senior living for the reasons we just talked about, we've seen some pressure there because of the mismatch between the revenue management and expense management. A little bit of pressure in watching in commercial specialty products, consumer specialty products, right? That's a function of consumers shifting from durables and discretionaries to consumables and non-discretionary and supply chain and inventory management issues. That's the trading down issue. And that's where we've seen most of the movement. The leverage portfolio from an asset quality standpoint has been stable and operating within our expectations. Okay. Thank you. That's helpful. And then sticking to credit, just my follow-up is around both commercial real estate and home equity. In commercial real estate, it looks like you did see pretty noteworthy move up in delinquencies as well as the non-accruals. And so, can you guys talk a little bit about property types within commercial real estate where you're seeing the distress and where your loan to value ratios are? And then in home equity, it looks like you also saw a pretty noteworthy increase in delinquencies there. Just want to get color around that portfolio. Thanks. Let me take commercial real estate. I think when you think about the delinquencies, if you look at the delinquencies and this is on the slide deck on slide 30, 90 plus is still zero. We've got none. Movements in 30 to 89, six basis points, it's off a really, really low, low base. So, it's not something that we're concerned about from a commercial real estate perspective. I think the thing we're watching for -- we're watching -- I know a lot of people got questions on office. We're watching office. That's a small number for us. In fact, our performance in office is actually in line with or better than the rest of the commercial bank. But there is some pressure there as occupancy attendance and lease rates continue to -- and sublease rates continue to fall. I think there's a couple of things. We've got a very small amount of urban central business district office. That's where most of the pressure is in terms of subletting rates. That for us is Class A property. I would also tell you that in addition to class, vintage matters. That's all new product. It's a new product. It's ESG, qualified lead golden platinum. It has all the modern amenities. So, we feel really good about those particular properties. The rest of our office portfolio sits more in suburban markets. And again, you don't have the same pressure from a lease rate, sublease rate and a tenant perspective across the board. Across the rest of commercial real estate, multifamily continues to perform very well. The demographic trends, the household formation continue to be strong. Rental rates continue to accelerate faster than construction costs. So, again, there's a positive tailwind there. Same thing with industrial. Industrial demand, this kind of goes back to the reshoring thing, trend. Industrial demand is really strong, continues -- lease rates continue to hold in. So, we feel really good there. Hospitality is stable. And that continues to be a good trend and then in retail is stable. So, feeling really good about where we are from an overall perspective in commercial real estate. John, I just was going to say on the equity side, all you're seeing, I think, in the consumer for us at the moment is just seasonality. Like a sequential comp from the third quarter to the fourth quarter are the wrong comparisons. Just given the natural seasonality in those businesses, I think it's better just to look at year-over-year. And we expect consumer credit to normalize over time. That's reflected in the guide that we gave. But the delinquency dynamics there are really no different than what you would have seen pre-pandemic, other than the fact that they're still muted relative to what we would have had in the past. So, I -- personally, home equity is not the area that's been an area of focus for me. That's for certain. Well, actually, the dynamic there is that for the first time in as long as I've been at the bank, we actually had quarter-over-quarter home equity growth. What's driving that outcome, but not a change in perspective for us on the quality of the credit or the likely outcomes there. Good morning. I might have misheard the comment on the indirect auto kind of loan growth expectations for this year. Can you just repeat that, what the strategy is and what you're seeing in the spreads there? Yeah. Actually, spreads have done well and are actually off to a very solid start in 2023. We finished the year in 2022 with 7.1 billion of production, if you take auto as well as the RV, marine and specialty business combined. So that fixed rate consumer secured loan category. Our expectation for 2023 for that asset class is to be down to about 6 billion or so. So, loan balances in that caption, we would expect to be down. However, yields, we expect to improve 100 basis points from the fourth quarter 2022 levels to fourth quarter 2023 levels. So, it is a nice accelerator to the earlier question around how are you able to deliver both NII growth and NIM expansion. That certainly is a helpful driver. Got it. And then just separately on the capital level, we're seeing some divergence in targeted capital out there. Obviously, there's like upward pressure at the biggest banks, not really relevant to you. But then some of your peers are targeting closer to 10%. And I'm certainly on board with 9%, seeming very high. But I'm wondering, is there any kind of behind the scenes pressure whether it's rating agencies or regulators to just hold a little bit more, given some of the macro uncertainty or anything else that we're not seeing? Yeah. Great question, Matt. Thanks for asking. I would say that as this environment unfolds, it really is, to your point, going to create differentiation in both performance execution and overall balance sheet positioning. We've, I think, for a number of quarters and years now been discussing how cautious our outlook is. And that has really informed what we're willing to do from a credit risk appetite perspective. So, the capital levels ultimately are a factor of the credit profile of what's on the sheet as well as the reserve levels that we have. So, the CET1 level at 925 and an ACL level of 198 creates a very sufficient loss absorption capacity. And given our SCB level is the at the minimum, I think external factors or forces would say that we're very well-positioned from a credit profile perspective as well as from a loss absorption capacity. So, we feel good about that. Hey, guys. This is Ben Reseck [ph] on for Ken. Just a quick follow-up on the Dividend Finance. As those originations continue to ramp up and mortgage loans go on balance sheet, when do you ultimately see that NII benefit overcoming the reserve builds and becoming accretive to earnings? And then, can you just remind us of what type of loss rates you're assuming on those dividend loans? Thanks. Yes. Great question. The PPNR levels for Dividend will be positive in the back half of -- or in 2023. The net income of Dividend post ACL will be positive or accretive in 2024. Certainly, if prepayments accelerate faster than what we have modeled, then that large amount of unamortized platform fees will come through the P&L, would it improve or accelerate the return profile. But for now, that's how we have it playing out. And we model roughly an eight-year life on the dividend asset and that we would expect to have loss rates in the 125 basis point area on a blended basis for the portfolio per year over those eight years. And there are no further questions at this time. Mr. Chris Doll, I turn the call back over to you for some closing remarks. Thank you operator, and thanks everyone for your interest in Fifth Third. Please contact the investor relations department if you have any follow-up questions.
|
EarningCall_1150
|
Good morning. Thank you for attending today's Insteel Industries First Quarter 2023 Earnings Call. My name is Faram [ph] and I will be your moderator for today's call. All lines will remain muted during the presentation portion of the call, with an opportunity for questions and answers at the end. [Operator Instructions] It is now my pleasure to pass the conference over to our host, H. Woltz, President and Chief Executive Officer of Insteel Industries. Mr. Woltz, please proceed. Thank you, Faram [ph]. Good morning. Thank you for your interest in Insteel and welcome to our first quarter 2023 conference call which will be conducted by Scot Jafroodi, our Vice President, CFO and Treasurer and me. While Scot has only recently been named CFO, he is a long-time Insteel employee who is intimately familiar with company markets and operations. We congratulate Scot on his elevation to CFO and we're confident he will add value to the company. Before we begin, let me remind you that some of the comments made in our presentation are considered to be forward-looking statements that are subject to various risks and uncertainties which could cause actual results to differ materially from those projected. These risk factors are described in our periodic filings with the SEC. Beginning in Q3 of 2022, residential-related markets began to weaken as interest rates rose and those markets remained weak through the first quarter of 2023. We do not expect significant recovery of residential markets until there are signs that the interest rate environment is changing. Unlike residential markets, we believe the shipment weakness we experienced in non-residential markets is related to customer inventory management and destocking rather than impaired demand for our products. Following several quarters of extended lead times and inadequate supplies, customers found that excessive inventory levels and purchase commitments could be safely curtailed as lead times normalized. Notwithstanding the weakness that is apparent in Q1 results, we believe that 2023 will be a good year for our non-residential markets and for the company. I'm going to turn the call over to Scot to comment on our financial results for the quarter and the macro environment and then I'll pick it back up to discuss our business outlook. Thank you, H., and good morning to, everybody, joining us on the call. I'm pleased to be here participating in my first earnings call as the CFO of Insteel. As we reported earlier today, our results for the quarter were unfavorably impacted by a decline in shipments and the narrowing of spreads between selling prices and raw material costs. Net earnings for the first quarter fell to $11.1 million from record earnings of $23.1 million a year ago and earnings per share dropped to $0.57 from $1.18 per diluted share in the prior year. As referenced in our release, earnings for the current year quarter benefited from a $3.3 million or $0.13 per share gain on the sale of property, plant and equipment. Net sales for the quarter fell 6.5% from last year on a 10% decrease in shipments, partially offset by a 3.9% increase in average selling prices. Our shipping volume for the first quarter, which has historically been our slowest period of the year due to the onset of winter weather and holiday schedules, was adversely impacted by the previous-noted inventory management and destocking measures pursued by our customers along with the continued weakness in the residential construction market that first began in the second half of fiscal 2022. On a sequential basis, net sales were down 19.8% from the fourth quarter due to a 12% drop-off in shipments and an 8.8% decrease in average selling prices. Falling raw material costs and competitive pricing pressures eroded ASPs during the quarter, with the largest decline in average selling prices from Q4 within our product line most exposed to the residential markets. Gross profit for the quarter fell $24.6 million from a year ago and gross margin narrowed to 10.7% from 23.7% due to lower spreads between average selling prices and raw material costs, along with a reduction in volume and higher overall plant operating costs resulting from lower production levels. On a sequential basis, gross profit fell $22 million from the fourth quarter and gross margin decreased 840 basis points. As we have highlighted throughout the prior year, during environments of strong demand and escalating steel prices, our results are favorably impacted by both the implementation of price increases sufficient to recover the higher replacement costs for our raw material and the consumption of lower-cost inventories under first-in, first-out accounting methodology. However, during periods of declining steel prices as we had during our first quarter, we experienced the opposite effect under FIFO and our gross margins narrowed due to the consumption of higher-cost inventories matched against lower average selling prices for our products. As we have noted in our fourth quarter earnings call, we finished fiscal 2022 with 4.3 months of inventory on hand, valued on a FIFO basis. As such, our first quarter spreads and margins have been adversely impacted by the matching of higher-cost inventory purchased in fiscal 2022 against lower average selling prices for our products. Going forward, we should benefit from a gradual reduction in these costs as more recent lower priced raw material purchases are consumed from inventory, assuming our selling prices remain flat or fall to a lesser extent. SG&A expense for the quarter decreased $5.2 million to $7.2 million or 4.3% of net sales from $12.3 million or 6.9% of net sales last year, mainly due to lower compensation expense under our return on capital-based incentive plan, which was driven by weaker results in the current year. To note, our return on capital-based incentive plan was fully expensed in the first quarter of the prior year, given the record financial performance. As we've highlighted in our release, other income for the quarter includes a $3.3 million net gain on the sale of property, plant and equipment. Our effective tax rate was virtually unchanged at 22.9% which is down from 23% last year. Looking ahead to the balance of the year, we expect our effective rate will remain steady at 23%, subject to the level of pre-tax earnings, book tax differences and the other assumptions and estimates that compose our tax provision calculation. Moving to the cash flow statement and balance sheet. Cash flow from operations provided $33 million of cash in the first quarter due to our working capital reduction that was driven by a $26.5 million decrease in inventories along with a $12.9 million decrease in accounts receivable. You may recall, we had ended the previous quarter with an elevated inventory balance, largely due to the increase in raw material purchases as we replenished our inventories from depressed levels earlier in 2022. Over the course of the first quarter, we scaled back our inventory purchases, particularly during December. As of the end of the first quarter, our inventory position represented 3.9 months of shipments on a forward-looking basis, calculated from our Q2 sales forecast. Finally, our inventories at the end of the first quarter were valued at average unit cost lower than the beginning of the quarter but still unfavorable relative to current replacement costs. We incurred $8.2 million in capital expenditures in the first quarter and remain committed to our full-year target of $30 million, given the many initiatives that we have underway. H. will provide more detail on this topic in his remarks. In December, we returned $39.5 million of capital to our shareholders through the payment of a $2 per share special cash dividend, in addition to our regular quarterly dividend, marking a 6-year over the last 7 years, we have paid a special dividend in the second year in a row, we paid a $2 per share special dividend. Also during the quarter, we repurchased $916,000 of our common equity, equal to approximately 32,000 shares. From a liquidity perspective, we ended the quarter with $42.6 million of cash on hand and no borrowings outstanding on our $100 million revolving credit facility. As you move into the second quarter of fiscal 2023, our market outlook for the remainder of the year remains positive as we are encouraged by continued strong demand and backlog in our non-residential construction markets. However, the most recent report from the third-party leading indicators for non-residential construction spending, ABI and Dodge, have been somewhat mixed. In November, ABI remained in negative territory for the second straight months, falling to 46.6. However, the Dodge Momentum Index, another leading indicator for non-residential building construction, has rebounded over the last several months, rising to 222.3 in December. On a year-over-year basis, the overall index was up 40% driven by strength in both the commercial component which was up 51% and the institutional projects that was 20% higher. Finally, last week, the AIA released the semi-annual construction forecast for non-residential building construction for 2023 and 2024, reflecting continued growth for the current year. Spending on non-residential building was projected to increase 5.8% during 2023, driven by gains in industrial, institutional and commercial sectors. Thank you, Scot. While we're not pleased by our first quarter results, we do not think our markets are deteriorating under pressure of macroeconomic weakness that jeopardizes performance for fiscal 2023. Rather, we think underlying demand from residential markets have stabilized at a lower level and that demand is robust in non-residential markets. Under these circumstances, inventory corrections should be expected, following an extended period of constrained supply conditions when customers make purchases and commitments just in case rather than following more typical demand pool purchasing tactics. Our view of the market is formed by conversations with many customers focusing on their projected operating rates, backlogs and overall expectations for business conditions during the year. Also, recovering customer activity and internal order entry levels support the hypothesis that the inventory correction is running its course. Scot mentioned in his comments that we have 3.9 months of inventory on hand which is more than is required, based on business conditions. Insteel's inventory imbalance is centered primarily in residential-related markets, while inventories for non-residential construction markets are much more appropriate relative to business levels. Recall that we turned to offshore wire rod markets last year beginning in fiscal Q2 when domestic sources were unable to assure us of adequate supplies for our third and fourth fiscal quarters. As is our normal practice, we targeted imported volumes toward our housing-related markets which are generally make-to-stop products that rarely require certification of compliance with by America regulations. Our plan to supplement domestic supplies was upended when housing markets turned down sharply beginning in May 2022. Subsequent deterioration of ASPs in these markets created significant margin pressure, exacerbated by lower production volumes that extended the time horizon for resolving the inventory imbalance. We continue to be optimistic about the impact on our markets of the Infrastructure Investment and Jobs Act and believe it will positively impact our markets during 2023. The need for infrastructure investment in the U.S. has been obvious for decades but funding has consistently been inadequate. It now appears that funding shortfalls will decline in significance as obstacles to investment in view of the strong fiscal condition of state and local governments together with new funding provided by the Infrastructure Investment and Jobs Act. Turning to CapEx. We believe that 2023 should come in at about $30 million, subject to uncertainties related to vendor performance and supply chain issues. These investments in state-of-the-art technology will expand our product capabilities and favorably impact our cost -- cash cost of production. As we mentioned in an earlier call, new production lines will be installed at the Missouri, Kentucky and Arizona plants to better address market needs. We're evaluating additional projects that would have similar beneficial impacts on our market position and cost profile. Going forward, we are aware of rising risks related to the future performance of the U.S. economy and are carefully monitoring the environment. At the same time, we plan to aggressively pursue actions to maximize shipments and optimize our costs and to pursue attractive growth opportunities, both organic and through acquisition. This concludes our prepared remarks and we'll now take your questions. Faram [ph], would you please explain the procedure for asking questions? As we've seen in years past, we've kind of accustomed these kind of adjustment -- inventory adjustment orders that periodically take place. And typically, the thought process and the question always becomes the duration of that adjustment to a stabilized pricing environment. And can you give us a little bit of how the quarter progressed as we got into December? And was the December impacted more materially because of weather holidays and just the slowdown destocking at the year-end for most of your customer base? And how that kind of progresses into the fiscal second quarter? Will we see a snapback basically as we get into the warmer months in the second half of the year? Or is this something more of a modest change for you? Well, let me try to address it like this Tyson. First, Q1 is always our lowest volume quarter. I attribute it primarily to holiday schedules more so than weather because typically October and November are not bad weather months for construction. But holiday schedules just dramatically reduce operating days. And I would say, this year is not much different than any other year with respect to that, except there has been some inventory liquidation going on by our customers as the supply environment changed from more of a highly constrained to not so constrained, with lead times returning to more normalized levels. In terms of inventory levels, as I mentioned in my comments, the over-inventory situation that we're facing is primarily centered in our residential standard welded wire reinforcing market. And of course, as we purchased based on forecasts and when we don't meet the forecast, then the inventory pipeline lengthens in an unplanned way which is what happened to us and we will be through the second quarter in working that off. I would say that these markets -- residential markets seem to have stabilized at levels that are higher than we expected when we did our last forecast and that overall, we would be cautiously optimistic about where we see those markets going. In the non-residential markets, they just continue to perk along at nice levels. So maybe the inventory reductions in the non-residential area aren't completely finished at this point, but the underlying level of demand for the product, I think, is robust enough so that it shouldn't be a material factor for us going forward. Okay. And we've seen mortgage rates drop 100 basis points recently from its peak over 7% on the 30-year. So that obviously doesn't hurt our cause of -- going forward. 3.9 month turns you mentioned, are we -- are you targeting a certain level of getting it back down towards 3, which implies a $30 million, $40 million benefit from the reduction in inventories? Or just give us a little more color on where you want to be at your inventory levels by the end of Q2. Well, of course, that is highly dependent on whether we meet our shipment forecast. But whether it is February or March or April, about 3 months, I think, is a more reasonable level for the business than close to 4. And that assumes that service levels from the steel producers that we do business with remain reasonable which appears will be the case. Okay. Are you anticipating then by the second half of this year that will get to more historical margin levels in those high double digits on a stabilized...? Yes. Last question for me. Obviously, there wasn't -- there appears no accrual for incentive comp in the Q1. Should you hit targets, what's kind of that maximum level that would be taken this year if you hit those incentive comp levels for the overall year that we'll have to true up later this year? Well, it will be on a quarter-by-quarter or month-by-month basis. There'll be no big surprises. And let me just -- let me say this also, Tyson. As we look at the business and we look at the spreads that are implied by contemporaneous purchases and sales of product that the business has not been impaired by any kind of macroeconomic weakness or downturn that -- we like where we are but for a little extra inventory. Okay. And your price, you talked about the overall average price being down 8.8%. We've never really gotten the shipments up like we wanted to see over the past year plus due to supply constraints and otherwise -- across different product categories like PC strand versus your standard welded wire that's more residential focus. Give us kind of the range of what you're seeing on the pricing environment. Has PC strand held much more favorably than the standard welder, so that is disproportionately lowering your average price? Well, I think what we've said was that ASPs fell pretty significantly in standard welded wire reinforcing product line and not so much in other product lines. Just reflect in the state of supply and demand in those various markets. Thank you for your question. Our next question comes from the line of Julio Romero with Sidoti. Mr. Romero, your line is now open. Good morning, everyone. My first question is, what is your sense for how much of the weakness you realized in non-resi shipments during the quarter was due to customer destocking versus easing supply chain constraints? In the residential-related markets, Julio, began in last May when interest rates began to really affect that market, we saw a significant reduction in shipments relative to our forecast to the tune of around 40%. Subsequently, those markets seemed to have recovered and stabilized, although at lower levels than they were running prior to the downturn, but have taken the brunt of the weakness in that marketplace. How do you -- thank you. My second question is, how do you expect price to change sequentially over the next few quarters? It's unknown and not forecastable. But typically, when demand for our products is strong, then we don't see significant price competition. Our order book and our competitors' order books are such that pricing is not so much of an issue. All right. Thank you for your question, Julio. There are currently no further questions registered. [Operator Instructions] There are no further questions waiting at this time, so I will pass back for any final remarks. Thank you. Okay. Thank you, Faram [ph]. We appreciate your interest in Insteel. And as always, we welcome your contacts and your calls for any follow-up questions that you have. Thanks and we'll look forward to talking to you next quarter. This concludes today's Insteel Industries first quarter 2023 earnings call. Thank you for your participation. You may now disconnect your lines.
|
EarningCall_1151
|
Greetings and welcome to the Crane Holdings Company Fourth Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to Jason Feldman, Vice President of Investor Relations. Thank you. You may begin. Thank you, operator and good day, everyone. Welcome to our fourth quarter 2022 earnings release conference call. I'm Jason Feldman, Vice President of Investor Relations. On our call this morning, we have Max Mitchell, our President and Chief Executive Officer; and Rich Maue, our Senior Vice President and Chief Financial Officer; and Aaron Saak, who is President and Chief Executive Officer of the Future Post separation Crane NXT. We'll start off our call with a few prepared remarks, after which we will respond to questions. Just a reminder that the comments we make on this call may include some forward-looking statements. We refer you to the cautionary language at the bottom of our earnings release and also in our annual report 10-K and subsequent filings pertaining to forward-looking statements. Also, during the call, we'll be using some non-GAAP numbers which are reconciled with the comparable GAAP numbers and tables at the end of our press release and accompanying slide presentation, both of which are available on our website at www.craneco.com in the Investor Relations section. Thank you, Jason. Good morning, everyone. Thanks for joining the call today. Well, we had an exceptional end of 2022 with outstanding fourth quarter results. Fourth quarter adjusted EPS was $2.13, an increase of 63%, compared to last year. We have broad-based strong operational execution with core sales up 11% and we drove adjusted operating margins up 660 basis points to a record 18.6%. On a full-year basis, adjusted EPS was a record $7.88, up 15% compared to last year, driven by 6.4% core sales growth and 220 basis points of margin expansion to a record full-year adjusted operating margin of 17.7%. Adjusted free cash flow of $395 million was also very strong and above the high-end of our last guidance range. As a reminder, last quarter we reaffirmed and tightened our adjusted EPS guidance range to $7.58 to $7.72 dollars with a $7.65 midpoint. At that time, we said that we felt that the high-end of guidance could only be achieved, if we had supply chain improvement and an ability to turn specific shipments quickly. We actually saw that play out in each of our businesses with a bit of unanticipated upside all aligning. With the biggest impact in the last few days of the quarter. While there are still broad based and random supply chain constraints across our businesses, we did receive shipments from a number of suppliers that we honestly didn't expect and our teams did an incredible job turning them into sales for our customers quickly. We also had some favourable tax items that contributed about $0.04 to EPS as well. Really just a perfect alignment of unexpected, but good news very late in the quarter and solid work by our teams and my thanks to all of our associates for the year end effort. To put this annual performance in perspective another way, remember that operationally, we maintained guidance to all year despite numerous headwinds, specifically since 2022 guidance was originally issued last January, we lost $0.25 of contribution from crane supply, which was divested in May 2022. Foreign exchange was an increasing headwind throughout the year and was a $0.19 headwind relative to original guidance, most of it from rate moves during the third quarter. The supply chain environment when â22 was far more challenging than most anticipated a year ago, and there was substantial inflation, spanning materials, freight, labor, energy, and other costs. Even with those headwinds, we held the mid-point of our guidance, while absorbing and offsetting all of these items. And then on a full-year basis delivered results substantially better, which again is a real testament to the hard work and dedication of our teams around the world. And the strength of the crane business system and our execution. These results should give you even further continued confidence in our execution and our ability to over deliver on our commitments as we turn to our outlook for 2023 and the upcoming strategic separation into two independent public companies. Rich will be providing guidance details for both companies post separation reflecting exciting long-term growth opportunities for each. Specific to demand environment, our leading indicators are still very strong. Core year-over-year orders increased 15% in the quarter and 13% for the full -year. Core backlog is up 28%, compared to last year. While the present environment is still similar today to what we saw in the second half of â22 and we still see continued robust demand across our end markets, we remain guarded watching carefully for signs of softening. Other than the RV market where the softness is well-known and understood, we are not seeing slowdown in our order rates yet. However, given broader macroeconomic trends, we are planning for slowing short cycle markets, particularly those in the U.K. and Europe, which are most impacted by energy inflation. From a supply chain perspective, material and component availability remain most challenging, but stable in our Aerospace and Electronics segment with continued, but slow improvement in the other segments. We do expect supply chain constraints to ease over the course of the year, but at a gradual and measured pace. From a cost and inflation perspective, as you can see from our continued margin strength, we've been appropriately assertive with pricing actions across all of our businesses and we continue to fully offset the impact of inflation on both a dollar and margin basis. While 2023 macroeconomic planning assumptions are muted, I couldn't be more excited about the growth opportunities that we have in front of us for both Crane Company and Crane NXT. In any type of demand and operating environment, we are positioned to drive above market growth with our strategic initiatives. This is where we are most focused across the organization, driving growth and advancing technology that has positioned our businesses for the future. We will provide more detail in March, but just a few recent highlights, include Aerospace and Electronics securing substantial new content on the Army's FLRAA Helicopter platform. The Army's largest Helicopter contract in 40-years. In addition, we have been selected to develop several products and systems for application on the next generation of long-range strike and fighter aircraft including brake. Brake control thermal management and fuel management equipment, this is the direct result of the strategy we shared with you in May 2021 targeting next generation technology demonstrator programs. At Process Flow technologies, we successfully launched the next generation digital transducers driving value and award-winning key OEM accounts in the mobile hydraulic system sector and now testing successfully with OEMs for hydrogen applications. With product sales set to grow 4 times in 2023, although from a small base today. We also are gaining traction with our new high efficiency motors and non-clog pump performance with 50% sales growth for these products in municipal wastewater applications as customers realize significant energy and maintenance savings. We had new installations in more than 100 municipalities in 2022 with substantial growth expected again in 2023. Just an incredible amount of activity across our businesses focused on growth. And we are making steady progress on the separation. We're on track for completion April 3 of this year. We continue to have high conviction that this separation is going to create value as it increases our operating and financial flexibility to pursue growth opportunities. It lets us develop capital allocation is for both Crane Company and Crane NXT that are optimized for their individual business and financial profiles. The separation will make it far easier for each company to attract shareholder base fully aligned with each business's strong and distinct value proposition. And we believe it will make M&A more viable at both companies. Simply, the separation will create two more closely aligned pure play companies, each better positioned to deliver long-term growth and sustainable value creation for all of its stakeholders. Significant milestones achieved during the fourth quarter included completion of the organizational design for each company. The announcement of Aaron Saak as CEO of Crane NXT and you'll hear from Aaron shortly this morning. Public filing of the Form 10 registration statement and completion of the capital structure designed for both companies that Rich will review later. Key upcoming milestones to watch for. We expect the Form 10 registration statement to become effective in February pending SEC approval. We will announce further details of the board composition for both companies, as well as the extended leadership team for Crane NXT between now and separation. We will be hosting separate Investor Day events for both Crane Company and Crane NXT on March 9 in New York City and When-Issued trading will commence in mid to late March. We feel very good about our progress to-date and our ability to achieve our targeted timeline. On last quarter's call, I told you how extremely excited I was about Aaron's appointment as CEO of Crane NXT, and how I was highly confident that he is the right leader to embrace the best of Crane's culture and the Crane business system, while moving NXT strategically in new directions. After having the opportunity to work with Aaron over the last two months, I'm even more confident and excited that he is absolutely the ideal leader for NXT in this next chapter. We've spent the last few weeks traveling together, visiting nearly all of NXT's sites and his excitement, passion, insights and strategic observations are impressive. I had great fun introducing Aaron to his broader extended global team and they're very excited about this new entity about to be formed and what the future holds. So, with that, let me turn the call over to Aaron for some comments on his first two months at Crane before Rich provides additional financial commentary and guidance details. Aaron? Thank you, Max, and thanks for those kind comments. I am incredibly excited for the future of NXT and would like to thank the Crane Board for their trust in my leadership, and I know they expectations are high and I am confident with the outstanding team we have here at NXT that the future is very bright. As Max mentioned, I've had the opportunity in the past two months to travel to all of our major sites and meet with our NXT associates. Our team has been incredibly welcoming and I appreciate their enthusiasm for our path forward. It's an outstanding team and one that I am honoured and humbled to be part of. Now in terms of my background, I'm an Engineer by training and I've spent my career with diverse well-known industrial technology companies. This background has given me a depth of experiences that I feel is uniquely positioned to help successfully lead NXT moving forward. In my most recent role, I had direct in-market overlap with NXT, so I'm really hitting the ground running and already working with the team to accelerate existing growth initiatives. I'm also passionate about innovation and delivering technology-based solutions to our customers. And we will continue to drive this focus at NXT and I look forward to sharing more about our strategy at our upcoming Investor Day on March 9. As I mentioned, over the past few weeks, I've visited all of our major NXT sites with Max and the Senior Leaders of the NXT business. During these visits, I've been incredibly impressed with the disciplined cadence and execution of CBS. The focus on continuous improvement and operational excellence, absolutely met and in many cases far exceeded my expectations. And it's exactly what I expected to see in joining Crane. I come from companies with a similar approach to driving continuous improvement and I can ensure our investors that we will maintain this capability as a competitive advantage for NXT. Additionally, I'm impressed that the new products and technologies the teams are commercializing. For example, at Crane Payment Innovations, the focus on automation to improve customers' productivity is really outstanding. This includes the Paypod platform with sales on track to double this year, as well as real momentum across the gaming sector where we have an extensive suite of market leading connectivity and service solutions. At Crane currency, the team has made great progress with our product authentication business, which nearly doubled in sales in 2022 and is on track to double again in 2023. This business is built on our micro-optic technology platform, which also continues to gain share in the banknote market adding 12 new denominations last year and bringing our total specified denominations around the world to 170. So Max, thanks again for the opportunity to introduce myself here today, and I look forward to spending time with investors in the coming months and during our Investor Day in March. Thank you, Aaron, and good morning, everyone. I will start off with segment comments that will compare the fourth quarter of 2022 to 2021 excluding special items as outlined in our press release and slide presentation. At Aerospace and Electronics, fourth quarter sales accelerated increasing 15%, compared to last year to $181 million; segment margins of 20.6% increased 750 basis points from 13.1% last year, reflecting the combination of strong leverage on higher volumes, improved pricing and productivity. Pricing fully offset the impact of inflation in the quarter. Despite the impressive increase in core sales growth, we remain somewhat capacity constrained, due to continued supply chain issues along with the rest of the Aerospace industry and leading indicators reflect that demand continues to outpace the supply chain generally. Specifically, core orders increased an impressive 45%, compared to last year and core backlog increased 34%. In the quarter, total aftermarket sales increased to 25% with commercial aftermarket sales up 25% and military aftermarket up 23%. OE sales increased 11% in the quarter with 15% commercial OE growth and 7% military OE growth. At Process Flow technologies, sales of $252 million decreased 16%, driven by a 19% impact from the May divestiture of crane supply and a 5% impact from unfavourable foreign exchange. Core growth for Process Flow technologies remained very strong at 8%. Adjusted operating margins of 16.1% increased 180 basis points from last year, primarily reflecting strong productivity and pricing and here as well pricing continues to fully offset inflation. Compared to the prior year, core FX neutral orders increased 11% and core FX neutral backlog increased 16%. Sequentially, compared to the third quarter, core FX neutral backlog increased 1% and core FX neutral orders declined 3%, reflecting normal seasonality. Moving to Payment and Merchandising Technologies, sales of $338 million in the quarter increased 8%, driven by a 14% increase in core sales, partially offset by a 6% impact from unfavourable foreign exchange. Operating margins improved 740 basis points to 25.9%, the same level as last quarter's record margins. Margin expansion was driven by higher pricing, higher volumes and very strong productivity, another quarter of really impressive performance from the team. Forward-looking demand indicators also remained very strong with 10% core FX neutral order growth and 35% core FX neutral backlog growth. Specific to the CPI business, the supply chain remains constrained primarily related to certain electronic components, but we continue to see gradual improvement in both availability and lead times. At Engineered Materials, sales of $52 million increased 4%, compared to the prior year as expected. Operating profit margins increased 50 basis points to 11.8%, driven by higher pricing and productivity, partially offset by lower volumes. Growth was led by transportation and building products with RV-related sales down in line with the industry production rates. Moving on to total company results, on a full-year basis, free cash flow was negative $210 million, because of accounting rules, which treat the one-time contribution from the August divestiture of asbestos liabilities as an operating cash outflow and we had additional one-time costs related to both the asbestos transaction itself, as well as the separation. Excluding those items full-year cash flow, free cash flow of $395 million exceeded the high-end of our guidance range. Our balance sheet is in extremely good shape. We ended the year with $658 million in cash and $1.24 billion in total debt, so our net debt is $585 million a very comfortable level as we prepare to set up the capital structures for both companies post separation. Now turning to our 2023 guidance. I hope you have all seen the earnings presentation on our website that accompanies this call. A lot of important information to help you better understand our guidance and I will be referring to it throughout this section. We are on track with the separation to take place immediately after the first quarter on April 3 of this year, that means we will be reporting the first quarter of 2023 on a consolidated pre-separation basis and the following three quarters reported as two separate companies. For segment operating results, this is very straightforward. We are providing all segment guidance on a full-year basis, which will be easy to reconcile after we report each quarter this year. Below the segment operating profit line, we are providing guidance on a pro forma basis for corporate expense, interest and non-operating expense, tax and shares as if the separation occurred on January 1 and as if the two companies were separate for the entire year. Before we get into the details of each company's guidance on slide 20, I want to highlight two reporting changes we are going to make concurrent with the separation. First, at Crane Company, we will continue to include service costs for pension and other benefit plans in our adjusted earnings. Service cost reflects the real ongoing economic cost of providing pension benefits to certain associates. However, starting in 2020, we are going to exclude the components of non-operating benefit costs from adjusted earnings. We are going to treat these non-operating benefit costs as non-GAAP items, because they add volatility to earnings primarily as a result of capital allocation decisions and market performance neither of which are related to the operations of our business and that volatility can obscure our underlying operational performance. On slide 21, you can see that these non-operating pension benefit costs contributed $0.23 to adjusted EPS in 2022. The second change is at Crane NXT. Starting in 2023, we will exclude intangible amortization from adjusted earnings, adjusted operating profit and adjusted operating margin. This amortization is significantly impacted by the timing, size, number and nature of the acquisitions that we complete and it is entirely non-cash in nature. We think that adjusting for intangible amortization enables more consistent comparisons of operating results over time, as well as permitting better comparisons to peer companies. Importantly, even after this change, we expect approximately 100% free cash conversion at Crane NXT defined as free cash flow divided by adjusted net income. On slide 21, we provide a walk showing our 2022 actual results and recasting them to get a like-for-like comparison to what we are going to report in 2023. Starting with our 2022 adjusted EPS of $7.88 there are three adjustments. First, remember that we divested crane supply in May of 2022. In the first five months of 2022, that business contributed $0.25 to EPS. Second, the pension accounting change I discussed has the effect of reducing 2022 EPS by $0.23. And roughly offsetting those two items is the intangible amortization adjustment, which would have increased 2022 EPS by $0.61. The far-right bar on this slide showing recast 2022 adjusted EPS of $8.01, now represents 2022 adjusted EPS on an apples-to-apples basis to our 2023 guidance. So, with that context I'm going to start with guidance for Crane Company on slide 22. As a reminder, this business has about $2 billion in sales and is comprised of two global strategic growth platforms Aerospace and Electronics and Process Flow technologies, as well as the smaller and domestic engineered materials business. On slide 23, you can see that for 2023, we expect 3% to 5% core sales growth driving 8% segment profit growth. With all businesses leveraging at about 35%. This guidance assumes that the overall economy continues to slow with only gradual improvement in supply chain. That said, we are very well positioned to ramp output if macroeconomic and supply chain conditions permit. Specific to the businesses, at Aerospace and Electronics, we are guiding to 10% core sales growth with 35% operating leverage, which should bring margins to just under 20% for 2023. This is the guidance where we have direct line of sight and what we are confident that we can deliver in 2023. However, with 10% sales growth, we would have approximately $50 million of cumulative unmet demand by the end of this year related to supply chain constraints. How much of that $50 million gets delivered this year versus in 2024 will depend on how quickly the supply chain improves. However, the overall message for the segment is unchanged, we expect 7% to 9% long-term annual sales growth plus this $50 million catch up of sales in the next year or two with strong operating leverage in the 35% to 40% range, a really fantastic position to be in. Moving to Process Flow technologies. In 2023, we expect 4% core growth with a 2% unfavourable foreign exchange headwind for total sales growth of 2%. The core growth should leverage at 35% driving nearly 10% segment profit improvement with guidance for margins up just over 100 basis points to what will be a record just over 17%. We have a very strong backlog and recent order activity has been strong. However, given broader macroeconomic trends, our guidance does assume we will be seeing slowing in short cycle activity and decelerating order rates into 2023. Long-term, we believe this is a 3% to 5% core growth business reflecting a combination of lower market growth along with our continued growth through share gains and new product introductions and likely improving over time as our end market mix continues to improve. We should also deliver consistent leverage in the 35% to 40% range. We expect the much smaller Engineered Materials business to see sales decline about 15% in 2023, driven by recreational vehicle OE production cuts, softened by relative stability in the building products and transportation end markets. We expect to hold deleverage to 35%, which equates to margins of approximately 10.5% next year. So overall, operationally, core growth of about 4% driving 8% segment profit growth and with segment margins increasing 80 basis points to 17.4%. On slide 24, we provide the non-operational elements of Crane Company guidance. Remember, this portion of guidance is provided as if the separation had been completed January 1 of this year. The key items presented on a post separation annualized run rate basis include corporate expense of approximately $65 million in 2023 and declining as a percentage of sales thereafter. Net non-operating expense, which is interest expense and related financing costs of $16 million, a normal post separation adjusted tax rate of approximately 23% and diluted 2023 shares of $57.3 million. We aren't guiding to a specific free cash flow number for 2023, because of complexities of allocating first quarter cash flow to Crane Company and Crane NXT, but free cash flow conversion or adjusted free cash flow divided by adjusted net income should be approaching 100% in 2023 and beyond. Layering these items on the operational guidance results in expected 2023 adjusted EBITDA of $321 million with an EBITDA margin of 16.2%. For adjusted EPS on a pro forma basis, our 2023 guidance is a range of $3.40 to $3.70. From a cadence perspective, we expect quarterly earnings to be generally even through the year. On slide 25, we provide some more specificity about the post separation capital structure of Crane Company, very consistent with our prior commentary. At Separation, Crane Company's only expected debt is a new $300 million term loan. The proceeds from that term loan will be paid to Crane NXT as a dividend and we expect the initial interest rate on the term loan will approximate 6%. The term loan is variable and will be fully pre payable. We also expect to have a new revolving credit facility in the range of $400 million to $500 million undrawn at the time of separation and about $150 million to $200 million of cash. That implied net debt of $100 million to $150 million and a net debt-to-EBITDA ratio of less than 0.5 times. With that balance sheet, and cash generation profile, we very comfortably have more than $1 billion of M&A capacity at the time of separation and $2 billion to $2.5 billion in M&A capacity over the next three years. We will provide more details on our capital allocation policy at our March 9 Investor Day. We do expect that Crane Company will pay a competitive dividend, but the overall priority will be on growth both organically and through acquisitions. For Crane Company, the key message to remember for 2023 and beyond, with this business is that we are well positioned for a post-COVID recovery. Our end markets will see long-term growth driven by favourable secular trends, our investments are driving growth above market rates and given the margin structure of this business, operating leverage should result in segment operating profit growth at twice the rate of sales. Turning to Crane NXT's guidance. Crane NXT has about $1.4 billion in sales and is comprised of the Crane Currency and Crane Payment Innovations businesses. On slide 27, we provide operational guidance in the same format that we did for Crane Company. Overall, we expect 2% to 4% core sales growth and a slight decline in segment profit related to a temporary mix headwind at currency. The underlying assumptions are similar to Crane Company. We expect that the overall economy will continue to slow with only gradual improvement in the supply chain. Starting with CPI, we expect strong mid-single-digit core sales growth of 5% leveraging at 35% with 29% margins. And remember, those margins now exclude non-cash intangible amortization. Total sales growth of 4% includes a 150-basis point headwind from unfavourable foreign exchange. This growth rate is consistent with the historical long-term growth rate of CPI and driven by broad-based strength across verticals, as well as our market outgrowth initiatives. At Crane Currency, we expect flat core sales and a modest decline in margins to a still very impressive 24% roughly 2 times to 3 times the margin rate when we acquired the business in 2018. While there are few moving pieces, the overall story and positioning for the next several years is extremely exciting. The product authentication business is expected to double in 2023, albeit off a base that is still relatively small. An exciting growth business that you'll hear more about in March. The international banknote business is also performing extremely well and we have high confidence in our outlook supported by a strong backlog. On the U.S. side of business, the most recent Federal Reserve Yield Currency Order or YCO, which is publicly available, includes a very wide range of potential U.S. currency printing volumes for 2023. There are a few factors at play. Demand for U.S. banknotes remains very hot and we believe actual demand is aligned with the high-end of the YCO range of -- at $8.6 billion notes. However, the low-end of the range of $4.5 billion notes reflects the minimum amount of Bureau of Engraving and Printing committed to providing. We expect actual production to be somewhere toward the middle of that range. One reason for the large range is that the BEP is allocating production capacity to essential projects, most notably what they referred to as the Catalyst N. This is the redesign of the $10 note is expected to enter production in 2025 with a public release in 2026. The redesigned $10 note is expected to have substantial incremental security content. As we have stated before, while the final selection has been announced, we feel very good about our prospects for securing incremental content on this note given our historical relationship with the Federal Reserve and BEP. Remember, the $10 redesign will be followed by the $50 and the $20 bill later this decade and then eventually the $100 bill. These redesigns are an extremely exciting growth opportunity for Crane Currency over the course of the next several years. Further, the YCO NXT was heavily skewed to the $100 bill over the last two years, relative to the longer-term average, due to extremely high demand for high nomination store of value notes, particularly those for who want the security of U.S. Currency and other countries dealing with high inflation or hyperinflation, [Technical Issues] and COVID-related risks. This year the YCO was skewed towards the lower denomination. Transactional notes as in-person transactions continue to increase in a post-COVID environment. The transient headwind from combination potentially lower the U.S. government volumes in 2023 along with the banknote mix is the driver for our 2023 margin guidance. We are excited about the book of growth prospects, as well as the margin potential for this business as we move into 2024 and beyond. On a total segment basis, pre-corporate margins are expected to be quite resilient at approximately 27%. On slide 28, provide the non-operational elements of Crane NXT guidance. Just like Crane Company, this is being provided on a pro forma basis. [Technical Issues] items presented on a post separation annualized run rate basis include corporate expense of approximately $50 million in 2023 and declining as a percentage of sales thereafter. Net non-operating expense, which is primarily interest expense and related finance costs of approximately $47 million, normal post separation adjusted tax rate of approximately 20% and 2023 diluted shares of approximately $57.3. Similar to Crane Company, we aren't guiding to a specific free cash flow number at this time. Because we have to report first quarter on consolidated basis. We do however expect Crane NXTâs free cash conversion to be approximately 100% on average over time. Total adjusted EBITDA for 2023 is expected to be $364 million, reflecting a 26.8% adjusted EBITDA margin. Pro forma adjusted EPS is expected to be in a range of $3.65 to $3.95. From a cadence perspective, we expect operating earnings in the first quarter to contribute approximately 21% of the full-year. With the balance fairly evenly spread over the remaining three quarters and this is driven by the timing of currency shift. Slide 29 provides some additional details about the executive post separation capital structure. Crane NXT will retain Craneâs existing 2036 and 2048 bonds totalling $545 million. In addition, we expect that Crane NXT will have an initial term loan in the $300 million to $350 million range for total debt of $845 million to $895 million. The existing 2023 bonds will be repaid with the $300 cash dividend NXT will receive from Crane Company at time of separation. We also expect Crane NXT will have a new revolving credit facility in the range of $400 million to $500 million, undrawn at the time of separation and about $200 million to $250 million of cash. The implied net debt is approximately $650 million, which is between 1.5 times to 2 times net debt-to-EBITDA. With Crane NXT's balance sheet and cash generation profile, we expect Crane NXT to have approximately $1 billion in M&A capacity at the time of separation growing more than $2 billion by 2025. We will provide more details on capital allocation policy at the March 9 Investor Day. We do expect that Crane NXT will pay a competitive dividend, but with an overall strategic focus on growth both organically and through M&A. The key message for Crane NXT in 2023 and beyond is that it is a very strong, resilient and durable business with a long track record of delivering mid-single-digit organic growth, driving substantial margin expansion and executing on numerous successful high return acquisitions. Looking forward, NXT will continue to deliver profitable core growth, while leveraging its strong free cash flow to expand into near adjacencies where it can directly leverage its differentiated technology and operational capabilities. Moving to slide 30, we show the walk from our recast 2022 EPS on a like-for-like basis to our 2023 guidance and 2023 guidance combined for NXT and Crane Company. Operationally, Crane Company is guiding to growth of $0.33. Crane NXT for the reasons I just reviewed is seeing a slight operational decline of $0.10 and then we have some known and expected dyssynergies relative to our current structure from post -- excuse me, from post separation corporate costs and interest. Those latter two headwinds corporate and interest costs will continue to decline over time. That was quite a bit to cover, but we really wanted to take the time to clearly explain guidance and assumptions for 2023. Please review our addendum slides in detail and Jason stands ready to assist with any questions after the call. Let's now get on to Q&A. Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first questions come from the line of Matt Summerville with D.A. Davidson. Please proceed with your questions. Thanks. Good morning. Excuse me, a couple of questions. First, on Crane Currency. You talked about just a little bit, but flat core growth, the 17% OP decline, I guess I'm looking at it, $11 million in revenue, operating profit down $23 million. I mean the deleveraging effect there is just more substantial than I would have thought. And I guess I'm just trying to kind of handicap whether or not you're basically assuming sort of a doomâs day sort of scenario. And we've done quite a bit of work on that business and the trends there globally. And I guess so maybe a little bit more upbeat relative to this outlook. If you can maybe help that a little bit. I'll take it, and then others can chime in as well, Matt. First of all, my compliments to you for your January 5 deep-dive Fed '23 print order, that is some incredible research. I would encourage investors to read the level of independent research that you did was -- is absolutely impressive. Look, if you think about where we've been where we are, and of course, the trajectory that we have as we move forward, leading up to COVID, the Fed used to published one number, and they absolutely took that number. Once we went into COVID, they moved into a range. and there was a lot of uncertainty. And we saw that play out in the mix and the mix change. The 100s were much higher than anyone anticipated as a store of value. And the Fed desired more notes than the BEP was even able to produce. Now we're moving into a range that's been somewhat lowered, but still a wide range. And Matt, even in the Fed's print order, this is all very positive news for us for the future, but it just paints a picture of a little bit of uncertainty in exactly how this is going to play out in â23. But when the Fed comes right out and says in their order of verbatim that they're allocating BEP production capacity to essential products to support the U.S. currency program strategic priorities that -- those priorities include producing a new banknote series with the signatures of the new Treasury and Secretary. So, they're absolutely trying to get to the new series, remediating deferred equipment maintenance, completing equipment upgrades, making note production process improvements, installing and validating new equipment and transitioning additional denominations to 50 subject-based sheets to improve efficiency and quality. Additionally, there was a shared Board and BEP support for allocating resources to achieve the planned security feature, that's us and bank note design milestones required to meet the Department of Treasuries announced 2026 issuance date. So, we got production in â25 for the Catalyst 10, which will require production of that note in â25. So, I couldn't have been more pleased with the order the transparency of the Fed, the BEP. We have our planning assumptions. I can tell you that we have very high confidence in our plan. We certainly didn't want to go out with a number that had variability that we were concerned about achieving. If you feel that based on your modelling, things might come in a little stronger that's your prerogative. I think that from a Crane standpoint, I hope that investors understand over our history, we've been incredibly transparent. We have significant credibility we put numbers out there that we feel very confident we're going to achieve and we work like heck to try to overdrive from there. So, I don't know if you guys would have anything. I mean, Max, I think you nailed it. Look, when denominations shift within the U.S. government or even you compare the denominations between the U.S. government and international, it's all about the technology on the notes. And that creates this margin headwind, but it is all about the volumes that Max has highlighted and the mix. And so, in this particular year, because they haven't had the same, it's not only more the low denomination in transactions, but it's also that they need to get back to their destruction rates to get the proper quality of bills in circulation. And so, you see a much heavier weighting to the ones as a bit of a catch-up and that mix, we just naturally have higher content on the $100 bill and higher denominations because of the security features involved versus the one, and that mix just is reading through. I mean it's just -- it is what it is. And with our careful prudent planning, this is -- we feel it's the right guidance to give. Understood. Appreciate all that color, Max. Just as a follow-up, sticking with NXT. Could you give maybe a little bit more of a detailed overview into the demand trends you're seeing with CPI, the major end markets there, retail, gaming, transportation, et cetera, what a little bit more granular outlook might be around that mid-single-digit organic with the end markets? Thank you. Sure, I will. Hey, thanks, Max, and thanks for the question, Matt. So, I think that's where we're very encouraged. As we go through each market and the ones youâve listed obviously are the key end markets for us. We'll start with gaming as an example, we continue to see strength in that market, again, tending to a run rate of high single-digits in terms of demand and a backlog that's growing and that's not just for our core components hardware, but also for the services and the aftermarket connectivity solutions we have in that market that helps us in terms of share of wallet. You take that to retail; we're continuing to see the underlying trend of automation. I'd say that's the, you know, one of the primary threads of that market. That's where I come from in my background and it's extensible here into the CPI business. So again, both on our components, as well as into more of our systems solutions. And as I mentioned in my prepared remarks, Matt, we see Paypod doubling this year and that's our self-checkout solution again on the trends of automation. So again, I'd start to think about that as mid to high-single-digit growth. And then I think broadly, you've got to look at what was done here two years plus ago with Cummins-Allison and expanding into more of a system solution, but that recurring service that comes along. So, we have a high attachment rate on that service thatâs accretive margin above fleet average and that's been very resilient and we continue particularly with deploying our operational excellence programs in CBS into that business to drive margin expansion. And I can tell you from looking at those businesses over the last few weeks, my background years ago in running large sales service businesses there's more margin expansion and more growth inside of that business as well. So very positive. Yes, absolutely and I appreciate all your guys' details -- through details on the guidance and everything. I just wanted to ask you first about Aerospace and Electronics. You mentioned you see yourselves outgrowing the market, but the 10% guidance does seem, kind of, low compared to, I think, more mid-teens to 20% outlook we've seen from some of the other large aerospace suppliers. So, it would be helpful if you could maybe just perhaps reconcile that and elaborate a little bit on how we should be thinking about this $50 million of unmet demand? Yes, Damian, this is Max. I'll take a stab and then let's see Rich or Jason want to add in as well. Very similar comments to currency. Listen, right now, while the supply chain is stable, we are still -- we have extended lead times, and we're still reacting to the odd unpredictable outage here or there. So, we just don't see that significant improvement at all. It's -- outside of Crane, if I think of CPI and some of the electronic components we have there, it's -- lead times are starting to come in, you're starting to see that gradual slow improvement. It's very difficult to predict when A&E will supply chain will see significant improvement. We don't believe that's going to happen in the first six months of this year. As a matter of fact, look, as we triangulate on this, I think we're continuing to be careful, prudent and we're going to absolutely hit these numbers and have the opportunity to deliver upside if supply chain improves. I think what you're going to -- my hypothesis is, as we head into Q2 and Q3, you're going to hear people describe -- they were caught by surprise, because China reopening with COVID and then going right into the Chinese New Year. We're not seeing this in terms of any impact yet or inventory because those longer lead times are being delivered. I think you're going to see a little bit of a lag spike there, while I think long-term, China reopening is incredibly positive for the back half of the year that we're baking in all of the economic uncertainty that we continue to see if the Fed makes the wrong move. So, while the demand is going to continue to be very, very strong, we're being very careful and prudent on the supply chain. We are not seeing significant improvement in A&E yet. We anticipate it to gradually improve in the second half, but that's where our assumptions are. If you believe that supply chain is going to improve significantly faster, I would -- you can model that and make those assumptions, because if we get the supply, we'll be able to deliver. It's really that simple. We don't see any significant capacity constraints if we get it all tomorrow, turning it around immediately will be impossible. But we certainly are not significantly capacity constrained. This is how I think about it in the guidance. I don't know if you have anything. The only thing I would add is that there's nothing unique about our supply chain constraints too, just to make sure that, that's very clear. It's not like we're seeing something very unique to Crane. This is our guidance assumptions based on when we think the supply chain will or will not improve. I think it's important. And I think we're very close to the details. And again, I would hope that investors give us credit for the credibility and transparency that we have historically provided and continued to. Understood. Appreciate your thoughts there. And then I wanted to ask you about corporate expense. I mean it just seems a bit higher than what you had previously communicated. So, what's happening there? And what's your plan to drive that down? Yes. It is higher than our original target. As we continue to build out both teams and this is pros cons separation, it's going to be significant value creation in separating and focusing two new teams, but we have those dyssynergiesâ with corporate costs. When we rolled up our initial estimates, we thought they were good targets as we pulled what is going to be required to support both teams and the growth that we are absolutely focused on. This is how it shook out. Now we didn't want to cut and just to hit the target. We want to staff up appropriately to support the continued transformation for both Crane and NXT. And we believe that we will absolutely grow into that expense line to lower as a percent of sales, that's the plan. That's how we're thinking about it. Thank you. Our next question is coming from the line of Kristine Liwag with Morgan Stanley. Please proceed with your question. Hey, thank you for all the comments, Max, Rich and Aaron, I mean, Rich, I think you deserve a glass of water now. It's a lot to digest here. I thought, I had to try to be there and [indiscernible] I was trying to sneak a sip in here and there. I couldn't get it done. Yes. So maybe first off, Aaron, congratulations on your role. And look, I think this is a hard question. I know you'll provide more details on the upcoming Investor Day, but wanted to get a 30,000-foot view from you. When you kind of look at the past decade as Crane Co. had acquired more payment businesses, we've seen multiple compression for the stock. Now with Crane NXT as a standalone, how do you think about getting the market to put in a higher multiple for the business? What's your strategy for that? And then also a follow-up question to that is, look, if the public market doesn't give a higher multiple to match the quality of businesses in NXT, how do you think about refocusing efforts to cash return to shareholders with a heavy emphasis on buybacks? I mean, ultimately, if the public market doesn't value NXT as it should, does it make sense to be private instead? I could have saved it for the Investor Day, but I was hoping to get a little impatient and get one off here. Yes. Hey, well, first of all, Kristine, thanks for those really nice remarks. I appreciate that quite a bit. And I think you know the answer as you've said we're really focused on telling the story at Investor Day and that's where we're going to be spending a lot of time outlining it. So let me frame it at least how I'm looking at it now to give you some conceptual model to think about how I'm seeing the business to some of the questions you're talking about on compression, but also long-term value to the shareholders. So, I think in any business and I think Crane has done a fantastic job putting together assets that are very strong core businesses. And Max has always talked about how we're starting the separation from a position of strength. I think you can see with the fourth quarter results and where we stand on our cash balances, that's absolutely true in margin profile of the businesses. And my observation is we have very strong healthy businesses with leading market positions mid to, in some cases, high single-digit growth or more in some of those businesses and very healthy backlogs that we're going to execute on going forward in â23 and beyond. And obviously, as Max alluded to and with Matt's question, lumpiness in this currency business in the U.S. government, but a wonderful long-term franchise that's very valuable to us. So strong core business. We want to continue to drive the operational excellence. I can tell you, as I said in my prepared remarks, Kristine, that this is an outstanding culture for CBS execution. And I see that, and we're going to continue to have opportunities and productivity that's going to lead to free cash flow generation. And as Rich said, that's going to be roughly 100% that we're going to put to work, first on growth. So, I think there's opportunities in our core business. We talked about product authentication. That's going to be a theme for us. And I think we feel very confident about that we have defensible moats around that business important technology that's leverageable and one we're going to continue to grow, both in the core currency business, but in new adjacent markets. I think you can also look to automation to the retail market where we're seeing growth in automation of workflows for a whole host of reasons, both in retail, and you can see that in gaming, financial services, et cetera, that's really aligned to secular tailwinds that we want to align in NXT too. And then you can take that further to near adjacencies in our service business, as I alluded to. And fundamentally, technologies that we probably haven't talked a lot about that are quite interesting and what our capabilities are in sensing -- in sensing and harsh environments that are -- where we do cash collection and validation. So, we're really taking a strong effort looking at this for me, my leadership team over the last several weeks and months since I've been a board, we're working with McKinsey to help formulate that strategy, and that's obviously what we're going to be talking about on March 9. And also, what we're going to target in terms of M&A and the discipline around M&A. And I would encourage to look at this history, as Max alluded to, a disciplined M&A deployment, that's a hallmark of Crane. It will continue to be the hallmark of Crane NXT to use our free cash flow to go into markets where we have defensible positions and generate a return to our shareholders and is not speculative, that is not where we will take NXT. And our strategy is coming together that I'm really excited to talk about in March. So let me address the second part of your question on shareholder value and return to shareholders. I think, number one, we start with a growth strategy that we're confident about, excited about, and we want to go execute. That's really job one for us. Certainly, as Rich alluded to, we're going to pay a competitive dividend along that journey. And we want to see that strategy play out. Certainly, over the course of time, we will always be open and look at our and re-evaluate our strategy and a good management team and company does that. But I think priority one is go execute on the growth agenda. And I think we feel very confident. I'm more excited here by the week as I visit our businesses that we have a lot of potential, both in the core and in near adjacencies. So perhaps a little longer answer, Kristine, but I hope you can tell my excitement and look forward to going in deeper in March. Great. Thanks, Aaron. I kind of regret not going to Malta, when I had a chance a few years ago, wish I did that. Great. And maybe as a switching gears, Max and Rich, following up on Process Flow Technologies, core FX-neutral orders were down 3% on the quarter. Can you provide more color on what you're seeing by end markets and how we should think about the outlook for the business, if, in fact, we do see a recession? Yes. Well, look, for the quarter, I would say just generally speaking, we had a good quarter from an orders point of view across PFT, right? When you look at project. We had some good project activity, a couple in Europe, a couple here in North America, China, actually as well. So, there were some just nice projects that did flow through in the quarter. But one I would tell you that we were expecting now whether that was expected to hit in December or January, some of them just happened to hit a little bit earlier, but overall, positive. On the MRO side, I would say that since probably around that October time frame and some of this is seasonally expected where you see that MRO demand tend to decline. We did see that. I would say so far as expected, both in North America and Europe. So absolutely, as we expected. Now the funnel of activities, I would say, is something that we're watching closely and to be cautious and careful about, and that's, frankly, I would say nothing new and all aligned with the way we set up our plans for 2023. So however, we have this backdrop of this wonderful backlog as we enter into 2023. We are seeing this underlying softness just a little bit. And we feel like with the supply chain that's in front of us and being a little bit cautious and careful, while improving slowly, I think the way I would think about our 2023 guidance is prudent as well in terms of how we framed up during our prepared remarks. You mentioned the 3% down that was actually sequential, so year-over-year, it's up 11. FX core neutral FX neutral. Well, it was down sequentially, still very, still very stronger than I anticipated. Yes. The sequential is typical at this point of the year, Kristine, so from Q3 to Q4, we generally do see that slight downtick. But on a year-over-year basis, up double digits. I'm going to re-ask Kristine's question, because it was such a good one. If the market assigns the NXT business relatively low multiple, but it looks like it probably will when these businesses split up. How would it be possible for you to make a better return on capital by making inorganic investments rather than buying your own stock, given that this business is likely to throw off a ton of cash and an analysis of the present value of discounted cash flows should get at a much higher multiple. I don't understand why you wouldn't embark on an aggressive share repurchase campaign under those circumstances? Well, I'll let Aaron take a stab out in a second, too. But I'll place Wager, friendly gentlemen's bet on the post trading range, getting closer to small, mid-industrial technology companies. I think that's what we're going to see, because that really -- when you really look at the underlying technology and margin profile of this business, as we've talked about, it's really quite unique and shouldn't be at that multiple. I think separating it, we hope investors are going to see that. Look, when you go to a stock buyback only, you're really saying that you have no other opportunities to provide value to shareholders other than core growth and just plough all that stock, all that cash back into stock. And I think there are a number of exciting opportunities that will far exceed return than simply stock buyback, if I just look at the economics. But there could be a debate on this and an argument. But that's clearly not the intent as we separate. I don't know, Aaron, if you have any other thoughts on value-creating options between full share buyback versus reinvesting inorganically. Yes. No, I think that's right, Max. I mean when you look at this business, Nathan, in the last few years, we haven't really done a lot of M&A since 2019, effectively. And as we're looking at what's in our funnel, our pipeline where we can add value, we see a rich set of opportunities that are adjacencies to the core, help diversify the business. We think we can go in and add a lot of value, and that's what we're going to be talking about in the -- at the Investor Day of how we diversify. So that really is strategy one, and we want to go after that invest in the core, but allocate to the M&A funnel, that's rich and deep and diversified. Certainly, we'll always take a look as that strategy evolves, but again, I think we have a high confidence we can give value to the shareholders and execute the strategy very well over the coming several years. Thanks for the commentary. Max, you talked about 15% core or FX. Can you give us some more details on price versus cost in the makeup of that? And then what you're looking at for price versus cost in 2023? Yes. So, Nathan, so on the price cost in the quarter you're referring to and the next year, right? Is that what you⦠Yes. So, I mean, in the quarter, we -- what I would say was a little bit different in the quarter relative to the first three quarters is that we saw volume a little bit more materially flips in the other direction in terms of being a contributor across some of the groups, which is a positive thing. Our pricing was, I would say, fairly accretive as well. So not just covering cost, we saw quite a bit of read through on our price, that disciplined cadence that we started a couple of years ago. So just good momentum, price cost, I would say it was accretive to our margin profile overall. Now as we look at next year, I would tell you that our pricing discipline is going to be, of course, intact and similar in terms of our approach. We're properly balancing price with demand. And as we see things shake out, our assumptions for next year, though are that price will continue to offset the cost profile in the business, and that's materials, labor freight and other types of costs that we experienced. It depends on which business, but I would say on the margin, yes, but not as much as what we saw in 2022. Thanks. There are no further questions at this time. I would now like to hand the call back over to Max Mitchell for any closing comments. Super, thank you. On track, exceeding expectations, strong close to 2022, well positioned for 2023 and beyond, another clear inflection point for value creation upon separation. As the late great Brazilian soccer star Pele said, "Success is no accident." It is hard work, perseverance, learning, studying sacrifice and most of all, love of what you are doing or learning to do. We love what we do at Crane and our team's success is no accident. I want to welcome Aaron Saak again, and we both look forward to presenting our new entities post-separation investor thesis to Investors March 9 in New York City. Thank you all, and have a great day. Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.
|
EarningCall_1152
|
Good day, and thank you for standing by. Welcome to the Universal Stainless Fourth Quarter 2022 Conference Call and Webcast. At this time participants are in a listen-only mode. [Operator Instructions]. Please be advised that today's conference call is being recorded. Thank you, Lisa. Good morning. This is June Filingeri of Comm-Partners, and I would also like to welcome you to the Universal Stainless conference call. We are here to discuss the company's fourth quarter 2022 results reported this morning. With us from management are Denny Oates, Chairman, President and Chief Executive Officer; Chris Zimmer, Executive Vice President and Chief Commercial Officer; John Arminas, Vice President and General Counsel; and Steve DiTommaso, Vice President and Chief Financial Officer. Before I turn the call over to management, let me quickly review procedures. After management has made formal remarks, we will take your questions. Our conference operator, Lisa, will instruct you on procedures at that time. Also, please note that in this morning's call, management will make forward-looking statements under the Private Securities Litigation Reform Act of 1995. I would like to remind you of the risks related to these statements, which are more fully described in today's press release and in the company's filings with the Securities and Exchange Commission. With these formalities complete, I would now like to turn the call over to Denny Oates. Denny, we are ready to begin. Thanks, June. Good morning, everyone. Thanks for joining us today. The fourth quarter of 2022 was marked by important top line growth, especially in premium alloy and aerospace products. At the same time, we were challenged by misalignment of surcharges and material costs, several unplanned outages and very difficult weather conditions in December. To summarize the fourth quarter compared to the third quarter, net sales increased 22%, premium alloy sales jumped 69%, aerospace sales rose 27%, order backlog hit a new record high of $288 million. However, our gross margin declined to 4.3% from 6.4% in the third quarter. Let me drill into the fourth quarter positives and negatives, beginning with the positives. Net sales for the quarter rebounded to $56.2 million. The $10 million sequential increase was due to higher shipment volume of $4.4 million and increased all-in pricing of $5.6 million. In addition to the $10 million quarterly increase, sales were up 30% from the same quarter of 2021 and the highest since the first quarter of 2020. Full year 2022 sales increased 30% to $202.1 million versus 2021. Premium alloy sales reached a quarterly record of $13.5 million or 24% of sales, a 92% increase from the fourth quarter of 2021. Full year 2022 sales of $39.2 million increased 48% compared to the full year of 2021. Robust demand in aerospace continues to be the main driver of our growing backlog, which reached a new record high in the fourth quarter. Order entry has remained strong. In other positive news, we are moving forward with our capital project in North Jackson, namely the addition of two additional vacuum arc remelt furnaces to expand our product portfolio with more technologically advanced, higher-margin premium products. The equipment has now been delivered and our goal is to install and commission these furnaces for integration into operations by Q1 of 2024. Additionally, we reached a new three-year collective bargaining agreement with our hourly employees in the Dunkirk facility effective November 1. At year-end, we completed a $7 million lease financing agreement related to the remelt expansion at the North Jackson facility, which increases our financial flexibility going forward. Steve will have more comments on this in his report. Moving to the fourth quarter challenges. The most impactful negative in the fourth quarter was a $2.4 million negative misalignment between surcharges and material costs. Fourth quarter surcharges were at the lowest level of the year due to the broad-based drop in commodity prices, which began late in Q2 and continued through the third quarter. In the fourth quarter, we were shipping products melted earlier in the year when commodity prices were at their 2022 peak. Frigid weather hit our region in December. While our teams are experienced in contending with bitter cold and we took steps to prepare, some of our equipment was not able to withstand in the extreme temperatures. As a result, dealing with localized freezing of pipes and related flooding negatively impacted production and increased maintenance spend. There were several additional unplanned equipment outages beyond those related to weather that occurred at key work centers in December. They would include the Bridgeville hot mill where December operating hours declined by 30% sequentially. The AOD melt shop in Bridgeville were operating hours for the lowest in six months, but output per equipment hour was the highest of the year. In the North Jackson forge, where we lost a warm gear leading to the lowest monthly operating hours of the year. These unplanned outages at our key facilities reduced gross profit by approximately $700,000 in the fourth quarter. Like most manufacturing companies, we have been wrestling with the nationwide labor shortage. On our last call, I reported that applications were increasing, and that trend has continued. Our employee count is now 485, an increase of 50 since the last call or 11%. Our outside contractors have been reduced from -- to 29, which is a 54% reduction. Onboarding and trading of new employees is a major area of focus as the rebuilding of our workforce accelerates. Although improving, supply chain issues, particularly for repair parts, continue to extend turnaround times on maintenance work. And lastly, inflation continues, albeit at a reduced rate. The net result of all these issues was gross margin for the fourth quarter of 2022 declined to $2.4 million or 4.3% of sales compared with $3 million or 6.4% of sales in the third quarter of 2022. The net loss for the quarter was $3.7 million or $0.41 per diluted share versus a net loss of $0.14 in the 2022 third quarter. For full year 2022, the net loss was $8.1 million or $0.90 per diluted share versus a net loss of $800,000 or $0.09 per diluted share for the full year 2021. Recall that 2021 included a gain of $10 million due to forgiveness of a term note from the Paycheck Protection Program. EBITDA for the fourth quarter of 2022 was $1.7 million, while adjusted EBITDA was $2.1 million. A couple of comments on our working capital and financial position. Managed working capital was $145.9 million at year-end 2022 compared with $147.4 million at September 30. Inventory was reduced to $154.2 million versus $158.9 million at the end of the third quarter, reflecting lower raw material on hand as well as supply chain issues have basically lessened and lower material costs flow in through work in process. Total debt on December 31, 2022 was $98.4 million, and Steve will delve into that here in a few minutes. Capital expenditures as reported were $1.1 million in the fourth quarter and $12.1 million for the full year 2022. The strategic vacuum arc furnace investment in North Jackson was the largest contributor. Turning to commodities. As I mentioned, surcharges were at their lowest level in the fourth quarter due to a drop in commodity prices at a time we were shipping products with higher material costs produced earlier in 2022. As a reminder, there is generally a two-month lag time on surcharges and the time between production and shipment production is typically -- between shipment and production typically averages about six months. For products produced in April, for example, the price of scrap was $0.34 a pound, while nickel was priced at $15.10 per pound. By October, scrap had fallen to $0.16 per pound, while nickel had fallen to $9.94 per pound near the lowest level recorded in 2022. And that's basically when the surcharges for the month of December shipments were set. Since then, scrap has continued to trade in the $0.15 to $0.16 per pound range, but nickel has moved back up to $13 per pound and even higher as you look at current pricing. The key takeaway here is that commodities have been volatile. Some are up from early Q4 and a few are down. The current impact on Universal is that our published surcharges for January and February are up 6% to 20% depending upon grade. Material costs and inventory are lower as we sold through first half 2022 production, which will work towards mitigating the material misalignment reported in the fourth quarter as we move through the upcoming months. Let's turn to end markets for a minute, beginning with aerospace, which is our largest market. Aerospace sales represented 74% of fourth quarter sales and totaled $40.1 million. That's up 27% from the third quarter of 2022 and up 56% from the fourth quarter a year ago. Aerospace sales for full year 2022 also demonstrated substantial growth, increasing 50% to $137.5 million or 68% of total 2022 sales. All indicators continue to suggest a multiple year aerospace expansion driven by three factors: first, supply chain activity reflects improving delivery cadence, increased order activity, ramping build rates, lean inventories, all of which point towards positive momentum for 2023 and beyond. Consider Boeing for a minute. Q4 deliveries were 152 planes, best of the year. Full year 2022 deliveries were up 408 [ph] to 480, up from 340 or 41% from 2021. New orders reached 346 planes in the fourth quarter, bringing the 2022 total to 808 planes, up substantially from 2021. Year-end backlog is 4,578 planes, many years of production regardless of your production rate assumptions. Lastly, it was nice to see Boeing book a large 787 Dreamliner order, which supports the thesis of the double-aisle recovery in 2025, which will drive increased metal production in 2024. Turning to Airbus. Airbus delivered 660 commercial aircraft and reported 820 new orders. Airbus deliveries were 8% above 2021. Build rates reflect improvement and continue to reflect the Airbus ramp-up trajectory despite all the problems they've announced and termed as complexity in their operating environment. The second indicator is air travel, which continues to grow and drives a very active aftermarket. IATA reports that total traffic in November 2022 rose 41% compared to November 2021 or 75% of pre-COVID levels. International traffic rose 85% in November. North American carriers reported a 70% increase in air traffic in November versus the previous year. And TSA reports screening 2.4 million passengers on January 2 of this year versus 1.9 million on that date in 2021 and 2.2 million in January 2019. And third, defense spending remains strong and the outlook remains positive. The fiscal 2023 National Defense Authorization Act calls for $817 billion in defense spending, $45 billion more than the present's original budget request. So overall, aerospace demand remains robust. In speaking with our customers, whether structural or in engines, the conversations are about how they will manage through 2025 and beyond to respond to growing demand. The consensus is that there is a strong pull environment that will be sustained for many years to come, which is good news for all of us. In the heavy equipment market, our second largest market, fourth quarter '22 sales were $5.6 million or 10% of our sales, which is 10% lower than the 2022 third quarter and off 38% in the fourth quarter of 2021. Full year 2022 heavy equipment sales totaled $27 million or 13% of sales. Metal fabrication demand drives our sales to the heavy equipment market, especially in automotive. Our sales in the market trended downward over the past year as customers who bought heavy at the end of 2021 remain cautious amid economic concerns and recent trends in key commodity prices. That said, the U.S. auto industry has made a huge commitment to new investment in automotive factories mainly for electric vehicle and battery manufacturing. According to the Nonprofit Center for Automotive Research, a total of $33 billion has been placed in the U.S. for construction of new assembly plants and battery-making facilities through November of 2022. Meanwhile, model changeovers to electric vehicles continues to move quickly. For Universal, our customers are proceeding cautiously in replenishing inventories as we begin 2023, and we expect demand to improve each quarter as we move through the year. The oil and gas end market was our third largest market in the fourth quarter of '22 with sales of $5.3 million or 9% of sales, an increase of 42% from the third quarter and 29% higher than the fourth quarter of 2021. Full year 2022 sales of $18 million were up 19% from 2021. There's a growing consensus supporting increased activity in the oil and gas exploration world based on supply shortages, underinvestment over the past five years and the announced increase in exploration budgets by virtually all the majors. More specifically, the current U.S. Energy Information Administration outlook forecasts that U.S. and other non-OPEC producers outside of Russia will increase oil production by 2.4 million barrels per day in 2023 and an additional 1.1 million barrels per day in 2024 with the largest growth occurring in the U.S. Chevron announced 2023 capital spending of $17 billion, largely focused at the Permian Basin. Schlumberger announced a distinctive new phase in the up cycle in oil and gas, including acceleration of activity in the Middle East, global offshore activity and on land in the U.S. For Universal, given the increasingly bullish sentiment, current supply chain inventories and operating difficulties confronting many European metal suppliers, oil and gas will definitely provide additional opportunities over the next several years. The general industrial market was our fourth largest market in the fourth quarter of 2022 with $3.6 million in sales -- or 6% of total sales, an increase of 59% from 2022. Our general industrial market includes sales to the general manufacturing markets, especially semiconductor equipment and medical markets. On the last call, I said that we expected general industrial sales in the fourth quarter to be the same healthy level as in Q2 and Q3. We clearly exceeded our forecast despite the current low in semiconductor sales reported globally. U.S. companies have pledged $200 billion for chip manufacturing projects in recent years, incentivized by $76 billion in federal subsidies. While I'm sure there will be delays and changes over the next 10 years, we view these trends as positive for our customers and for Universal over the long term. Looking at our first half 2023, we expect general industrial sales to remain very healthy. Power gen market was $1 million or 2% of sales in the fourth quarter, down 33% sequentially and 12% lower than the fourth quarter of 2021. On the other hand, full year power generation sales of $6.1 million were up 32% from 2021. Demand for maintenance and industrial gas turbines used in electricity generation continues to account for most of our power gen sales and there is not being much news of late about new builds and gas turbine manufacturing. GE has announced plans to spin off its gas, wind turbine and energy businesses to a new company in 2024. GE has also noticed and expects the gas market to remain stable over the next 10 years, and that gas will play a key role in any transition to renewable energy sources. While the formation of a new GE company focused on energy may translate to some new build opportunities in coming years, we expect maintenance demand to continue to drive our power generation business for the foreseeable future. Thank you, Denny. Our sales for the fourth quarter were $56.2 million, representing an increase of 22% sequentially and an increase of 30% versus the fourth quarter of 2021. This increase in sales was achieved despite the sequential decrease in raw material surcharges per pound within our selling price and was driven by higher total selling prices, partly from selling a greater mix of our premium product and partly from further base price increase captured during the quarter. Volume was also a contributor as we shipped about one million more pounds in Q4 compared to Q3. We will continue to capture more base price increase within sales as we progress through shipments in each quarter of 2023. Fourth quarter 2022 gross margin totaled $2.4 million or 4.3% of sales, a decrease from 6.4% in the third quarter and 8.7% in the 2021 fourth quarter. The sequential decrease was caused by negative misalignment between our surcharge component of our selling price and material cost of sales as we sold through material that was melted in 2022 at higher melt costs. But we also experienced several unplanned outages, key production units in December, and the impact of our previous liquid metal spill continue to linger, the estimated negative impact on profitability in the fourth quarter due to the related cost impacts from those items was $1.1 million in total. The outages have all been resolved, as Denny mentioned, and the spill negative impact, which is down from $2 million reported in the third quarter. We do not expect any significant spill impact on future periods in 2023. Additionally, Q3 included $0.5 million more of the AMJP grant benefit compared to the current quarter. Selling, general and administrative costs in the third quarter totaled $5.6 million or just under 10% of sales, in line with our expectation. The increase compared with $5.3 million in Q3 was due to the higher cost of business insurance as we renewed our policies in the fourth quarter. The increase versus $4.8 million in the fourth quarter of 2021 was due to the business insurance increase as well as higher employee costs. For the year ended December 31, SG&A expenses were $21.2 million, up about 4.5% in 2022 versus last year. We expect SG&A expenses in the first quarter of 2023 to approximate the fourth quarter of 2022. Our reported operating loss for Q4 was $3.2 million, about $850,000 worse than Q3, which reflects the cost of sales items outlined previously and our higher SG&A expenses, partially offset by our increased sales volume and base selling prices. Total interest expense for the quarter was $1.6 million compared with $1.2 million in Q2 -- in Q3 and about $600,000 in Q4 of last year. Interest expense has risen each quarter this year along with higher market interest rates and higher borrowing levels on our revolving credit facility. The interest paid on the majority of our revolver and term loan is variable and fluctuates with changes to the SOFR benchmark interest rates in our credit agreement. Due to the movement in market rates, our variable rate paid more than doubled from the beginning of the year to the end of the year, and accordingly, our interest expense followed. Our income tax benefit for the year was $2.6 million on a pretax loss of $10.7 million for an annual effective tax rate of 24.5%. The effective tax rate is greater than the federal statutory rate of 21% due to the impact of our research and development tax credits, which increased the income tax benefit for the period. Other elements of the rate calculation are not significant. We recorded an income tax benefit of $1 million on our pretax loss in the quarter, resulting in a Q4 effective tax rate of about 20.5%. Net loss in the fourth quarter was $3.7 million or $0.41 per diluted share. Our fourth quarter EBITDA totaled $1.7 million, bringing our full year 2022 EBITDA to $12.8 million. Our adjusted EBITDA was $2.1 million for the quarter and just under $16 million for the year. Adjusted EBITDA includes add-backs for noncash share compensation expense and other unique items impacting our results for the period, including impacts of our liquid metal spill that occurred in the second quarter and the aviation manufacturing jobs program grant we were awarded during the year. The EBITDA and adjusted EBITDA calculations are provided in the tables for the press release. Now I'll move on to cash flow and debt. We used $2.6 million of cash in our operations in Q4 despite managing our working capital down from Q3 as we reduced raw material inventory levels. Our CapEx decreased to $1.1 million for the fourth quarter, and as a result, we increased total net debt through those activities by $3.7 million. The net debt increase shown on our statement of cash flow primarily reflects incremental revolver borrowings of $4.7 million during the quarter and $1.8 million of cash received at closing of our new lease financing arrangement related to the capital project to expand our vacuum arc remelt facility at our North Jackson, Ohio plant, net of $2 million of cash on our balance sheet and about $750,000 in total payments made on our term loan facility and prior leasing arrangements during the fourth quarter. The new lease arrangement helps fund the remelt expansion project and is effectively a six-year financing lease transaction for $7 million in total. It is structured as a $5.2 million capital lease for the furnaces, plus a $1.8 million sale-leaseback transaction of ancillary equipment purchased for the project. At the conclusion of the arrangement, we own all of the underlying equipment. The $1.8 million as shown on the statement of cash flows as direct proceeds from the sale leaseback component, while the $5.2 million is a lease liability and has a corresponding asset recorded within the property, plant and equipment line on our balance sheet. The total $7 million liability is included within the year-end total debt balance of $98.4 million. The deal helped expand our financial flexibility as we closed the year, and at December 31, we had $2 million of cash on our balance sheet plus about $24 million of total revolver availability. Okay. Thanks, Steve. So let me summarize. In the fourth quarter of 2022, you saw top line growth. Sequentially sales increased 22%, premium alloy sales were up 69%, aerospace sales were up 27%. Solid bookings drove order backlog to a new record of $288 million. However, we had a gross margin problem, came in at $4.3 million versus $6.4 million in the third quarter mainly due to $2.4 million of surcharge and material cost misalignment, unplanned outages at several key facilities and the weather we ran into in December. As we enter 2023, working on our record backlog, all facilities are off and running as Q4 outages have been resolved. Trends in surcharges, commodity prices and material cost and inventory will reduce the misalignment reported in Q4. Momentum is building as we rebuild our workforce. Inflation and supply chain difficulties do continue, but they are improving. The capital project, which will add back in arc remelt furnaces at our North Jackson facility is moving forward. We plan to go operational in the first quarter of next year. All of these factors, coupled with increased selling prices that are already in our backlog, make us optimistic we will deliver improving sales and margin expansion as we move through 2024 -- excuse me, towards 2024. In closing, let me reiterate that our optimism for the future would not be possible without the commitment and relentless effort of all of our employees and the support of our Board. It's because of them that we have been able to continue to overcome unexpected challenges and see the substantial opportunities we have before us. Denny, obviously a lot of moving pieces on margins. Compressed spreads in Q4. Nickel has gone up. You've had a little bit of improvement in ferrous prices as well, and I know that there's some timing lags within the business, as you talked about. But what should we expect in terms of margins in the first quarter? Can we get back to double digits? Or is that something reserved for progression? I think it's reasonable to expect us to approach double digits in the first quarter and go significantly into the double digits as we move through the year. And the reason why I say that, in the short term, as I tried to outline in my script, the misalignment will ease. Our current surcharges in January and February are up fairly significantly based upon the increase in commodity prices during the fourth quarter itself. At the same time, our material costs that will flow into the P&L in the first quarter, have been averaged down through our production in the third and fourth quarter where we had lower raw material costs in our AOD shop. So I expect the misalignment, which is $2.4 million in the fourth quarter, to be significantly reduced in the first quarter. The other factor is base price increases. As you know, we've announced a series of price increases over the last 1.5 years. Those price increases are embedded in our backlog, and we've already booked that. So it's a matter of getting those products produced and shipped out the door, and that will add to the margin accretion. And we have been struggling, as everyone knows, with the labor, the whole labor issue, getting enough people into the plant, trained to ramp up the facility. And I see that improving. We've added 50 people to the workforce since our last call. I would expect to do that again during the first quarter and we'll continue to do that. We probably need somewhere between 50 and 100 additional employees to really get to the point of performance for what we expect in 2024. So the labor shortage is still an issue, but it's something that seems to be breaking. Applications have been up for the last three or four months. And we put a lot of people out in our facilities learning how to make our products and do that safely and efficiently. So it sounds like labor costs creeping up given the fact that you're adding in internal headcount from some of the outsourcing, and then you also mentioned you have a new deal with one of the unions. Is there any other... There are some hourly rate increases, no doubt. I mean, the puts and the takes on the labor front would be higher hourly labor cost per hour, but we'll also be running at higher activity levels, which will give us productivity to offset a portion of that. And the other factor to keep in mind is we've been using contractors. We've had as many as 75 to 85 contractors in our facilities to support production. And as I mentioned, we've been cutting those pretty consistently here for the last couple of months as we bring in employees. So we're down to less than 30 contractors currently, and we would expect that number to be zero here, but as we get into the second quarter. So that's a cost reduction for us. So net of all the contractors rather coming off and then the labor increases but you also have the headcount increases, you think that's going to be -- all as it rolls up, going to be neutral? I think it's going to be neutral to a low single-digit number because the cost increase per hour will be offset by higher activity levels, less contractors. And our workforce is coming up a learning curve, which is intangible, I can't quantify it, but it's there. So as we move through 2023 and people gain experience, the throughput will accelerate, our cost will come down from a productivity standpoint, but the hourly rate that we're paying will go up. Okay. And then on the net working capital side, I think that there was a little bit of reduction in inventory, as you mentioned. That will be, I'm sure, the biggest driver to net working capital. What should we expect on the inventory side in '23? So on the inventory front, just some background on that, if I can use your question to further explain. If you recall in earlier calls, I mean, things were very difficult in the first half of the year and supply chains were very tight. We did buy on the heavy side to make sure that we could run and operate. Those supply chain issues have somewhat eased at this point in time. So as you look at the fourth quarter, we reduced the absolute volume of raw materials, number one. Number two, the price tag on those raw materials in the third and fourth quarter relative to the second quarter and first quarter were down. And then when you look at work in process, as those raw materials that were lower flow into our work in process in the fourth quarter production, the cost per pound and inventory of work in process inventory is down on our AOD products. So that will come out in the first and second quarters of this year. So as you look at inventory, there's -- you're right, there's some moving parts. Our goal is to keep working capital under control and managed very carefully. And we don't see the big ramp in raw material costs in the first half of the year and we see opportunities to reduce our inventory per pound shipped or in other words, increase our turnover in the first half. Okay. That's helpful. And then I was going to ask after the labor piece. Any step-up in contractual consumables in '23? Or anything other than outside of the spares that you mentioned, which are costly? If you look at maintenance spares, we still have supply chain issues in terms of very long lead times by historical standards and very unreliable delivery, which has made maintenance a challenge in terms of fixing things on a timely basis. So that's an operating issue. As far as cost goes, throughout 2022, we saw double-digit increases pretty much in MRO as well as most of our consumables. As we come into 2023, we continue to see inflation. But instead of being up pushing 18% to 20% increases, we saw this time a year ago, we're probably half of that high single digits. There are some standout items like grinding wheels, for example, are up 30% effective with January. That's -- it's a large percent but a small buy in a total picture of things. But I would say, on average, we're looking at high single-digit inflation here as we come into 2023. And then last question, just on interest expense. I think it was $1.5 million. You did have some increase in debt that phased through Q4. And I would assume you're trying to manage the debt in and around current levels, if not bring it down. But what's the interest expense moving forward? Thank you. Interest levels have remained pretty flat the SOFR benchmark rate levels in early January. So if that holds true, we think interest expense in Q1 will be about $1.8 million to $1.9 million in that range. That includes the interest expense on the new lease financing arrangements we went through. Hi, good morning, Denny and everyone. You painted a pretty optimistic picture. The backlog was up. I guess just two brief questions. One, what is the CapEx budget for fiscal '23? We'll come in $16 million to $18 million. And the reason I give you that range is with the supply chain issues we have, it's kind of challenging to really pin that number down. But right now, we're planning on $16 million to $18 million. Okay. Great. That's helpful. And on the debt situation, if everything goes according to plan, and I know that's a big if, where would you anticipate that to be a year from now? I think it's, what, $90 million, $98.4 million? What should we think about for year-end debt levels? The $98.4 million includes the new lease arrangement you're -- just to make that point since that's a change, and I would expect that number to be below $98.4 million. We'll probably have some use of cash in the first half of the year as sales ramp and then flatten out and pay down during the second half of the year. That's the way I would look at our numbers. So you're $98.4 million, somewhere in the $85 million to $90 million range a year from now. Good. Thank you. Could you comment on what your expectations are on volume increases in '23 versus '22 on some basis that you would look at it to get an idea on how much more is going to be flowing through the plant and equipment? Two comments there. In terms of total pounds, you're probably looking at something in the range of 10% with a significant shift in mix towards more premium melted products, which you've already started to see. And the wild card in that volume number is going to be some of our semi-finished products like plate that go into the heavy industrial market. Yes. On that product, that is a shorter lead time product compared to -- so in terms of our backlog, you're talking, I don't know, 6 to 10 weeks of lead time for that product at this point. And we'll be working to reduce that lead time, but that probably is the most economically sensitive part of our business as compared to the aerospace side with all the things you and I hear about on the news and stuff. Some of our customers in that supply chain have been a little cautious recently and managed their inventories down, and you see that reflected in our sales. Our personal view is we will see that improve as we go through 2023, and there is some upside potential there. Okay. Good. And I think that's the main question I had. Just on -- you've made some investments in VIM and VAR to upgrade the metallurgy of your products. How much capacity is added when you put it all together? It was not clear to me. You started probably a year or two years ago when you're complete with this new, I guess, initiative. I guess you mentioned first quarter of '24. How it's gone from A to B? What are A and B in terms of capabilities? Well, if you look at premium melted products, it's -- we invested in North Jackson basically to add that technology to our company. So we didn't have it before. So -- but if you look at what we can do somewhere in the range of 18 million to 20 million pounds of premium melted products would be a capacity number to use. That's production. Yields on those products are typically somewhere in the 55% to 60% range. I would -- let me publicly just to add to that, so I don't want to confuse anybody. When we made that initial investment, we quoted incremental sales revenue from vacuum-induction melted products, which is premium melted products in the range of $105 million to $110 million when we get to 85% of capacity. So we have ways to go there. We had sales of roughly just under $40 million of those products in 2022. And our goal really over the next couple of years is to double that sales volume. To do that, we need some additional remelt furnaces, which is the investment that we've alluded to a couple of times in our call. Yes. Yes, that's -- we've built the building and the equipment just arrived, and we'll be installing the equipment. And then we've got to go through a cold and hot commissioning phase because of the quality of these products, it's not something you just install and turn it on. So our plan is to install that over the rest of the year, get the commissioning done and be ready to hand it over to operations in January 2024. Right. And just the last one, just on that point. What's the premium in pricing per pound versus your standard product, more stainless-related? Generally, you're talking about $7 to $9 range compared to 11% to 15%, would be a good proxy between our specialty and our premium products. [Operator Instructions] There appears to be no more questions in the queue. I would like to turn the call back over to Mr. Oates for concluding remarks. Go ahead, sir. Okay. Thanks, operator. Once again, I want to thank everybody for joining us this morning. I also want to apologize for the frog in my voice. So hopefully, everything came through loud and clear. We are starting the New Year with a high level of optimism and are committed to seizing our market opportunities, especially in aerospace. We're looking forward to updating you on our progress on our next call, which will be in April. In the meantime, be well, stay safe, and have a great day. Thank you. Thank you all for joining today's conference call. This concludes today's event. You may all disconnect, and have a great rest of your day.
|
EarningCall_1153
|
Ladies and gentlemen, thank you for standing by. My name is Brent and I will be your conference operator today. At this time, I would like to welcome everyone to the Lightspeed third quarter 2023 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. Joining me today are JP Chauvet, Lightspeed's Chief Executive Officer; Brandon Nussey, Lightspeed's Chief Operating Officer; and Asha Bakshani, our Chief Financial Officer. After prepared remarks, we will open it up for your questions. We will make forward-looking statements on our call today that are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Certain material factors and assumptions were applied in respect of conclusions, forecasts and projections contained in these statements. We undertake no obligation to update these statements, except as required by law. You should carefully review these factors, assumptions, risks, and uncertainties in our earnings press release issued earlier today, our third quarter 2023 results presentation available on our website, as well as in our filings with US and Canadian securities regulators. Also, our commentary today will include adjusted financial measures, which are non-IFRS measures and ratios. These should be considered as a supplement to, and not a substitute for, IFRS financial measures. Reconciliations between the two can be found in our earnings press release, which is available on our website, on sedar.com and on the SEC's EDGAR system. And finally note that because we report in US dollars, all amounts discussed today are in US dollars unless otherwise indicated. Thank you, Gus. And welcome, everyone. Thank you for joining us this morning. Lightspeed reported another strong quarter today. Our adjusted EBITDA loss of $5.4 million came in better than our expected loss of $9 million. Our revenue of $189 million came in at a higher end of our outlook range of $185 million to $190 million. GTV grew 75%, much higher than our GTV growth of 10%. And on a constant currency basis, GTV grew 17%. I believe our results today reflect Lightspeed's commitment to profitable growth. Part of that commitment is a deliberate effort to pursue larger, more profitable customers. Although customer locations were flat from the previous quarter, we continue to shift towards higher GTV locations. Excluding certain locations, as highlighted in our disclosures, customer locations with over $500,000 in annualized GTV grew by 15% over the same quarter last year and now represent 32% of total locations, up from 29% in the same quarter last year. Customer locations with over $1 million in annualized GTV were our fastest growing cohort, both year-over-year and from the previous quarter, and were up 19% year-over-year. In this quarter, we signed several multi locations in marquee customers, all with our latest flagship offering, including Soletrader, a British shoe retailer that operates 28 locations across the UK adopted our latest Lightspeed retail offering along with Payments; CASETiFY, one of the fastest growing tech accessory brands reaching one in seven millennials chose Lightspeed Retail with payments to power their first Australian flagship store; three Michelin star restaurant, Le Petit Nice, located in [indiscernible], will be adopting Lightspeed' Restaurant and Payments; Moët Hennessy will be using Lightspeed Restaurants in its rollout of one of its initial restaurant projects; The Sky-Line Club, a Chicago fine dining institution delivering world class cuisine since 1926, will adopt Lightspeed Restaurants along with analytics and payments; in our B2B network, we were happy to add Santoni, the high end handmade Italian shoe brand, as well as Gerber child's wear. Earlier this fiscal year, I laid out three priorities for Lightspeed which were, one, to finish the integration of our acquisitions into two core platforms and one company, an effort we referred to as One Lightspeed; two, expand payments across our global customer base; and three, position the company to reach profitability. Two weeks ago, we announced the reorganization that included eliminating approximately 10% of our headcount. The main catalyst for this reorganization was the near completion of our One Lightspeed initiative. As we focused on two flagship offerings, it was always our intention that this initiative would unlock considerable savings for the company. I believe our new structure gives more accountability and authority to our existing senior management team, while at the same time, removing costs and complexity from the organization. Approximately 50% of the cost reduction will come from management roles. Under the new org structure, we expect to streamline our organization to leaner working models, focus on key projects and customers, and continue to invest in our growth drivers. Deciding to reduce headcount is never an easy decision. We are parting ways with many talented and dedicated employees that helped build Lightspeed into the company it is today. But it was a necessary decision that strengthens our foundations for future growth. In terms of Payments, as I mentioned, we had another strong quarter. Although our GPV still heavily depends on North America, we continue to see strong momentum in APAC and EMEA where payments was launched just over a year ago. Before I discuss profitability, I want to touch on the current macroeconomic conditions and how Lightspeed is positioned. Given the macro uncertainty, our focus has turned to running the business with a greater focus on profitability. This includes focusing on attracting the right customers, those with over $500,000 in annualized GTV, and upselling our existing base, reducing operating expenses, and limiting marketing spend to areas with the highest returns. I know that the macro environment is presenting challenges for our customers, but these conditions only highlight the need for complex SMBs to adopt technology. Lightspeed's cloud based platform can help SMBs better manage their inventory, operate with fewer employees, eliminate mundane tasks, deliver data driven insights and give managers and owners more time to dedicate to their customers. Over the last few years, we have been building the most compelling offering for complex SMBs, and I've received very positive feedback from our customers. In my view, we have never had a stronger product market fit. In addition, we have a more agile, cost effective and accountable organizational structure. With costs coming out and accountability increasing, I believe we will be in a better position to address the long term opportunity ahead of us. And finally, we assembled an exceptionally strong management team with the right experience to take us forward. Through a combination of strong internally developed talent and the addition of experienced and distinguished external candidates, we have the right people in the right position to continue to build Lightspeed into the dominant platform for complex SMBs the world over. The macroeconomic conditions will likely present a challenge, but economic cycles come and go. I believe Lightspeed has never been better positioned. Getting back to profitability. In the quarter, we delivered adjusted EBITDA loss ahead of our previously established outlook. And we took the hard, but necessary, decision to reduce our overall headcount and cost base. I believe we are on track to meet our commitment of adjusted EBITDA breakeven or better in fiscal 2024. I'm very proud of the company we are building. Our mission of igniting businesses everywhere in the world is an important one. And our suite of competitive products means we have never been in a stronger position to deliver on this mission. But in the end, profitability is a vital part of building a successful business. And to that end, profitable growth will be the key driving force for the company for the foreseeable future. Thanks, JP. And good morning, everyone. I will first provide an overview of our third quarter results, highlighting in particular our continued focus on operating discipline and profitable growth. Then I will discuss trends we are seeing across our global merchant base and finish with our outlook for the remainder of this fiscal year. Before getting into our third quarter results, I'd like to remind everyone that this quarter's total growth represents organic growth, given that our latest acquisition was made at the very beginning of our third quarter in the prior fiscal year. Now turning to the quarter, Lightspeed delivered another strong quarter with adjusted EBITDA loss ahead of our previously established outlook and revenue of $188.7 million, at the high end of our range, growing 24% from Q3 last year. Subscription and transaction based organic revenue growth was 28% year-over-year on a constant currency basis. Recall that, in Q3 of last year, we received a one-time payment of $5.5 million from one of our payment partners, and in this quarter an additional $3 million from a different partner. When excluding the impact of these one-time catch-ups, subscription and transaction-based revenue grew 31% year-over-year, again, on a constant currency basis. We exceeded our adjusted EBITDA loss outlook, with an adjusted EBITDA loss of $5.4 million, ahead of our previously established outlook of $9 million, our lowest quarterly adjusted EBITDA loss in over two years. As you've heard from us before, we continue to exercise prudence in our spend. The results of this is continuous improvement in operational efficiency, which has been driving better-than-expected EBITDA margin. We're happy with our progress here. Turning more specifically to the market environment. We continue to see the impact of foreign exchange rate, inflation and shifting consumer spending on our merchants businesses. I will walk you through some of the specific trends we're seeing across our customer base. Last year, we saw third quarter GTV grow 124% and 53% organically over the previous year, driven by back to physical shopping and dining in many of our regions. This year, our total GTV in Q3 was $22.4 billion, which grew 10% year-over-year or 17% on a constant currency basis. Omnichannel retail GTV grew by 6% whereas hospitality GTV grew by 16%. In retail, we saw average GTV per location decline in several of our verticals, with bike shops, home improvement and pet stores being particularly weak as these categories spiked during COVID and are now coming back to more normal pre-pandemic levels. Hospitality GTV growth was stronger year-over-year, given the impact of the COVID resurgences in the three-month period ended December 31, 2021, but declined from our previous quarter. Helping to offset this macro weakness is our ongoing rollout of Payments. We are fortunate to have a large customer base that remains underpenetrated with our payment solution. Our payments uptake has resulted in our gross payments volume, growing 75% year-over-year to $3.9 billion. We launched Payments globally in our last fiscal year. And although still early in our rollout, gross payments volume coming from outside North America is up 44% from the prior quarter. Turning to locations, we would like to remind everyone that Lightspeed remains focused on profitable growth. As you heard from JP, given the uncertain environment and the fact that we derive our highest ROI from upselling our base, our go-to-market focus has shifted to prioritizing high value GTV customers from a net new perspective and growing our ARPU within our base, primarily through attaching payments. The result is a quarter where overall net new location count was flat from last quarter, but with larger GTV locations growing within the overall mix. Customers with annual GTV of $500,000 were up 15% year-over-year, and customers with under $200,000 in annualized GTV were our fastest declining cohort, down 4% year-over-year. I think it's worth repeating that not only do larger GTV customers tend to adopt more software and their payments potential is much greater, but they also exhibit less churn. As I mentioned last quarter, customer locations with over $500,000 in annualized GTV represent less than 10% of the churn of our overall base. The higher overall ARPU and lower churn from these customers results in our highest LTV to CAC ratios coming from this customer base. After excluding customer locations attributable to the Ecwid ecommerce standalone product, ARPU continues to trend in the right direction, with total ARPU of $348 increasing 20% year-over-year. The bulk of the ARPU increase came from increased Payments revenue. The headwinds brought on by a strengthening US dollar relative to foreign currencies was most felt in our subscription revenue line, which was flat quarter-over-quarter and grew 13% from the third quarter last year on a constant currency basis. Transaction-based gross margins improved over last quarter, thanks largely to the one-time catchup payment of $3 million from one of our payments partners, as well as to Lightspeed Capital. Our merchant cash advance business is gaining traction with merchants globally, particularly in today's economy where traditional lending institutions are becoming more and more selective with lending smaller businesses. Our Lightspeed Capital revenue grew 26% from the last quarter and 221% from a year ago with our default ratios continuing to remain under 2%. Hardware gross margins continue to bring down overall gross margins as rising costs and supply chain issues continue to drive the cost of our hardware up. We had a goodwill impairment charge in the quarter of $749 million. I'll walk you through the mechanics of this. Goodwill is required to be tested for impairment at least annually. Our annual test date is December 31. Given the decline in the valuations of technology companies broadly, and Lightspeed's share price specifically, our net assets exceeded our market cap at December 31, 2022. This was a goodwill impairment trigger for us. This goodwill charge is a non-cash accounting entry that does not reflect any current or future cash outlay for Lightspeed. We're also prudently managing our share-based compensation expense, and have taken a number of actions to reduce it as a percentage of revenue. Our share-based compensation expense has declined as a percentage of revenue for every consecutive quarter this fiscal year, from 22% in Q1 to 18% in Q3, and with the impact of the recent restructuring, we expect this ratio to decline even further. We ended the quarter with approximately $838 million in cash. Our cash decreased by approximately $24 million in the quarter. The largest uses of cash were working capital movement, including the growth of our merchant cash advance business, which we fund from our own cash balances today. Now turning to our outlook. We expect consumer spending to remain challenged in the near term. And given that our transaction based revenues are now over half of our total revenues, weaker growth of GTV presents a headwind for us in the months ahead. We expect to remain vigilant on spend and to continue to focus on profitable growth. For the full year fiscal 2023, Lightspeed now expects an adjusted EBITDA loss of approximately $37 million, improved from previously established outlook of approximately $40 million. The company now expects annual revenue to come in at the low end of the previously established outlook of $730 million to $740 million, or approximately $740 million to $750 million on a constant currency basis. Thanks, Asha. Before we go into Q&A, I want to welcome a new member to our senior executive team. Kady Srinivasan. Kady is our new Chief Marketing Officer, and comes to us with over 15 years of experience leading marketing efforts at organizations such as Dropbox and Electronic Arts. I'm thrilled to have Kady on our team as we continue to focus on our core customers of complex SMBs, raise our brand awareness and improve our go-to-market momentum. I just had a couple of questions here. Specifically around subscription ARPU being flat over the past several quarters, you kind of touched on it a little bit. But I guess my question is, as you're making this pivot to, obviously, more profitable clients, I'm wondering what the pricing environment is around subscription and to what extent do you have to have discounts to incentivize certain merchants who want to take payments? I think the last phrase you said I think is very much in line, is what we look at is net take rate, which is net payments in that software. And on that front, what we try and do is bundle a package that is going to be just positive for Lightspeed. So when you look at the bigger customers, especially the higher GMV, if I attach payments to the software, you'll realize that the bulk of the revenue on a net take basis is software. So, again, what we try and do is we just try and ensure that we maximize our take rate from when we sell to customers. Just quickly on the EBITDA guidance for 2024, I looked back, it looks like you've tweaked the language a little bit. I think previously it was breakeven. Now it's breakeven or better. But you've got the $25 million now of incremental annualized savings from this workforce reduction. I'm just wondering, are you suggesting that maybe you're more concerned about the top line to just kind of stay in that breakeven or slightly better range or should we be thinking about that $25 million actually potentially falling through as we think about 2024 numbers. The $25 million and the reorg, we had already contemplated that we would unlock operating efficiencies from the integration of our acquisitions when we committed to EBITDA breakeven next year. We do anticipate breakeven or better. We anticipate that that's going to happen somewhere in the mid-range of the year given that, in Q1, we have our in-person sales and partner and customer summit, which does drag down EBITDA. And as you know, Q4 is our seasonally weakest quarter. But we do expect adjusted EBITDA breakeven or better for the full year falling within those two quarters. Thanks for all the color on the customer locations. Just hoping you can help me reconcile your comments regarding larger locations. But if we look at the ex Ecwid locations, those were flat quarter-over-quarter, and then the Ecwid locations actually grew by 1000 quarter-over-quarter. So just wondering if there's some strategic initiatives that still need to be rolled out or whether there was⦠Just wondering if you can just help provide some color on why the Ecwid locations grew sequentially by 1,000 locations, whereas the non-Ecwid locations stayed flat sequentially, whereas you guys are targeting to lap your larger locations. Again, when we look at Ecwid, Ecwid is part of Lightspeed omnichannel. And inside of the omnichannel strategy, we're going after bigger customers, and we're selling them, call it, a channel agnostic platform. So with that in mind, that has an impact when you upsell or you sell to existing customers, that omnichannel platform that creates new stores on Ecwid. So maybe that's one of the reasons. But I think, ultimately, we are focused on attracting the larger and more sophisticated, and that's going to continue, and that's going to be the focus for the company. And that really brings us to profitability. And that's really what's â the key message is profitable growth, as I said. Is it fair to say that when you upsell a brick and mortar store to the omnichannel that one location gets counted for the brick and mortar store and then the other location gets counted for the Ecwid? Look, I think, for the US, it's been very clear. We are going off to the more sophisticated segments, we're going off to the more established segment, we gave a few names here in our script. So again, we are going to be deploying marketing dollars and sales teams to ensure that we attract the customers in a profitable way. And so, we will not be going after the internal market, but after the more established. And on that front, we're happy with the progress. Nice to see the location disclosures. Looking at the $500,000 [Technical Difficulty] are those numbers relatively consistent with what you guys have seen in prior quarters? Do you see any benefits from the shift away from the lower value merchants [Technical Difficulty] more centralized focus on that lead to better win rates [Technical Difficulty]. I think I understood, but we could barely hear. But I'm going to address the question. So we are focusing more and more on the $500,000 and plus and the $1 million and plus. We talked about this at the Investor Day. When you look at LTV over CAC and you look at profitable growth, you have to double down on that segment. So what we've been seeing this quarter, like all the other quarters, is a vast majority of our churn comes from customers that are under $200,000 of GMV. And what we're seeing here, especially with the economic headwinds or difficulties in the economy, the smaller ones are much more prone to churn than the larger customers. So I think, for us, this 15% and 19% growth is very much in line with what we've been seeing all year. And I think it's just a good reflection of our focus on that segment. So, again, yes, this is going to be more and more priority. And I don't know if you remember, but even at the Investor Day, I said, if we have the same number of locations a few years from now, but all of these are within the right segments, Lightspeed will be in a really strong position. And, of course, those are the fastest growing cohorts for Lightspeed. I guess you touched on the One Lightspeed initiatives. Are we actually there yet with the final restructuring announcements you made two weeks ago? Or is that still [Technical Difficulty] in the months ahead and maybe any updates on the benefits you're anticipating to see from that? The question I guess is, with regards to One Lightspeed, and are we on track, and we always said, as we hit the end of the fiscal year, the vast majority of our sales are going to be on the new platforms. We did the restructuring early January because that was the right time because we now have very strong confidence in the product going forward. We are in the final steps of this. We are slightly more advanced with retail than we are with hospitality. But there are still a few little tweaks to do, but we are very much very much on track with what we said. With regards to the expectations here, we are going to see â well, we have seen leverage because now we restructured according to these two products, and we will continue to see leverage, it will just simplify the business everywhere. When you look at acquisition, when you look at onboarding of customers, support calls, it's going to just de facto become a much simpler business because we will be just selling one payment platform globally and one retail platform globally and one hospitality platform globally [indiscernible]. JP, I wonder if you could comment a little bit on sales cycle as you increase your focus, tighten the focus on bigger and more complex merchants and whether or not that's affecting payments attach? Or if the payments attach that kind of stalled out this quarter a little bit as a percent of total volume is more of a macro impact? And I've got a follow-up. Sales cycles, we've always had well understood the sales cycles with the larger segments. We've been doing this forever. I think that's the real â when you look at the real value prop of Lightspeed, we really shine with the more sophisticated SMBs. And we know how to sell, we know how to onboard. So doesn't change much in our sequence on that front. Second piece of the question, attach rates, we are seeing very good attach rates on new customers. And if you look â and I think what gets us excited is attach rates and new customers, even outside of the US, are very strong. So we're not having any difficulties on that front. And maybe just to address the last piece of the question, which is penetration, that is purely a factor of industries and GMV per merchant. As a follow-up, recognizing that nobody's macro crystal ball is particularly clear, it feels like perhaps we're coming to the end of this normalization period that has seen retail, especially in certain verticals, to which Lightspeed oversamples perhaps, get to a point of normalization and maybe start to bottom out, how do you think â I understand you're taking an appropriately conservative approach to guidance, but how do you feel about returning to a more normal sort of consumer spend environment where we could see more balanced growth across your two primary verticals? You're absolutely right. We are taking a conservative approach to guidance, especially given what we saw in the third quarter where you're seeing overall GMV pretty flat versus the quarter before. But we are in a position of strength in terms of focusing on profitable growth. And if and when the macro does turn around, to your point, we're in a position to take advantage of those growth opportunities as they arise. I appreciate the disclosures on the locations by size. I'm just kind of wondering, if we play this forward a couple of years, more or less how much of a change you expect or potentially we could see in the locations with greater than $500k of GMV? Look, again, just talking about a big theme here, the company is focusing on this. Just maybe two years ago, we would probably be much broader in our fishing net with marketing, we would be much broader with sales. And this has changed. So, right now, we are hyper focused when it comes to every function in the company even in our roadmaps to creating more and more value to that segment. That segment is really important to us. And I think it's very important to the SMB space because when you look even at the GMV, the total GMV, it's hyper concentrated into the more established. And so, because we are doing suppliers, we're doing payments, for us, it's just going to continue to be the focus as we go forward. And so, what we are hoping is that as we continue to focus on that segment, we will see the numbers in the segments that matter, do better for lightspeed. I don't know how much more do you want that â again, what is really great for us, and when we look internally, is we are attracting more of the established, we're looking at churn, the churn is decreasing in that front when we look at payments attached. We're now focusing more and more â and even when we're looking at upselling the base, there's a lot of initiatives internally around getting the more established customers. And I think, finally, what you can expect is with what we're doing with suppliers and verticalization here, you can expect us to see better attach rates as we go forward and better close rates because they'll be helped by the brands and suppliers within those industries to sell. So, yeah, feeling good about the strategy and very happy with the results on that front and with the progress with more established merchants. Maybe just a related follow-up. So when you look at really the marketing and advertising budget, has it been fully recalibrated, which I imagine involves a shift from digital and performance more so towards outbound and field sales and that type of thing. Has it been fully recalibrated? Or is that something that we'll continue maybe to shift as we exit fiscal 2023 and go into fiscal 2024? We are in the midst â we just hired a new CMO. And that is probably her number one focus today is to try and recalibrate. Even you'll see updates on the messaging. But I think just to be clear, more established SMB for Lightspeed doesn't mean field sales. The majority of our motion is still going to be in [Technical Difficulty] it's going to be marketing led and the majority of our deals are still going to be closed with Zoom and onboarded with zoom. And I think that's what's very exciting to Lightspeed, is that even though these are much more established merchants and you look at the cohorts and they're much more profitable, the good news is the cost of acquisition is very similar. And most of it is done inbound and with a recipe that we understand very well. Obviously, you can only control what you can control in this environment. But can you talk a little bit about the churn levels on the on the lower end? Is it just what we're seeing now? Is that just kind of â you'd be emphasizing it a little bit or do you see elevated churn coming from the recession already? And how do you see that playing out? I think maybe just overall churn for the company is in line, and so there's no major changes there. But what we are continuing to see, and we started exposing this, is we are seeing very â much higher levels of churn in the lower end and under 200k. That's really â I think if I remember correctly, it was 84% of our churn coming from under $200,000. Whereas if you go up and as you go to the $500,000 plus and the $1 million plus, that's where your churn really becomes almost inexistent. And that's because there is no business failure. If I can just add on that. JP used the fishing net analogy. When that net isn't cast as wide to catch that cohort of customer quite as much as we're now focused less on, you're not replacing that cohort and that churn as much as we would have in the past. So you're seeing it come through a little more, if that makes sense. Makes sense. And then one follow-up on. So, you adjusted the cost base. Now, you're adjusting your program? Like, , how long will it like? What do you anticipate in terms of the impact that will have on the organization in terms of people in the right positions, people in the organization settling down? Is that part of your thinking as well? And when do you think we're kind of done with that? First of all, as you know, we did a big restructure. And the goal of this restructure was to really remove a lot of management, remove a lot of overhead, become much leaner, and also focusing on the right segment of customers. And so, there's a number of initiatives that we now narrow to â okay, now we know this is what we're going after, what are we doing that is not in this segment that makes no sense. What part of our org chart have people working on this segment that is not vital to us. So I think highest level, we are going to be automating as much as possible for our existing smaller customers. And we're going to focus our people, focus our attention on the segments that matter for us. So it is a journey. And we started the journey at the beginning of the year. We are now well progressed with this. But I think in my mind â and then that's the only way forward is to look at where is it profitable, and then you start digging there, and you remove the nice to have and you just focus on the must have, the real answer is there. And so, just a simple example is, if I know that 50% of my customers are the more established, that means instead of having all my support agents just focus on every customer, I'm going to always privilege my highest GMV customers. When leads come in and they are under $200,000 and we know that, well, we will probably actually not even try to serve them and not onboard them. So I think we need to just remain hyper-focused. And as I said, for me, the store counts are not the driver. The drivers is, for every dollar of marketing and every dollar of spend, what is my return? That's the only way forward. So, as we go forward, we're hoping to get better and better numbers in the more established and we're hoping that the entire company is just going to be focused on that. Just wanted to come back to on macro headwinds for a minute. Can you elaborate a little bit on the sources of the headwind. I can think of kind of two types, right? One is a normalization, which I think was already mentioned. So kind of the bike shop example. And the other is more is more fundamental weakness in consumer spending that might be related to kind of recessionary environment. Can you elaborate a little bit? You think both of those or is it more one versus the other? It is really both of those. You're right about the COVID, the COVID normalization. But we're also seeing, with rising interest rates and inflation, just consumer spending is shifting, shifting to groceries, gasoline, things that are not in our core verticals. And in addition to that, we're also seeing some FX headwinds about almost half of our customer locations are outside the US. And so, that revenue is worth less in US dollars. And so, outside of what you mentioned, I would say those would be the other two headwinds that we're seeing. Related question, I wanted to ask about Lightspeed Capital, which you highlighted again, and sounds like doing very well. So, yeah, maybe you can elaborate a little bit on the traction you seeing there and also in the more challenging economic environment, obviously, a product like that could be a little trickier. So I would love to hear your philosophy on how are you managing that through that kind of potential recessionary risk? Capital continues to go well. Revenue, I think, something better than 200% this quarter. Advances, we continue to make it available to a broader base of our customers. And that advanced volume has been increasing as well. So far, so good on losses remaining minimal for us as well. So we're seeing great returns there. The benefit we have, of course, and the impact of the macro is not something we consider and we factor in. As we see all the trends on a daily basis from our customer base and that informs the offers we extend from the merchant cash advance, because we have that line of sight and that visibility into these trends, we can make what we think are pretty far and good decisions on who to advance to and how much. With respect to becoming cash flow positive, perhaps as we think about timing, you said profitability should be middle of fiscal 2024. Just given the working capital dynamic, should we think about cash flow being positive maybe a couple quarters after or how should we think about that? For now, we're focused on adjusted EBITDA breakeven or better. We do manage our cash flows from operations very closely. But as Brandon just talked about, our merchant cash advance business is growing, and we are funding that from our own cash balances. And so, as we see that business growing, we should expect to see cash from ops out of line with our adjusted EBITDA. As that business grows larger and larger, we are considering putting that off our balance sheet, but in the interim, while it's on our balance sheet, we wouldn't expect cash from ops to be breakeven. Any update in terms of monetizing the supplier network, such as with B2B payments? Will that be sort of the next focus now that you've launched the unified retail and hospitality platforms or how should we think about that? Yeah, you're exactly right. So we are investing a lot in our B2B network. We do believe that's going to be the moat as we go forward, and going into the verticals, working with the suppliers, ensuring that suppliers get the sell through from the network. So that's a big piece of our strategy. But you're absolutely right. When you look at the sequences for us, the number one sequence was to get one product globally, which is Lightspeed Retail X-Series integrating all of the greatest of ecom and omnichannel workflows. And so, that now is out, or will be fully out by the end of this fiscal year. Then the next step now, and we have a lot of initiatives, and we'll be announcing a lot on that front, we have now the B2B team working in conjunction with this launch to now create value for the suppliers. We have a number of beta customers on suppliers and everyday we're continuing to improve this. Next fiscal year, we'll be coming out with a lot of announcements on this and progress with suppliers within the industries that matter for us. I know that the inbound sales and virtual sales will remain the most important and dominant. I was wondering what the update is on the size and productivity of the outbound sales force. And I guess, more broadly, just the update on the go-to-market in US restaurants. Maybe just again being clear, the outbound is well, we progress well, we've hired a lot of people. And we are tracking very carefully LTV over CAC. And here in our mind, we are going to use a lot of the outbound for the more established because that's where we can afford to have that sequence. And we're happy there with what we're doing. And I think as we go forward, especially in the context of payments, especially in the context of geographical areas where we have a lot of concentration, cities basically around the world, we will have teams that are going to be upselling customers on payments and installing customers with a pure outbound motion. Now with regards to X-Series â sorry, K-Series and hospitality. We're very pleased with the progress. We've signed a few really good marquee customers in the US. And that motion is going well. And again, for us, just being very clear, we are optimizing every dollar we spend. And that's the theme. And so, again, being very focused on hospitality on the more established, those that really find the value â I think a lot of you have seen the progress we did on that product, it's absolutely outstanding, but it is very well suited for established merchants. And so, like all the other divisions at Lightspeed, coffee shops, small/medium/large coffees, quick serve is not what we're going to be focusing on. We're going to be focusing on fine dining, table service, Michelin stars, because those are high GMV customers and give us really good unit economics. On hardware, I know it's not a super important part of the financial statements, but the decline in hardware, was that also a function of discounting just related to payments attach and sort of how you think about everything altogether, or more reflective of new location additions or just a change in customer behavior? Yeah, you're absolutely right. It's really a result of the discounting, particularly in North America hospitality, where that's what the customer base has come to expect, given the competitive environment there. But as JP mentioned, we're laser focused on LTV to CAC and unit economics on a customer by customer basis. And these discounts are worth in the end for us because the LTV to CAC ratios of those customers, which as you know is the larger, more established, the LTV to CAC ratios are very high. And so, it makes sense for us, even though it requires discounting, that hits our P&L and immediately. First is, JP, what was the most meaningful change to you in the business environment since last quarter with all this discussion of the macro? I'm trying to get a sense of whether Q3 was really a continuation of the same trends we've been talking about for previous quarters or if there was really a change here that makes your view of the business environment worse or an improvement potentially? So I'd love to get your thoughts there. Look, that's why in my mind, I distinguish what we can control versus what we can't control. And on what we can't control, the biggest driver â and I'm just going to try and give you a few numbers that are in my mind. Last year, if you look at GTV growth from Q1 to Q3, it was about 25%. And if you look at this year, GMV growth from Q1 to Q3 was zero. We were $22 billion, $22 billion, $22 billion. So I think just there, this is for me the biggest headwind that is not related to Lightspeed is just spending is not what it was. And so you compare to last year, 25% growth on two quarters versus this year flat, there's not much you can do against that. And so, I think, for me, the macro is confirming that our strategy is the right one, the strategy of profitable growth is the right one, the strategy on focusing on the larger customers is the right one because that's how we've been pairing well in a market that's been very difficult when you look at the consumer spend. And I think that's why I look at the â it is a tough year for restauranters and retailers, no doubt, when you look at GMV globally. Yet, we can help them. And so that's why we're focusing on the higher GMV merchants and doing everything we can to help them automate and do more with less. I think that's the main answer. Just a follow up, as we think through the implied guide for Q4, Asha, could you just help us think through the different offsets? I think you mentioned a catch up payment. There's a currency headwind here. And so, when you think about the items that would grow sequentially versus being flat and potentially offsets, that mean that the underlying growth may be up sequentially, but the reported number maybe still flat. Could you help us think through the factors there to consider? The one time, as you mentioned, is something that we saw in Q3. That was about a $3 million one-time catch-up from a payment processor, which we don't see in Q4. But I think what's also important to keep in mind is that Q4 is seasonally our weakest quarter. And even in years where there are no macro headwinds, we typically see about a 20% decline from Q3 to Q4 in overall GMV. And so, as we enter our seasonally slowest quarter of the year, that's what we're contemplating in terms of the Q4 guidance. We expect FX to remain around the same in terms of Q3 levels. But I think it's really more the GMV decline and the one time, those are the two biggest items that we're expecting to affect the sequential Q3 to Q4 revenue. As you sort of move up market with these larger merchants, like how's the competitive environment changed with respect to how you sort of go after those markets? I think that's the good news. And that's why store count is growing well. And as you go up, there's fewer competition. And I'm just going to give you a few examples here. If I'm a coffee shop, I have no real value in understanding Lightspeed's analytics that gives you a magic quadrant of your menu items. Yet, if I'm a Michelin Star, I see tons of value in this. If I'm a retailer and there's no value in our advanced analytics if you're only selling a couple of 100 SKUs, yet if I have 10,000 SKUs, that's where I see. So I think as we go up market, to simply answering the question, it is a much better landscape for us where we provide a ton of value to customers. In terms of capital allocation, clearly, you're focused on sort of efficiency here. You sort of look at the stock and you sort of look at your cash balance, it's just under $1 billion, would you ever sort of consider kind of a buyback program? It seems that as you get more efficient and you approach breakeven, that cash will get a bit of release. So what's your thinking on that, especially given where the stock â where it is today here? It's something we continue to evaluate, the board of directors, obviously. We certainly still feel like we're early in the journey here. We've got a growing part of our business on the merchant cash advance program that we're leaning into, lots of growth opportunities, we still see, and hopefully, the macro environment will start to solidify at some point. These economic cycles do come and go. So, to date, we haven't concluded to do anything specific there. But we will continue to evaluate it. Wanted to ask a question on payment attach rates. Doing the math, it looks like it's about flat quarter-over-quarter. Is that right? And I guess kind of thinking forward, how should we be thinking about payment attach rates over the next several quarters in a presumably tougher macro environment? Payment attach rates, when we speak to those, that means how many â what percentage of our new customers take payments alongside the software when they buy it. I think, based on your question, what you're probably referring to is how much of our GTV do we monetize through our GPV? And that continues to progress well for us. A lot goes into the equation when you divide those two numbers, a lot of mix things, both geographically and how specific verticals are performing at any given quarter. So you just have to be â there's a lot of variability that goes into that when you start to divide those two numbers. Overall, what we focus on is our GPV and is it growing. And it's up 75% year-over-year which is good, steady progress from our standpoint, and we'll work hard to keep that going in the right direction. Just one follow-up here, if I may. When I look at the headcount reduction and the $25 million in annual savings, 300 people being affected, roughly shakes out to about $83,000 per employee. So with the prior commentary of 50% coming from managers of the headcount reduction, I was just looking for some more color maybe to reconcile the profile, the remaining 50%, what departments were affected there. I'm going to paint the story, just so we can understand it. If I'm selling seven products across multiple regions and each of these products I'm selling have many layers, have contributors, have managers, and then at the top, I probably have somebody accountable for this globally. And so when you go from, call it, seven to two, which is what we're preparing to go for, as we go into the end of this fiscal year, you naturally just have layers of people in all groups that have been removed from the organization or replaced. And at the top, that means you need fewer leaders to run the business, and you have more accountability with fewer leaders and way less distortion in terms of focus points. So that's really what happened. So I think just answering your question is, like, it is â yeah, unfortunately, contributors, managers, directors, VPs, Cs â so there's a just a simplification of the business that impacts pretty much everybody. But I think, for us, now that we are in a much leaner organization, we now need to double down on hiring more sales people, on hiring more onboarders and hiring more support people in the right divisions in the right geographies. And so, that's what we're doing now, is we're â between now and, call it, the end of Q1 next year, we're building our go-to-market engine. We're building all the functions to double down on what matters now for Lightspeed. I know we touched on this a little bit, but it is a really important idiosyncratic driver for the company, that payments penetration, but specific to the attach, meaning for new customers. So I know that we talked about this a little earlier in terms of some of the promotions that you've been doing, I believe those started two or three quarters ago. Could you just talk about what that has done to the payments attach? In other words, how much success it has driven? Meaning if the new customer attach for payments used to be X percent, how many points higher has it been as a result of these promotions? Do you can expect to continue to offer these given maybe some success that you've seen or have not seen? I think there's two things in my mind when you look at these promotions. They have two objectives. The first objective was to attach more new customers to Payments. And the second objective was to reduce time to transact because you understand that the new economics for us is â or previously, when it was just software, I sign a customer, I started recognizing revenues. Now what happens is, I sign a customer, I get the revenues on software, but I don't get the kick in on payments before they are transactional. And so here, a lot of those promotions were really related to getting the customers transactional. So if I tell the customer within their first three months, you're getting a better rate, that's going to give them an incentive to get the payment terminal up and running, plugged in, et cetera, as quickly as possible, which in returns for Lightspeed will give us a faster revenue recognition on â and so that will decrease greatly your payback. So, on that front, maybe just again, looking at the two blocks, they've had a really good impact. And that's why I think, for us, especially in markets outside of the US that are much more conservative in terms of adopting payments, we were very happy because these promotions have created attach rates for Lightspeed everywhere in the world, from Australia, to Europe, to any country in Europe to the US, where we have very strong attach rates on new customers. And that's why, for me, when I look at it medium term and you look at how churn works in our cohorts, just assuring that you have the majority of your new customers that are buying payments, means that, over time, you're going to end up with 50% of your â at least 50% of your GMV that is on Lightspeed Payments â your GPV, sorry. And so, that's why we're very happy with both. And the promotions really had a very strong impact on time to transact. And actually, this is still the number one focus in the company, is removing the backlog between when someone signs and someone becomes transactional. And I think they're â going back to the first question we had on the call, we will be probably also for the larger customers doubling down with people with foot on ground that are actually going to physically go in and plug the terminal in because it is a world where our customers have a number of priorities and you've got to get them to plug in the terminal, make it work, et cetera. And so, we're doing everything we can to reduce time to transact. That's really helpful on the time to transact. The follow-up is around payments penetration. You mentioned earlier that some of the sort of flat quarter-over-quarter and part of that was just related to the verticals that might have higher or lower payments penetration. Maybe you could just recap what those verticals were in the calendar Q4 and how that might change over the coming quarters. Clearly, golf is one, right, that's more seasonal, but also, correct me if I'm wrong, but US retail was one of the earlier parts of the business to get Lightspeed Payments and I would have expected the Q4 US retail to have stronger volumes just due to holiday season, et cetera. But maybe just recap some of those various industries that are higher and lower and how that will look over the coming quarters. It just comes back to the messages we've kind of outlined earlier. We're well penetrated in some of our strongest verticals, like bike shops and sporting goods stores and things of that nature. And you're absolutely right that, typically, during the holiday season, we see a nice bump there. As you heard from Asha earlier and JP earlier as well, this holiday season for those verticals, due to, A, normalization off of COVID and, B, weaker consumer spending just didn't have the bump that we will typically see. And that just all contributes to that mix thing when you're doing that math, Tim, of dividing GPV into GTV. So that's the macro again. As JP said, we focus on what we can control and unfortunately consumer spending isn't one of them right now. So if I heard that right, it's more or less â yes, calendar Q4 actually would have a better mix of payments penetration, but it was more just that those verticals with the higher penetration maybe were a little bit macro impacted and that left us with the overall number in that 17% range. Thank you, Brian. Okay, thanks, everybody, for joining us today. We will speak to you all again after we release our Q4 results. And have a great day.
|
EarningCall_1154
|
Good day, everyone. And welcome to the RBB Bancorp Earnings Conference Call for the Fourth Quarter 2022. At this time, all participants are placed on a listen-only mode and the floor will be open for questions and comments after the presentation. Please note that todayâs event is being recorded. It is now my pleasure to turn the call over to your host, Ms. Catherine Wei. Maâam, the floor is yours. Thank you. Good day, everyone. And thank you for joining us to discuss RBB Bancorpâs financial results for the fourth quarter of 2022. With me today are President, CEO and CFO, David Morris; SVP and Chief Accounting Officer, Shalom Chang; EVP and Chief Administrative Officer, Gary Fan; EVP and Chief Risk Officer, Vincent Liu; and EVP and Chief Credit Officer, Jeffrey Yeh. David will provide a brief summary of the results, which can be found in the earnings press release that is available on our Investor Relations website and then we will open up the call to your questions. During this conference call, statements made by management may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based upon specific assumptions that may or may not prove correct. Forward-looking statements are also subject to known and unknown risks and uncertainties and other factors relating to RBB Bancorpâs operations and business environment, all of which are difficult to predict and many of which are beyond the control of the company. For a detailed discussion of these risks and uncertainties, please refer to the documents the company has filed with the SEC. If any of these uncertainties materialize or any of these assumptions prove incorrect, RBB Bancorpâs results could differ materially from its expectations as set forth in these statements. The company assumes no obligation to update such forward-looking statements unless required by law. Thank you, Catherine. Good day, everyone, and thank you for joining us today. Loan growth increasing loan yields and declining expenses drove record fourth quarter and 2022 results, with quarterly net income of $17.6 million and earnings per share of $0.92, and an annual net income of $64.3 million and earnings per share of $3.33. Net interest income for the quarter was stable at $39 million as the positive impact of loan growth and increase in yields was offset by sharply higher deposit costs. Fourth quarter noninterest income of $2.4 million was down slightly from the third quarter due to lower loan sales and servicing fees. A $3.6 million decrease in net interest expenses from last quarter was primarily attributable to bonus reversal of $2 million and lower loan origination commissions of about $6 million, sorry, $5 million -- $500,000 as new compensation guidelines took effect. Basically, the team, myself included, miss Board established goals on deposit gathering and loan originations and our compensation was affected as a result. Fourth quarter net interest margin of 4.26% was down slightly from last quarter but up from 3.43% a year ago. We remain cautiously optimistic that we will be able to maintain our NIM around 4 in the first quarter, but expect that it will likely -- that it likely peaked in the third quarter of last year. Annualized return on average asset and return of total common equity were 1.8% and 14.59%, respectively, in the fourth quarter. Net loans held for investments increased by about $111 million to $3.3 billion in the fourth quarter and CRE and residential mortgages showing good growth and construction and other decreasing for the last quarter. Our yield on average earning assets increased to 5.75% in the fourth quarter, which was a 62 basis point increase from last quarter and 178 basis point increase from the prior year. Continued commercial customer activity and rising rates drove $108 million decrease in average non-interest-bearing deposits over the quarter. Our average cost of interest-bearing deposits for the quarter was 1.93%, which was up 111 basis points from the prior quarter as the expected catch up in deposit costs materialized. We continue to be below our competitors on deposit pricing, but have been forced to increase rates to retain deposits. Non-performing loans were stable at $11.5 million from last quarter and loans 30 days to 89 days past due returned to a normalized level after a temporary increase in the third quarter. Subsequent to our adoption of CECL, we recorded a provision for credit loss of $3 million in the fourth quarter of 2022, compared to $1.8 million in the third quarter of 2022. We also recorded a reversal of provision for off-balance sheet commitments of $930,000 in the fourth quarter of 2022, compared to a reversal of $28,000 in the third quarter of 2022. Our capital levels remain strong with all of our capital ratios well above regulatory minimums. We purchased 49,000 shares in the fourth quarter at an average price of $20.77. We have 433,000 shares left on the buyback. Finally, we are saddened by the tragic loss of life in the three recent shootings in California, including the one last Saturday in Monterrey Park. All of our employees are safe, but are understandably upset by such a horrific event that occurred so close to one of our branches. In response to this tragedy, we made a $20,000 donation to Asian Pacific Community Fund, of which 100% of the donation will be going to victims families in an effort to help the community recover. Thank you. Thanks for the question. Can start off with expenses, you noted in your prepared remarks that there was some reversals in there. Just trying to get a sense of what actually fell out of the run rate, as well as whatâs a good kind of go-forward outlook and starting point given the movement that occurred this quarter? Our policies to accrue -- has been to accrue at 6% of pre-tax and pre -- and pre-tax bank earnings. We are changing that to accruals to pre-tax Bancorp earnings right now. But really changed is the amount that we have conformed our bonus structure to that of our peers. So for example, I am eligible to get received up to a 150% of my salary versus before the President and CEO was eligible to get 2.5% of our pre-tax earnings. So that is really the biggest number there and thatâs the biggest change, okay. I donât -- 2.5% of our pre-tax earnings would have been like $2.5 million for me. So that would just not -- but thatâs not 1.5 times my salary, okay. Got it. Thanks for the help. Just trying to understand how that ties into the go-forward run rate. It seems like there is this reversal perhaps in 4Q for what⦠⦠was the crude on a go-forward basis, if we were to kind of back out how the reversal, maybe thatâs a different way of asking what a number we can build off of, because $13 million after the prior three quarters feels low, but again, you also had the wrap-up of the investigations and things like that. So I am just trying to understand when you take out kind of reversals in 4Q, what would be more normal had you have been accruing under how you anticipate to do so going forward? So, I think, again, if you look at it in the way that I have -- I still have a couple of positions open that are going to be executive level and they will be getting, again, there are going to be additional bonuses next year, not the full amount of the $2 million, but certainly, possibly significant dollars and taking us up to the holding company level instead of the bank level of pre-tax income. I think you will -- we will get a very much closer number for what we will actually spend, okay, because we base our bonuses on Bancorp numbers in all. As far as the legal expense is concerned, this year, I think, you will have significant -- we will have less expense to the tune of up -- well, our legal is going to go down, but our auditing expense is going to go up, because we went accrual, who was significantly more expensive than our -- than EV is. So I do think legal will be going down, not quite sure, okay, we put all of that here. I am just checking some numbers. Yes, those fees should be going down by a couple of million dollars actually on an annualized basis, okay? Got it. Thatâs helpful. Maybe last for me and then I will step back and let some more into the queue, but just wanted to ask on the deposit side. Thereâs been some pressure on non-interest-bearing over the past year after increases during COVID. I am wondering kind of the cadence of deposit flows when you anticipate to starting to slow down and it looks like the gap was funded with time deposits, was any of that brokered funding? Just any color as to the cadence of mix shift and⦠Okay. Our biggest issue has been, we have these couple of trust accounts, which I have talked about in the past, which we asked to have moved last year December had about $550 million with us and we asked them to move it down between $250 million and $300 million, of which they did. But one of them is a crypto company exchange and that went again with crypto winner from $250 million down to 1 -- approximately, I mean, $150 million at the end of the third quarter and then in the fourth quarter, we decided to have one of the customers we sub -- one of our -- the sub customers. We had a discussion that I didnât really like that customer and two weeks later, they moved that customer out of our book, we went from $150 million down to $25 million, okay? So thatâs the big issue with the demand deposits. $300 million was planned to go off, then we had the crypto winner with the one that went from $250 million to $150 million and then we asked -- we are still banking this customer, we asked that one big customer, we didnât really like them and we asked them to move away, okay? And that is not FDX or anybody else thatâs headlined in the news, just so that you know. Got it. Thatâs helpful, David. If I could just sneak in a follow-up to that real quickly. Those are quite large accounts. Just wondering now that you have taken those levels down, what is -- any color as to kind of what the largest account sizes are at the bank? I am not sure if you want to frame it as top 10 accounts or however you look at it, but just curious as to any⦠Yeah. We have -- our policy now is no customer over $100 million, okay. No single customer. Well, when I say single, single relationship over $100 million with the bank anymore, okay? And we do have some⦠⦠we have most of our high are -- most of our people that have deposits over $25 million are either directors or former directors or also our former Presidents of banks that who left companies of banks that we have purchased, okay. So when you look at that, we have a good number, we have retained a good number of the deposits from the either the chairperson or the President of the banks that we have purchased in the LA region, okay. Good. I just wanted to make sure I heard your NIM commentary correctly. You are expecting a 4% in the first quarter and do you have any color on that -- on the trajectory throughout the year or just sense of magnitude at this point? I think our NIM will contingent as -- I think the history of rates going up and up and up has ceased. So most of our competitors are in the 4.25% range on CDs. For us to attract CDs we have to be around 4%, okay, about 4%. So you are going to see everything re-price to about 4% if we want to retain those depositors, okay, for the remainder of the year. So I think you are going to see over the next quarters our NIM going down even though rates may go up still 75 basis points, I donât think the deposit rates are going to continue to go up as much. I may be wrong with that, because they are supposed to be -- they havenât really with the last rate increase at an increase, okay. The community priced everything starting September and early October at 4%, 4.25%, 4.5%, 4.75%. Thatâs where they have been people have been pricing stuff. So we have has taken a conscious effort to keep everything between 4% and 4.25%, okay. So can you give me a sense for -- at this point, obviously, a lot can change and itâs a wildcard, but what are your thoughts kind of in the middle of the year? Do you think the magnitude starts to slow down in terms of the cost increases on the liability side or just any sort of quantification would help there? Well, I think, like I said, I said about 4% first quarter, we are optimistic on that. The second quarter, I think, will be around 3.75%. I think it will be about 25 bps for the next couple of quarters, okay. Thatâs helpful. Okay. Thank you. And then in light of your capital position and valuation, are you expecting a more forceful repurchase activity over the course of the year relative to 2022? Just a follow-up on the deposit cost questions there. What were or what was your spot rate on deposits at the end of December? If we kind of flip to the loan side and the borrower side of the equation, what kind of commentary are you hearing from them? Is it more related to rates or is it just more economic outlook thatâs given the many kind of hesitation? Well, everybody that has a floating rate loan wants to try to fix it at 7.5%, which we are not doing and if they pay off the loan, we get the prepayment fee. So loans in general commercial lending has slowed down greatly, okay, in the last two months, greatly in the last two months and I think itâs all rate driven. Okay. Okay. And then whatâs the -- I mean how should we think about the efficiency ratio going forward? It seems like itâs got the possibility to break above 40, but does it hit 45? I havenât done any modeling of that, Tim. I think we will be -- I havenât done any modeling so I canât answer that question on that. Okay. Okay. And then, sorry if I missed this, I might have already been asked, but do you have any sense of where your non-interest-bearing deposits as a percentage of total deposits might exit this year at? I think our non-interest-bearing deposits regard. I think the run-off has happened for us. I mean we still have some customers who want to go, everybody wants once their DDAs to become interest, but when you are a business thatâs kind of hard to do because you need to have the cash flow and we are still a bank that require -- follows Reg D on all the interest-bearing stuff. So we still count six transactions. So I think itâs going to be relatively the same. Oh! Good morning. I guess [inaudible]. I apologize just if itâs belaboring the point on expenses, but kind of that gives puts and takes here, is it fair to say once you have the hires excluding gateway into the fold, something around 16 per quarter as a good run rate throughout the rest of the year, so 32.64 total on the year or am I thinking about it incorrectly? Okay. Yeah. Thatâs fair. Okay. I had pretty close. I am sorry. Itâs just a lot of puts and takes, so forgive me on that. And then kind of just more diligence perspective, just sort of curiosity, do you have any other crypto related clients either lending or deposits? Well, we only have the two. The one is active. The other one is in CDs. So we donât worry about it, okay. Got you. And then my last question is kind of more of a philosophical a 10,000-foot view. You just said that lending demand has come down and overall customer deposit rates have continued to go up. Is there any source of new deposit kind of initiatives that could be used rather than going to market at a high CD rate? I am just -- I know you are not going to have as much loan demand to match again, so just curious if thereâs different avenues of funding outside of CD or broker deposits. . Well, we hired Gary. One of the things heâs going to do is take over the New York regions and we have a lot of interesting thoughts on different things that we could try. So thatâs wonât really see much of that probably until the third quarter or fourth quarter of this year, but we are going to implement a lot of things in New York that may be slightly different than what we do here in California. At least I think here in California, we are a completely a relationship bank and once you contact all your relationships you only grow as your relationships grow. So we could bought -- bring in additional relationship officers to help grow faster here in California and so forth also. But that would be adding to the expense side and/or we would have to reallocate headcount to do such, okay. Yeah. We have things in our strategic plan that we are looking at, but we are not ready to announce any of those things at this time. So there are some things that we are planning to do that could really help on the deposit side. And one of them⦠Well, one of them I could tell you is we donât really do C&I variable and we are putting in a C&I platform that will hopefully be able to attract depositors and the C&I customer to the bank, okay. David, maybe just on the last point first, getting into maybe a little more C&I type lending that could bring deposit relationships with it as well. Can you just talk about maybe, I mean, obviously, maybe a bit different type of lending than current composition of the balance sheet. Can you just talk about kind of risk parameters in place as you make that kind of pivot or step more heavily into that market? Well, let me step back for a second, Andrew. We already do C&I and we already have the risk parameter set, okay. They havenât changed. The issue is it takes us two weeks to do alone. It needs to be done within a day. On a C&I loan you have to be able to have this loan done within a day and it takes us two weeks, okay. So thatâs what we are really doing. Okay. And just so you know, on the rest of our book, we have either decreased or have loan-to-value on almost every product twice, okay. So by 5 basis points each time and we have increased our DCF -- DFCR wise by 5 basis points also on every product type. So we did that over the year too. But that isnât -- we are not even seeing loans that fall out of those boxes even right at the moment. I would say aggregate would be the policy, probably, the aggregate is 125, actuals will probably be north of 130 and loan-to-value is around 60 now and I would say actual would be probably in the 50s. Now mortgage is slightly different. Mortgage is still -- we havenât -- we are still max, max is 70% loan-to-value, but most of our average loan to value on mortgage is around 60%,okay. Okay. And if I could shift over to the fee income side, can you just maybe provide some expectations for gain on sale and then overall fee income as we move into 2023? Well, we are seeing the New York that investors come down from their 8.5%, they are in the 7.5% range now. We are still not producing loans at 7.5% and mortgage we are around the 7% rate. So if they could get that -- if we can get it down a little bit further, we could be selling some. We do have two $30 million pools out to a local -- not a local bank, but to a bank, another Chinese-American bank thatâs on the East Coast that they would want to possibly purchase. So we are looking at that also. Our one of our major goals is to get the gain on sale of loans back up to about a $2 million per quarter number, okay. Okay. And then last one for me is just kind of a point of clarification on the margin and the interest-bearing deposit costs. I think you mentioned spot interest-bearing costs at the end of the year low 4%. I just want to make sure I am hearing you right, but the full quarter average for interest-bearing costs was 1.93%... Now the spot -- the cost that I am talking about is the -- our offering rate what we offer to our customers. Hey. Thanks for having me step back in the queue. Just know we spent a lot of time on the deposit side and your loan growth was really strong this quarter. I know you have to balance whatâs going on in your markets, in the economy, as well as pressure on funding. But just wondering on kind of what your broader outlook is for loans as we look throughout 2023. Is it mostly going to be CRE and resi driven, I know you spoke about C&I as something potentially to ramp up over time, but just generally wondering what your thoughts are for this upcoming year? I see what we are hoping is mortgage will take a back seat, because we have already put our mortgage portfolios now about 40%, 43% of our total portfolio, which really, if you think about it is the safest loan you can do, okay, especially at a loan-to-value of 60%. So we donât really want to grow that. With the rest, we want to grow CRE and C&I. C&I is not going to be a huge growth number this year and so forth. We will see how well it does and then take time to roll it out probably by really roll it out to larger loans and so forth at the end of the year maybe. But itâs really meant for the smaller loans of $500,000 type of C&I loan that we just canât really do, because it takes too long. So, right, most of our growth will be in the commercial real estate side. We are looking at rates most, well, not all. We have rates anywhere from like 6% and 3% -- 7%, 8% up to 10% right now on that -- on those products. So I see maybe in the summer time, you may see a little bit more construction out there because of they can build. We have had a month of rain. So nobody is drawing down on their construction loans. So, but we are not going out and particularly stressing any one category, okay. Hi. Just to answer you -- really answer your question. I do see production to be below -- significantly below 10%. I would say mid single digits this year, okay, on loan growth. Thank you. As we have no further questions in queue at this time, I will hand it back to Mr. Morris for any closing comments you have. Once again thank you all for joining us today. We look forward to speaking to many of you in the coming days and weeks. Happy New Year. Go and sleep far south [ph]. Thank you. And this does conclude todayâs conference call. You may disconnect your lines at this time and have a wonderful day. And we thank you for your participation.
|
EarningCall_1155
|
Welcome to Investor's Q4 and Annual Accounts Presentation. Today, as usual, we have our CFO, Johan Forssell -- CEO, Johan Forssell; and our CFO, Helena Saxon to go through the results. After Johan's and Helena's presentations, we will have a Q&A session. Both over the phone, you can post your questions or you can write your questions over the web and we will address the questions. Thank you, Viveka, and warm welcome everybody, to this presentation of our fourth quarterly report. So let me see. There we go. Well, as we all know, this was a tough quarter for the global -- or the year was very tough for the global economy. We had, as we all know, sharply rising inflation, interest rate, energy prices. There were significant supply disturbances during the year, but most of all, of course, the terrible war in Ukraine. In this environment, I do believe that Investor and our companies had a very resilient performance. If we look on 2022, in summary, our net asset value and total share, the return outperformed the stock market in Sweden. And we had an overall good operational performance in the companies. At Investor, we had a strong cash flow generation, and that meant that our financial position that was strong when we entered the year strengthened further and that, in turn, made it possible for the Board to propose a dividend increase of 10%, which is in line with our dividend policy to have a steadily rising dividend to our shareholders. If we then dig into the figures a bit during '22, our net asset value was down 10%, and our TSR was down 15%, and that can then be compared with the stock market being down 23% during the year. Same figures for the fourth quarter, the net asset value was up 7%, TSR was up 16% compared to the stock market being up 11%. Moving then over to Listed Companies. And you can see here that the total return continued to be very strong, up 12% in the fourth quarter, just ahead of the stock market being up 11%. More importantly, I think if you look on '22 -- full year '22, there was a significant outperformance in the Listed Companies being down only 5% compared to the stock market being down 23%. And Helena will later on come back to the reasons for that. If we look on the focus during this year, of course, there has been a high focus to handle the very volatile market environment that the companies have seen. It has very much been about handling the disturbances in the supply chain, but also, of course, high work with price management to offset the cost increases that we have seen in many places during '22. But there has also been a number of important strategic initiatives taking place within portfolio management. I think ABB is a good example that the spin-off of Accelleron during the year, and actually this morning released that they are now also divesting the power conversion business for about SEK5 billion. Working with the portfolio within the companies is a very important part of creating long-term value. Many other companies are spending a lot of money on R&D and actually accelerating those investments. I think one good example here is the strong development we have seen within AstraZeneca's oncology franchise. And then many companies are also making complementary acquisitions to put a stronger foothold across different segments and regions. I think two good examples during last year was Atlas Copco and Epiroc that really strengthened the position within a number of important segments and technologies, I should say. And then finally, of course, there are many initiatives going on in the companies to improve the climate footprint, both in their own operations but also to bring forward energy-efficient environmental-friendly products and services to the customers. Moving then over to Patricia Industries. For the full year, total return was minus 2%. We saw good underlying growth with an organic sales growth of 9% during the year and a profit growth of 20%. Also within the companies -- within Patricia Industries, of course, there has been a high focus on handling the volatility in the market with the supply chains and the price management that I talked about when I talked about the Listed Companies. There has been a number of important strategic investments. You know that these companies compared to the Listed Companies, they are smaller. And that means that we are spending significant efforts and money to really build these companies, invest more in R&D and development, building out the sales organizations, building strong footprint to really continue the long-term journey of growing these companies. There was also important add-on acquisitions made by a number of the companies during the year. For example, Laborie, Advanced Instruments, Piab and Permobil also made good acquisitions during the year. And also here, of course, there is a high focus on improving the climate footprint. Moving down to the fourth quarter. You can see that the organic sales growth was strong, up 11% and the profit grew 34%. And I think this is interesting. That was achieved despite the weak margin in Molnlycke during the quarter. So the weak margin in Molnlycke was this quarter compensated by a very good development of the rest of the portfolio, which gives us strength, I think, to the Patricia portfolio. If you look on the total return being down 4%, given the fact that the stock market was up 11% in the quarter, and we had a good profit growth, of course, that might look a little bit strange. So let me try to give a brief explanation for that number. You know that when we present our estimated market values, the purpose of that is basically saying that if our companies were -- should have been on the stock market, roughly, what would have been the value of the companies if we look on the multiples in the public market and just put those on our company's earnings. That's basically the basics of it. The mechanics to do that is that in this particular quarter, as an example, we take the average market cap of the peers during the fourth quarter, we add the net debt at the end of December to get an enterprise value. And then we put that enterprise value in relation to last 12 months EBITDA and then we get the multiples for the companies. And of course, the multiple is dependent on both the share price performance of the peers, earnings and the net debt development. And we used the median multiples of the peer groups and normally have quite broad peer groups. So that's the mechanic. In this particular quarter, we had a very pronounced V-shape of the stock market. As you can see on the graph, from September 30 to December 31, the Swedish stock market was up 11%. But if you look on the weighted average market cap in the fourth quarter compared to the average market cap in the third quarter, it was more or less unchanged. If we do the same for the peer group of Molnlycke, the development from September 30 to December 31 is plus 10%, while the weighted average 4Q versus 3Q is actually down somewhat. So that is an explanation. All else equal, this will, of course, mean that we will have higher multiples expansion in the first quarter. So it can, of course, be timing between the quarters. But the basic is the same. We take the market -- how the market values public companies and we put it on our earnings. And the reason why we see this, call it, a little bit strange this quarter is just because of the V-shape during these two quarters. So with that explanation, let me then move over to what is much more important, the operational performance in the companies. Here, you can see on the blue bars, the quarterly profit within Patricia and we reached SEK3.3 billion in profit in the fourth quarter, which is the second best after the last quarter. And on a rolling 12-month basis, we reached SEK12.3 billion during the year. Here is a short summary of the development of the different companies. As you can see, both BraunAbility and Permobil had a very strong development during the quarter. And the reason for that is that both companies saw strong demand, but also the fact that these two companies have had significant supply chain challenges during the year. And that, especially in the beginning of the year, and that is now -- has now eased up. So they have also been able to deliver goods out of -- to the customers. And that, in turn, has led to good operating leverage. So you see good growth and good margin expansion in these two companies. Molnlycke, I will come back to. Laborie, good development, organic growth of 9% and a good margin expansion. Atlas Antibodies, organic growth of 9%. Here, the margin was down, but there is a good development in this company. This is, as you know, a small company and we are investing heavily behind this company to put the right platform for long-term growth. Piab had an organic growth of 7%. And here, the margin was down due to strategic projects that are going on in the company. Sarnova had an organic growth of 6% and a good margin expansion. And then Advanced Instruments had a tougher quarter. And the main reason for that is that in the quarter, the sales of instruments to the biopharma sector was down, and we have very good gross margins on these products. So let me then go over to Molnlycke. If we start on the top line, it continues to be a very strong development, as you can see, with an organic growth of 9%, mainly driven by Wound Care and Gloves. On the other hand, the margin was weak in the quarter. And to be fair, the margin should not be at the level where we were in the fourth quarter. There are three main reasons for the weak margin: Number one being customer care reorganization, mainly in Europe; secondly, disturbances in the U.S. Wound Care manufacturing plant; and thirdly, the new factory in Malaysia within Gloves. So let me say -- expand a little bit on these three areas. The customer care, basically, what the company has done is that they have had a -- call it, a central customer care organization in Belgium. And to be more agile, they have pushed out these service people out in the sales organization in Europe, and that has led to extra cost during the quarter. So that is one reason. The second one is the production disturbances in the Wound Care plant in Maine in the U.S. As a reminder, Wound Care have two major plants in the world, one in [indiscernible] in Finland and one in the U.S. And the disturbances is related to supply issues, but even more perhaps due to staff shortages, and staff shortages is actually a big problem generally in the U.S. today. After the pandemic, not all workers have come back to work. And to give you some information of what has happened, I can say that the staffing shortage has gradually improved during the quarter. So the situation we are now is clearly better than it was in the fourth quarter, but there are still challenging remaining. So that is the short summary. And of course, the management is putting all efforts now to normalize the situation in the plant. Moving then finally to the third factor, and that's related to new plant in Malaysia, producing gloves. And here, we are in a ramp-up phase with the new factory. So the utilization in the fourth quarter was low. But here, we can see when we look forward that the utilization will gradually improve in the coming quarters. So those are the three main explanations for the weak margin in the quarter. But as you all know, disregarding this quarter, it's a good cash generation in the company was able to distribute EUR300 million to Patricia during the quarter. If we then look forward, I think we have an excellent portfolio, and I'm very pleased to see that the rest of the companies were able to cover up for the weak margin in Molnlycke in this particular quarter. These companies have very good growth opportunities due to the industries and the positions they have. So one of the key priorities going forward is clearly now moving into '23 to make sure that we achieve a good organic growth. That's number one. The second priority for this year, of course, is to come back to higher margins in Molnlycke. Moving to EQT. The total return was weak during the year, as you can see, being down 35%, driven by the weak share price development of EQT AB on the stock market being down actually more than 50%. On the other hand, we had a record cash flow during the year. As you can see, more than SEK6 billion, which can be compared to an average of about SEK2 billion to SEK3 billion over this period. In the quarter, the performance or the TSR was up slightly in EQT. So summarizing then. I think that we are well prepared, both for challenges and opportunities. If we look forward now, it looks like -- if we look on leading indicators that we are entering a tougher period. On the other hand, we can also see that most macro economists believe that inflation will come back during the latter part of this year or the second half of this year. And of course, if this would ease a little bit on the central banks, that could, of course, support consumers. We also know that China has opened up, and we also see that the gas prices in Europe has come down significantly. Let's see how sustainable that is. But there are, of course, a potential that this could change going forward. Irregardless how the market will develop, I think we are ready. So let's see if it will become more of a mild downturn or a tougher one. But I think we are ready. We have a good cash position, good financials, good cash flow at Investor and our companies are really well prepared with plans should it be tough out that. So to summarize, what are our priorities for this year? We will continue to stay here and now, manage the current market environment, and that is a top priority for us and, of course, all our companies. But we will also continue to make sure that the companies invest in areas which are important to drive continued good organic growth long term. So all continuous plan contains two parts. If it gets tough, when should we cut And the second one, where should we not cut. Where should we continue to invest because it's too important to in long term. And we will use our financial strength to capture opportunities. And I do believe -- continue to believe that there is an advantage of being able to act both in the public and the private setting here. Thank you, Johan. Let's go into the financials. The adjusted net asset value ended the year at SEK673 billion, and the average annual growth with dividend added back was 14% for the last five years, and that should be compared to SIXRX spend. Looking at the total return by business area. The 7% in the quarter that Johan talked about was built up of a -- so somewhat mixed picture with excellent development in the Listed Companies of 12%; Patricia, down 2%; and EQT around 2%. Looking at the full year is minus 10%. We can see that the Listed Companies and Patricia's return was negative 5% and 2%, respectively, while investments in EQT, the return was minus 35%. Looking more carefully at Listed Companies, 70% of total adjusted assets or SEK475 billion. We can see that the return here was also a mixed picture. The massive outperformance of minus 5% compared to SIXRX, minus 23%, was built up of strong absolute return in our health care companies and Saab. And we also had significant outperformance in some of our larger holdings, ABB, SEB and NASDAQ. Going over to Patricia Industries, some 20% of the assets or SEK138 billion. We can see that the estimated market value was down compared to the end of Q3. And here, two companies stand out, Permobil on the positive side and Molnlycke on the negative side. And this graph also shows significant distributions in the quarter. Looking at the major drivers of estimated market value in the quarter, we can see that Molnlycke's estimated market value declined by SEK8.5 billion in the quarter, and this was due to lower multiples and distribution. Three, Scandinavia was down SEK1.6 billion, also due to lower multiples and distribution related to the divestment of the passive network infrastructure. And this is the last distribution from that exit. Advanced Instruments, estimated market was -- market value was down due to lower multiples. And here also, FX impacted negatively. We see the same development in Laborie, lower multiples and negative impact from currency, but here, higher earnings impacted positively. So we had a slight mitigation there. Permobil had a positive development. So estimated market value of Permobil increased SEK2.6 billion, and this was due to higher earnings, actually a doubling of earnings in the quarter. And this, of course, increased the value even though multiples contracted in the quarter. Our financial position remains strong and leveraged at 1.5% at the end of the quarter. We have no debt maturities until 2029. And looking at this graph, we have added a year to the summary of cash flow generation, and we can see that all business areas contribute to the SEK145 billion generated -- accumulated over the period. And this has allowed, of course, for investments in both Listed Companies, Patricia. It's also allowed for net debt reduction and distribution to our shareholders. And talking about distribution, this morning, it was announced that our Board of Directors proposed a dividend of SEK4.4 per share to be paid in two installments during 2023, and this represents a 10% increase compared to the dividend paid last year. And then I always end with this slide showing the total shareholder return, and we can see that the Investor share was resilient in very difficult year, but has also outperformed the stock market, both in the long term and the short term. Thank you. By that, thank you, Johan, and thank you, Helena. We will now start our Q&A session. And we will start off with the questions over the phone, and we have our facilitator, Sabrina, who will lead and take your questions over the phone. So I hand over to you, Sabrina. Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question is from Joachim Gunell of DNB Markets. Please go ahead. Thank you and good day. So three questions from me. Starting off with the fact that corporate governance advisor, ISS, were out in their, call it, proposed quality changes here saying that, yes, unequal voting rights perhaps isn't the way to go. So as an active owner, what scenarios do you see play out here? And how would it -- this basically impact Investor's owner model? Okay. If I start with that, first of all, I must say that I think it's a very strange thing that they came out with saying that, that should be one of the decision points for approving the [indiscernible] and also whether they get sort of [indiscernible] Discharge of liability. Thank you. Because that's actually not the ownership structure and the ownership of A and B share is not the question for the Board. It's an ownership question. Secondly, I think it's important to remember that there are a number of countries around the world that have different votingâs. And thirdly, I would say, I personally believe that it has served Sweden well and Swedish companies well over a number of years. We have had strong long-term owners that have really been behind the companies with the combination of, on the one hand, being tough, of course, on the quarterly reduction and all that, but also willing to invest during long term. So that is my view. Understood. And secondly, given the ongoing, call it, structure action in ABB, can you just comment here on how Accelleron fits your investment criteria going forward? Yes, basically, how that ties into your list of core investments? Thank you. Our view is that we will and we are evaluating the ownership in Accelleron, and we will do what we believe is best for our shareholders. Very clear. And yes, I mean, just coming back to the margin development in Molnlycke. Can you say anything about, call it, the longevity of this, call it, extra cost impact or what you call it, underlying adjusted profitability would have been without this? What I can say is that when it comes to the long -- how long it will stay, so to speak, clearly, the utilization in the gloves factory will improve going forward, and it will improve already in the first quarter, and it will gradually improve. That, we see in the plans. And of course, unless there would be a dramatic change in the market demand, but that is what we see that we will see that coming through. And when it comes to the situation in the plant in Maine for Wound Care, what I can say is that the situation right now is better than in the fourth quarter, but it is not yet resolved. There are still some challenges, but the staffing shortage in the plant is clearly less now than it was during the fourth quarter. And then when it comes to the reorganization in Europe with the customer care, the majority of that was taken in the first quarter. A little bit will continue in the first quarter, but then it will be down. And all three, I should say, all three factors have a material impact on the margin in the quarter. Yes. I think one question from me. That's related to the demand situation in the -- mostly in the health care vertical in Patricia [indiscernible] remained strong in the quarter? What can you tell us about the underlying demand situation going into three? Some companies in the sector have commented on rising stocking levels at hospitals. Is this something that could become a factor for changing demand trend going forward? Thank you. Yes. It's very good question when it comes to the inventory situation, because if you talk more broadly and not about our medtech companies, it's clearly the case if you look on the global economy, that during the period when we have had this significant supply challenges, a number of distributors and customer centers have built up inventory. So of course, if you then get a more moderated demand situation, that can have an effect until you clean out the inventories. When we look on our companies within Patricia, within the medtech areas, of course, it varies between regions. It varies between the companies. But I would say that, yes, there might be some areas where you have excess inventory that can affect the quarter or so. But in other areas, it's more lean, so it differs between the companies. Yes. Good morning. Three sets of questions for me. The first one on Molnlycke. You mentioned that one of your key priorities will be recovering your margins here in 2023. I mean apart from the sort of special costs that you incurred here in the fourth quarter, and it sounds like it also slightly in the first quarter, what are the actions that you see will drive a recovery of margins? And to what level do you seek to recover those margins? Or what's the plan? And also here on Molnlycke, are there any kind of structural changes to this industry post COVID that might make it different to or might make profitability and growth different to what they were before? So that's my first question. And the second one is on strategy. You talked earlier about the interest in acquiring a new unlisted asset, and I think it popped up as one of your priorities for 2023 as well. What is the outlook for this in terms of sort of attractive assets that are available, valuation levels? Any new thinking on this. So those are the two. Thanks you. Okay. Thank you for all those questions. When it comes to the margin development, I think I was quite explicit how it affected the fourth quarter. And as you know, we never give guidance for the coming quarter, but let me give you a couple of comments. First of all, even though there was a lot of extra cost in the quarter and as I said, one should be fair. The margin should not be at this level as it was in the fourth quarter. If we look forward though, first of all, one should, of course, acknowledge that first quarter normally is somewhat seasonally weaker. What will drive margins going forward? Of course, high focus on continuing organic growth and fixing the plant in Maine will be important. And then given the plans that are in place, it will gradually come through also on Gloves with improved utilization. So that is what we see. When it comes to more structural questions, I think that it's always a battle out there. But I think that if you relate it to the COVID situation, one structural change is, of course, that the competition within [indiscernible] within ORS business has increased. And that is a fact. But as you know, that is also a low-margin business. So one of the key priorities for Molnlycke is to focus the ORS business on the areas where you can have a really competitive advantage and build better margins going forward, areas such as, for example, the trays business. When it comes to new assets, your third question, we continue to look for opportunities. The key priority for us is to grow our companies organically because coming back to your margin question, that is, of course, essential. That, in combination with good price management. Secondly, continue to do add-on acquisitions in our strong platforms we have. In addition to that, we are also open for new platforms, companies should we find a sizable acquisition within our priority segments. We are not looking for adding a small one. But if we can find a quite sizable company, that could also be interesting. So that is how we see it. I think the key question for us would be to find the right assets. That is where we are spending our time. Hopefully, the pricing levels are -- have become a little bit better than it was during the really good hay days out there. Yes. Thank you and good morning. I'd like to follow up one more time on Molnlycke. You very explicitly explained the situations around these one-off elements. But I was wondering if you could also comment on sort of the underlying cost pressure here, if whether that's actually eased because in the Q3, you mentioned rising or elevated raw material costs as well as logistical costs, but how this is compared to earlier? Thank you. I think it's quite complicated because it's different products in different regions, but more generally on -- when it comes to the logistics cost, they have eased from the peaks previously. Okay. Great. And also in terms of the potential to doing increased prices here. I mean, we've seen some other peers in the sector who are actually having a positive selling price environment. How do you view the opportunity for Molnlycke here? I can only say that price management is a top priority for management in the company. And that is, of course, something that management needs to handle for each business area for which region depending on what they believe -- create most value. But it's top on the agenda. Especially, I would say, on the ORS business, there Molnlycke is clearly focusing on improving prices to get profitability up. Yes. Thank you. Back a little bit of pricing in the Patricia companies, solely around the 10% organic growth you have now for a few quarters. How much is price? And how much will you say is volumes? Thank you. We don't say how much is price. I can only say that the price -- how much is the volume component and how much is the price component differs quite a lot between the different companies. I mean it is a material figure on average that is a positive price effect. But I would say that, in total, for the total Patricia Industries, the volume component is the bigger of them. Okay. Thank you, Sabrina. We have some questions over the web. I will start with the first one that came in from Samarth who asks if you -- sort of a big picture question. If you see demand recovery to pan out in 2023, especially compared to what we saw in the second half of 2022. Clearly, some of the strong growth we saw within Patricia Industries also reflected a lower base. So in that context, any commentary that you can provide on demand and margin outlook within your private investments would be very helpful. Okay. Thank you. When it comes to the demand for '23. I think that in general, we see that, of course, that there are a number of challenges in the global macro economy as I said before. But we also see potential for easing going later or going into the year, later stage. But let's see how that plays out. I think it's very difficult to be general here, because the companies are in different situations, different customer groups, different situations. So I would not even dare to go into and try to generalize that question. When it comes to Patricia and the growth and the base levels and so forth, of course, having an organic growth of 10% is a very strong number. We will push organic growth, as you know. That's the top priority to really grow long-term value for this company. And I do believe that the companies have excellent positions because they have strong market positions in attractive niches with growing end customers. But of course, 10% is a very high growth figure long term, given the fact that the global economy might grow something like 3%, 4%. But we will, of course, try to grow as high organic growth as possible. That's the plan. Then we have a question from [Michael Gilkens] (ph), maybe this is for Helena. Can you give a rough percentage estimate of the impact of the multiple change after year-end on the Patricia Industries' valuation? Well, we'll talk about that in the Q report. But yes, as Johan said, there is a factor when we use averages. But we have no idea where the quarter ends. Yes. And we have a second question from Samarth Agrawal. It may related to the comment on higher financial flexibility. Your leverage levels are conservative, end of the target range. Is it intentional given the current markets? Or is this also a reflection of muted deal activity generally? If latter, should we reasonably expect the investments by Investor to increase in 2023? You have commented on a similar question before. I think it's a relevant question. I would do twist it around that last year we invested some SEK3 billion â SEK2 billion, SEK 2.5 billion, we invested in Patricia to grow them through acquisitions, and we invested in Atlas Copco in the third quarter. And now we also announced a dividend increase of 10%, which is a good dividend increase. Our plan is to -- we have -- we are fortunate. We generate strong cash flow generation, and we will use that to invest and continue our dividend policy of giving a steadily rising dividend. The size depends on what opportunities that arise. Last year, it was -- you might say, on the lower level, but thatâs very attractive acquisitions we made. If there would be larger acquisitions coming up this year, of course, the figures could be much larger, but it depends on where we see attractive opportunities rather than the figures that we have a strong financial position so we are ready to act if we see -- if we find good opportunities. Okay. Then we have a fourth and last question from [Mark Arrowsmith] (ph). Could you give a bit more color on what was driving staff shortages at the U.S. Wound Care plant of Molnlycke? Is this COVID or just a function of a very tight labor market? It's a great question, and I can only say what I see, not only in this particular plant in Molnlycke. I can say generally that there is a challenge in the U.S. with getting the staff to many manufacturing plants. And the -- it could, of course, be a number of reasons for that. I think one of the reasons is that, after the pandemic some people choose not to come back to the labor force. And it is a tight market. But I cannot say how it will play out. I can say that what I see is that actually it is a tight labor market in the U.S. at the moment. Okay, we don't have any more questions over the web, and Sabrina has there been any more questions over the phone? Okay. With that, we would like to thank you for joining us today for our Q4 report and annual accounts presentation and we will be back with our Q1 in April. So until then, bye for now.
|
EarningCall_1156
|
Ladies and gentlemen, thank you for standing by, and welcome to the Elevance Health Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, where participants are encouraged to present a single question. [Operator Instructions] As a reminder, today's conference is being recorded. Good morning and welcome to Elevance Health's fourth quarter 2022 earnings call. This is Steve Tanal, Vice President of Investor Relations, and I'm joined this morning on our earnings call by Gail Boudreaux, President and CEO; John Gallina, our CFO; Peter Haytaian, President of Carillon; Morgan Kendrick, President of our Commercial and Specialty Business Division; and Felicia Norwood, President of our Government Business division. Gail will begin the call with a brief discussion of some of the highlights of the quarter and year before turning to our recent announcement of the acquisition of Blue Cross and Blue Shield of Louisiana and a number of other updates on key strategic initiatives. John will then discuss our financial results and outlook for 2023 in greater detail. After our prepared remarks, the team will be available for Q&A. During the call, we will reference certain non-GAAP measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are available on our website, elevancehealth.com. We will also be making some forward-looking statements on this call. Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond the control of Elevate Health. These risks and uncertainties can cause actual results to differ materially from our current expectations. We advise listeners to carefully review the risk factors discussed in today's press release and in our quarterly filings with the SEC. Thanks Steve and good morning everyone. Today, we're pleased to share that Elevance Health delivered strong fourth quarter results, closing out another year of growth, consistent with our long-term targets and considerable progress in our transformation to become a lifetime trusted health partner. In the fourth quarter, Elevance Health delivered GAAP earnings per share of $3.93, and adjusted earnings per share of $5.23. For the full year, we reported GAAP earnings per share of $24.81 and adjusted earnings per share of $29.7 and reflecting growth of 15% year-over-year from our adjusted baseline of $25.20 in 2022. 2022 marks the fifth consecutive year in which we grew adjusted earnings per share within or above our 12% to 15% long-term target growth rate. This reflects the focused and sustained execution of our strategy to optimize our health benefits businesses, invest in high-growth opportunities, and accelerate capabilities and services. Elevance Health ended 2022, serving more than 47.5 million medical members, up nearly 2.2 million members year-over-year, including more than 1 million new commercial and over 1 million new government members, investments in enhancing the customer experience, delivering innovative, customized whole health solutions, deepening digital engagement, and prioritizing health equity, all helped to deliver strong growth across customer segments. Membership growth, coupled with expansion in both the scope and scale of Caroline's business with our health plans, helped to propel double-digit growth in CarelonRx and Carelon services. In total, for the year, Elevance Health produced nearly 14% growth in operating revenue and double-digit growth in adjusted operating earnings. Now, I'd like to discuss a number of recent developments, including the acquisition of Blue Cross and Blue Shield of Louisiana that we just announced on Monday. Like our Anthem Blue Cross, Blue Shield family of plans, Blue Cross and Blue Shield of Louisiana is deeply rooted in its local community, serving Louisiana for almost 90 years. And like our health plans, Blue Cross and Blue Shield of Louisiana is committed to improving the health and lives of the people of Louisiana. Our organizations are well aligned in our mission and purpose. And have worked together in partnership through our Healthy Blue Alliance, serving Medicaid and dual special needs plans in Louisiana for a number of years now. Upon closing, Blue Cross and Blue Shield of Louisiana will be our 15th Blue state, providing us with deep local roots in a new market, while we bring national scale and access to our portfolio of innovative solutions and capabilities to support the community. We're looking forward to accelerating Blue Cross and Blue Shield of Louisiana strategy to make an even greater difference in the health and lives of the 1.9 million individuals they serve. Blue Cross some Blue Shield plans are at our best when we collaborate. Together, the Blue system provides health benefits to nearly 15 million consumers across all 50 states. There are many untapped opportunities to leverage our unique scale. One recent example is Synergy Medication Collective. Earlier this year, we became a founding investor in this new contracting organization founded by a group of Blue Cross and Blue Shield affiliated companies. The collective focuses on improving affordability and access to medical specialty drugs that are injected or infused in a clinical setting. Synergy will seek best-in-class medical drug pricing, leveraging our collective industry-leading specialty drug spend to enhance affordability, and drive toward value-based care representing another example of Blue's partnering for progress. Inside Elevance Health, we are also directly addressing fast-growing areas of cost trend. In November, we announced the acquisition of BioPlus, the largest independent specialty pharmacy provider offering a complete range of specialty pharmacy services for patients living with complex and chronic conditions. BioPlus will enhance our ability to deliver on our whole health promise and enable us to leverage our resources and scale to deliver greater affordability and access to critical medications. Over time, it will allow us to bring specialty pharmacy fulfillment for our members in-house, at what is a dynamic time in this field, given the anticipated growth of biosimilars. Upon closing, BioPlus will become part of CarelonRx, our pharmacy services business that we rebranded at the beginning of this year, with the addition of specialty pharmacy, we will expand the scope of the services and capabilities inside of Carelon and by extension, the proportion of overall healthcare spending that we manage or address. The acquisition of BioPlus furthers our commitment to scaling healthcare services to address the needs of health plans beginning with our own. Of Carelon's nearly $41 billion of revenue in 2022, approximately 60% came from partnering with our health plans. Meanwhile, in 2022, Carelon achieved the goal we set at our March 2021 Investor Conference of managing at least 20% of our consolidated benefit expense by 2025. This is three years ahead of schedule, a testament to the growing suite of capabilities within Carelon. Carelon has made significant progress since our last investor conference. And we look forward to providing shareholders an update on our long-range planning at our next investor conference, which will be held on Thursday, March 23, 2023 in New York City. Increasingly, we are evaluating and growing our enterprise through two primary businesses; health benefits and healthcare services. And we're continuing down the path of scaling Carelon by addressing the needs of our commercial, Medicare and Medicaid health benefits businesses. Beginning with the first quarter of 2023, we will evolve our external reporting to better align with this approach and begin to report Carelon split between Carelon Rx and Carelon Services, while we combine our commercial and government health benefits operations for reporting purposes into a single health benefit segment. Our new reporting structure will allow stakeholders to more clearly track the progress we are making against our enterprise strategy and better reflect how we evaluate our business results against our enterprise strategy today. John will discuss this more in his remarks, and you can also find a pro forma view of quarterly and full year 2022 results, the new reporting structure at a supplemental table in this morning's press release. Now, I'd like to touch on a few recent highlights before discussing our outlook for 2023. During the fourth quarter, we were pleased to become the first managed care organization in the nation to earn the full three-year health equity accreditation from the National Committee for Quality Assurance for all of our own Medicaid health plans, covering nearly 90% of our Medicaid membership. This recognition demonstrates that focus and resolve yield results. We have long been dedicated to countering health and equities across our enterprise and through partnerships with care providers. We continue to work toward health equity through policy and practice in pursuit of better outcomes and experiences for all, and ultimately to improve the health of humanity. Our Medicaid team is prepared to uphold that commitment by ensuring access to care for underprivileged populations through continuity of coverage for all beneficiaries eligible for Medicaid, who will be subject to the eligibility redeterminations this year. We look forward to working alongside state partners to help minimize loss of coverage due to administrative challenges and to ensure beneficiaries no longer eligible for Medicaid understand their coverage options. Our ACA exchange plans are now being offered in almost every county in our 14 Blue states. We remain committed and prepared to ensure seamless transitions of those Medicaid members, as they move into exchange plans or employer-based coverage. Across our health plans, we are optimizing our businesses. The pandemic brought with it substantial uncertainties and that resulted in margin compression in our commercial and Medicare health plans in 2021 that we didn't recover in 2022. It has since become apparent that COVID costs are not going to zero. And as we discussed last year, we've been repricing our risk in our commercial business, and we are enjoying improved reimbursement rates risk adjustment revenue and star quality bonus payments in our Medicare Advantage business in 2023. With January 1 renewals behind us in commercial, and the 2023 Medicare Advantage plan year underway, we remain confident in the margin recovery previously discussed and for the improvement in our commercial and Medicare businesses to more than offset anticipated member attrition in our Medicaid business when redeterminations begin on April 1st. Our confidence in operating our Medicare Advantage business solidly inside our long-term 3% to 5% target margin range has been underpinned by our bid strategy, in which we took a balanced approach. While the AEP proved to be somewhat more competitive than we expected, we still expect to grow Medicare Advantage membership relatively close to our prior targeted growth rate in 2023. Turning now to our outlook for 2023. We expect adjusted earnings of greater than $32.60 per share, reflecting growth of over 12%. Our guidance reflects double-digit growth in operating earnings in each of our health benefits and Carelon businesses that will be driven by the focused execution of our enterprise strategy, to optimize our health benefits business, invest in high-growth opportunities and accelerate capabilities and services. Our outlook contemplates a range of outcomes on Medicaid redeterminations coverage shifts and retention and our expectation for commercial and Medicare margin recovery from pandemic aero loans. John will discuss our assumptions in greater detail. The strong growth we achieved in 2022 would not have been possible without the hard work and dedication of our more than 100,000 associates. Our collective determination to improve lives and communities is unwavering, and we look forward to making a meaningful difference as Elevance Health. I would like to thank them for the important work they do and the impact they make every day. Thank you, Gail, and good morning to everyone on the line. We are pleased to have delivered solid fourth quarter financial results, closing out another strong year of growth for Elevance Health. The focused execution on our enterprise strategy continues to drive progress against our stated long-term targets. Fourth quarter adjusted earnings per share of $5.23 was ahead of our expectations and drove full-year adjusted earnings per share to $29.7, reflecting growth of over 15% year-over-year off of our adjusted 2021 baseline of $25.20 and above our long-term 12% to 15% annual earnings per share growth target. We ended the year with 47.5 million members, up $2.2 million or nearly 5% year-over-year, with organic growth having comprised more than 85% of our overall increase. In the fourth quarter, medical membership grew by 248,000 members, led by growth in Medicaid, driven in large part by the ongoing suspension of eligibility redeterminations and the acquisition of Vivida Health, which added 29,000 Medicaid members. For the full year, we added 1.1 million net new commercial members and 1.1 million net new government members. Total operating revenue for the year was nearly $156 billion, an increase of approximately 14% over the prior year, reflecting solid growth in our health benefits businesses and continued momentum in Carelon. We are pleased with the progress made to accelerate our service capabilities during the year as Carelon Rx and Carelon services grew revenue by 12% and 27% over 2021, respectively. The consolidated benefit expense ratio for the fourth quarter was 89.4%, a decrease of 10 basis points over the fourth quarter of 2021. This strong performance includes an improvement in commercial underwriting margin and also benefited from the reclassification of certain quality improvement expenses. These improvements were partially offset by the Medicaid business, which carries a higher benefit expense ratio than our commercial and Medicare health plans. Elevance Health's SG&A expense ratio in the fourth quarter was 11.5% and 11.4% for the full year reflecting an improvement of 20 basis points in the fourth quarter and full year. These positive results include the negative impact on the SG&A ratio related to aligning certain quality improvement expenses with CMS guidelines. The overall improvement was driven primarily by expense leverage associated with strong growth in operating revenue. In 2022, we produced another year of strong operating cash flow of $8.4 billion, representing 1.4 times net income, which was significantly better than our outlook to start the year and was driven by stronger risk-based membership growth and maintaining a prudent balance sheet. Additionally, relative to our initial guidance, a shift in the timing of certain payments to state-based partners added over $500 million to the fourth quarter operating cash flow that we now expect that we will pay in the first quarter of 2023. We ended 2022 with a debt-to-cap ratio of 39.9%, in line with our expectations and within our targeted range. During the fourth quarter, we repurchased 1.1 million shares of our stock for $567 million. For the year, we repurchased 4.8 million shares for $2.3 billion, exceeding our initial outlook for 2022, as we took advantage of the volatile periods in the market and opportunistically repurchase shares. Consistent with our approach throughout the pandemic, we maintained a prudent posture with respect to reserves. Days and claims payable ended the year at 47.7 days, an increase of 2.5 days year-over-year, and stable with the third quarter. Medical claims payable grew over 15% year-over-year compared to premium revenue growth of 13.5%. In summary, 2022 was a very strong year. We grew adjusted earnings per share by over 15%. We grew operating gain by nearly 13%. We grew membership by 2.2 million, and we grew revenue by nearly 14%, all with a stable medical loss ratio, a 2.5-day increase in days in claims payable and operating cash flow of $8.4 billion or 1.4 times net income. Before turning to our 2023 outlook, I would like to provide more detail on our decision to adapt our external segment reporting to better align with our enterprise strategy. Beginning with the first quarter of 2023, we will begin to disclose Carelon as a separate business division and provide operating revenue, operating gain and operating margin information separately for Carelon Services and Carelon Rx. Carelon offers a diverse suite of services across behavioral health, advanced analytics and services, complex care, pharmacy services and digital assets, and we remain committed to expanding the scale and scope of services Carelon provides to our own and third-party health plans. As we've continued down the path of scaling Carelon by addressing the needs of our commercial, Medicare and Medicaid health benefits businesses, it's become increasingly apparent that the similarities between our health plans have evolved to outnumber the differences. And we have also decided to combine our employer, individual, Medicare, Medicaid health plans and products into a single health benefits division. The remaining segment, Corporate and Other will include a small amount of revenue and earnings from non-Carelon, non-health benefits businesses, as well as our corporate unallocated expenses. The new health benefits segment will combine the same group of businesses that currently comprises the commercial and specialty and government business divisions. In the Carelon Services segment, reflects the same group of businesses that comprised the diversified business group, now Carelon services, which has historically been included as part of our old other segment. We are excited to begin disclosing the performance of our two primary and distinct businesses in a manner more consistent with how we will grow our enterprise for years to come and to be doing so at the time of strength for our organization. As you can see, our commercial health plan margin recovery is well underway and will extend into 2023, which is reflected in our Health Benefits segment margin guidance provided in our press release this morning. To ensure a smooth transition to our new reporting structure, we have also included a supplemental table in this morning's press release, showing our quarterly and full year 2022 results pro forma for new reporting structure alongside new supplemental performance metrics for CarelonRx and Carelon services that can be used to model revenue for each business. Our commitment to elevating whole health and advancing health beyond health care is unwavering, and our new segment reporting structure will allow our stakeholders to more clearly track the progress we're making against our enterprise strategy. Now, I'd like to discuss our outlook for 2023 in greater detail. We are pleased to have provided initial earnings per share guidance of greater than $32.60, reflecting growth of over 12% year-over-year, putting us on track to produce a sixth consecutive year of growth in adjusted earnings per share, consistent with our long-term 12% to 15% compound annual growth rate target. 2023 will be a year of optimization, but we will also demonstrate the balance and resilience of our health benefits businesses as we execute the planned recovery of our commercial and Medicare health plan margins from pandemic era low's, which we expect will more than offset the impact of membership attrition and margin normalization in our Medicaid business when eligibility redeterminations resume. For 2023, we anticipate growth in medical membership despite commercial repricing and Medicaid redeterminations. Commercial risk-based membership is expected in 2023, up over 200,000 at the midpoint, ending the year in the range of 4.9 million to 5.1 million members. Growth will be driven by individual and small group risk-based membership, partially offset by attrition in our large group risk business, driven by the repricing discussed earlier. Note that we expect commercial risk-based membership to decline by approximately 60,000 in the first quarter, with individual up approximately 100,000 and group risk-based membership down approximately 160,000. We anticipate growth in individual and group risk-based membership over the balance of the year, concentrated in the second half, as consumers transition from Medicaid to commercial coverage. Fee-based membership is expected to grow by approximately 600,000 members at the midpoint to 27.1 million to 27.4 million at year-end 2023. The wider-than-normal range contemplates a variety of scenarios related to coverage shifts out of Medicaid, and into employer-sponsored plans and the relatively uncertain macroeconomic backdrop. We expect approximately one-third of this growth to occur in the first quarter with the balance more heavily concentrated in the back half of the year as consumer's transition from Medicaid to commercial coverage. Total commercial membership will end the year in the range of 32 million to 32.5 million members, up over 800,000 members at the midpoint. Medicare Advantage membership is expected to grow by approximately 75,000 to 125,000 members, with growth in both individual and group pushing our membership over the 2 million member mark. Medicaid membership is expected to end the year in the range of 10.8 million to 11.3 million, driven by the attrition associated with eligibility redeterminations beginning on April 1 of this year. This wider-than-normal range contemplates a range of scenarios on the pace of redeterminations and the prospect of macroeconomic headwinds developing over the course of 2023. And finally, we expect our Medicare supplement and federal employees' health benefits memberships will be relatively stable year-over-year. In total, medical membership is expected to end 2023 in the range of 47.4 million to 48.5 million, reflecting growth of over 400,000 members at the midpoint. The consolidated medical loss ratio is expected to be 87.2% in 2023, plus or minus 50 basis points, an improvement of approximately 20 basis points compared with 2022, primarily driven by the re-pricing of commercial risk-based business and margin expansion in Medicare Advantage, related to the improved reimbursement levels across rates, risk adjustment and star quality performance. The SG&A expense ratio is expected to be 11.2%, plus or minus 50 basis points, a reduction of 20 basis points at the midpoint driven by expense leverage associated with growth in operating revenue, partially offset by continued growth in our Carelon businesses, which carry higher SG&A ratio than our health benefits business. We expect operating gain for the year to be greater than $9.35 billion, reflecting growth of at least 10% over 2022, again, being the primary driver of growth in adjusted earnings per share. Below the line, we expect investment income to be approximately $1.6 billion and interest expense to be approximately $1 billion, both reflecting the impact of higher interest rates. And our effective tax rate is expected to be in the range of 22% to 24%. Our full year operating cash flow is expected to be greater than $7.6 billion, including the unfavorable impact of a timing delay on the payment of approximately $500 million to certain Medicaid state partners that we previously believed we would pay in the fourth quarter of 2022. Adjusting for timing, our 2023 cash flow outlook will be greater than $8.1 billion or approximately 1.1 times our expected GAAP net income. We expect full year share repurchases of approximately $2 billion, and our weighted average fully diluted share count for the year is expected to be in the range of 239 million to 240 million shares outstanding. Our 2023 guidance does not include the pending acquisition of BioPlus or Blue Cross and Blue Shield of Louisiana, which we expect will close later in the year. Importantly, neither is expected to have a material impact on earnings in 2023. At the segment level, we expect the Health Benefit segment operating revenue to grow in the mid to upper single-digit percentage range year-over-year in 2023, with segment operating margin up 25 to 50 basis points year-over-year. We expect CarelonRx revenue to grow in the upper single-digit percentage range with low single-digit growth in adjusted scripts and mid single-digit growth in revenue per adjusted script. And we expect Carelon Services to grow revenue in the low double-digit range organically, excluding all pending or unannounced M&A, driven by growth in revenue per consumer served, as we expect consumer serve to grow in the low single-digit range from 105 million at year-end 2022. Carelon Services operating margin is expected to expand by 25 to 50 basis points year-over-year in 2023. With respect to earnings seasonality, we are projecting similar profitability patterns to historical ranges and expect to earn slightly more than 55% of our full year adjusted earnings per share in the first half of the year with slightly more than half of that in the first quarter, consistent with current consensus modeling of seasonality. Finally, we remain committed to enhancing shareholder returns through capital deployment, including share repurchases and dividends and are pleased to announce that our Board of Directors recently approved a 16% increase in our regular quarterly dividend to $1.48 per share, our 12th consecutive annual increase, which will be paid on March 24 and to shareholders of record at the close of business on March 10. In closing, 2022 was another year of strong growth for Elevance Health as we continue down the path of transforming from a traditional health insurance company to a lifetime, trusted health partner, and we are well positioned to deliver another year of strong growth in line with our long-term targets in 2023. We look forward to discussing our enterprise strategy and long-term financial targets at our upcoming investor conference, which we will host in New York City on Thursday, March 23, 2023. Yes. Thanks. And can you talk a little bit about, the growth in the services business, which is really interesting. Both org changes that you're intending to put in place to kind of support the new segment reporting, if any? And then, in the Care delivery aspect of that, can you just talk a little bit about what you've been doing to date with some of your partnerships with Aledade and Privia and how that's kind of being deployed in the market and what your expectations are for care delivery long term? Well, thanks for the question, Lance. Let me frame a little bit of what you asked, and then I'll ask Pete Haytaian, who leads Carelon to give you a little bit more color on that. First, in terms of org structure, we've actually been building our team over the last 18 months, and Pete's done a really strong job of both, bringing individuals who are in the services industry to Carelon, but also taking individuals from our health benefits business, who have a deep understanding of that business and having them lead. So we feel we've got a really good mix of talent and have been building our bench strength pretty effectively. So we don't envision any structural changes, obviously, as acquisitions come in, they fit into the verticals that we've shared as part of our strategy. So let me just have Pete comment a little bit about -- a little bit more about Carelon and our growth there. Yes. No, thanks a lot Gail. Thanks a lot, Lance, for the question. Overall, as Gail said, we're really pleased with the momentum and performance that we saw in 2022. And as Gail noted, in the year, we did do a lot around restructuring. We obviously went through rebranding, which there was a lot of excitement around. And as she said, we infused a lot of new talent across the organization. And then, in terms of the infrastructure we built internally, we're very focused. As you know, a core part of our strategy is focused on internal growth and serving Elevance affiliated health plans. And so we built the infrastructure to engage, to a much better degree, with our associates and partners internally. And we're seeing really good progress there. I hope you can see that through the numbers and the improvement in the year. We remain keenly focused on whole health and improving the patient experience. That's something else that we're very focused on looking from the outside in, in terms of the patient experience. And I'd say the other thing that we've been really focused on internally, and we're trying to change the culture, and its working, is driving more risk and capitation through the portfolio. And that has really helped in terms of the acceleration of our growth and the innovation that we're seeing going forward. As it relates to your question on some of the care delivery partnerships. We're seeing really good progress there. Again, when you look at the assets within Carelon, it can add a lot of value to our partners. And so, we continue to look to wrap around those services and create incremental value. And as we look forward, we have that in mind as well. When we talk to our provider base partners, where are they feeling stressed, where can we support them. So there's a lot of opportunity that we got going forward. Yes. Thanks, Pete. And Lance, specifically, in terms of how we're deploying, we see those partnerships and some of the investments we've made as part of our overall value-based care strategy. Our penetration has been strong, we're around 63% driven by purposeful collaboration. Those are two really good examples. We continue to learn and improve that approach, and part of that is how we work closely with Carelon to capitate services and actually, I think, impact more of the health care dollar and impact more of overall services. But we feel really confident about the strategy that we've deployed. And as I've shared before on these calls, we know that sharing -- the downside risk is really the most important part of where we need to achieve better outcomes. And so we're continuing to grow those arrangements, Early days still, but we feel good about the partnerships that we have, and we continue to expand them, and we feel on track to deliver on the goals that we've shared previously at our Investor Day, but also in these calls. So thanks very much for the question and next question please. Thanks. Hi, everybody. Congratulations on the Blue Cross Blue Shield of Louisiana deal. It's been quite a while since we've seen one of those. My big recollection is the approval process and navigating the regulatory side of things can be a little tricky. Can you give us a sense of any discussions you have with the states at this point and your confidence level? I know you're saying by year-end close. And John, you mentioned that it wouldn't be meaningful to this year's numbers. I'm assuming that's partly due to late closure. But is it -- can we say that it would be accretive? Is there anything you can say financially about it? And then the last aspect of this is, obviously, there's a lot of changing things related to the Blues generally with the antitrust settlement, et cetera. Are you seeing more discussions, Gail, as you're out there, or is there more interest in collaboration, maybe we could see a broader upswing in activity? Well, thank you, A.J. That was a very comprehensive set of questions, and let me try to kind of go through them. First, we really are excited about the acquisition of Blue Cross and Blue Shield Louisiana. As you said, it's been some time since one of these has occurred. But I think as you think about like the driver for this, this is very much a strategic acquisition. The Board of Blue Cross and Blue Shield of Louisiana, really wanted to have a greater impact and accelerate the strategy that they put in place. This is a solidly run plan, 4.5-star Medicare plan. And I think those are really important things as you think about this acquisition. The other thing that I think is really important for us is Blue Cross Blue Shield of Louisiana very much aligns with our strategy. They're deeply rooted in their local communities. They -- as we shared, they've served Louisiana for more than 90 years. Our mission and purpose is well aligned. And we've had a healthy Blue Alliance partnership with them that serves our Medicaid and dual special needs plans for a number of years now. So we've worked together culturally, I think there's a great alignment there. And the other thing is we're excited because this brings the 15th Blue state. So we can -- just as we have in our other 14, we've kept our deep local roots in a new market, but we also can bring our national scale and access to our portfolio of innovative solutions and capabilities, again, accelerating what the Blue Cross Blue Shield strategic focus has been, and that supports the community. And I think accelerates their strategy and making an even greater difference in impact on the 1.9 million lives. In terms of closing, this will be subject to the normal closing conditions. And as we shared, we believe that we expect the deal to close in the second half of 2023. So again, not much more there. We do feel the impact that we can have on the community and the citizen in Louisiana with the foundation, accelerate Louisiana really is a strong component of this and helps accelerate health care status, accessibility, affordability as well as health equity, and those are areas that we've been deeply investing and committed to as well. In terms of collaborations, you heard that we've done a number of collaborations and feel good about the Synergy Medical Collective, which is a great example of all of us coming together around medical specialty and again, with an alignment and focus around fundamentally improving affordability. We have 150 million Americans that we serve across this country. And we feel that ability for us to work together to have an even greater impact, again, on access and affordability is really important. And I would just point to that as an example. So, thank you very much for the question. I think we, again, are excited about this. We think it's a great collaboration for us and feel that there's an opportunity for us to work together and for us to obviously use Carelon to help support the advancement of all Blues. So thanks very much. Next question, please. Thanks. Good morning. Just wanted to check in, in 2022, you did about 7% margin in that commercial business. I know you're not reporting it specifically anymore. But you had 11% target out there for 2025. I wanted to check in on that target and just find out if that is still what you're expecting to do by 2025. Maybe you could share with us how much progress you're making towards that in 2023? And then give us -- I'm sure there's an offset there in terms of more conservatism on the Medicaid side from a margin perspective. Can you share what you -- where you expect your Medicaid margins to be versus the 2% to 4% target you have out there long term? Thanks. Thank you, Justin. Good morning. And we do appreciate the questions. In terms of commercial, we're actually doing very, very well. We have a repricing effort going on that began on July 1 of 2022. And what we had seen was, the overall cost structure of the commercial market was higher than we had assumed. And so, this repricing was about 25% of the large group block in July. And then we repriced about 50% of the block here on January 1, 2023, and it was really to ensure that the premiums more accurately reflect the underlying cost structure of the book. The result of that would be margin recovery associated with that. We feel very good about the progress that we're making, and we still stand by the commitments that were made in our prior Investor Day to get the commercial margins up to the level that we had estimated by 2025. You have to look at now the health services segment in total. And as you had asked, we have the commercial margin improvement ongoing, we will have Medicare margin improvement, as our risk adjusters are really recovering, risk-adjusted revenue really recovering from pandemic era lows. Also, we do have 74% of our MA membership in 4-star plans or above for the 2023 payment year. And we believe our Medicare Advantage business will be solidly within the target margin range of 3% to 5%. And then, on Medicaid, which was your final question, we've been working very closely with our state partners on Medicaid and feel very good about the rating actions. And that the rates are actuarially sound rates and feel very good about that. However, we were making either at or above the high end of our range here in the last couple of years, which obviously resulted in MLR collars and various other rebates being paid back to the states. We expect that the Medicaid business will be solidly within the 2% to 4% range, closer to the high end, but still with actuarial equivalent rates. So hopefully, that helps clarify all that. Thank you. Hi. Good morning. Thanks for the questions. On Carelon, you mentioned that you hit the target for 20% of benefit expense through Carelon ahead of schedule. Could you talk about how much higher this percentage can go from here with your current capabilities? And then specifically on the outlook for 2023. The revenue guidance for Carelon Services came in a bit below your long-term target. How are you thinking about growth from here just given the progress that you've made? And will more growth come from external customers going forward? Thank you. Yes. Thanks, Nathan. I'm going to have Pete Haytaian provide a little perspective. And as we shared earlier, we are going to be updating our long-term planning at our Investor Day in March. So we probably won't go into like where we think our updated guidance is on that, but we can certainly give you some color on how each of the components are playing and feel very good about the progress that Carelon overall is making. So Pete? Yes. No, thanks for the question, Nathan. As it relates to 2023, just to be clear, and John noted this in the prepared remarks, the low double-digit range growth in 2023 is really organic growth. It does not include M&A. I think if you look at our recent history, there's been a lot of M&A that's contributed meaningfully to us. And we're being very intentional about that. We're very focused on it. It's something that we'll continue to do. And I think it's an important part of our growth strategy going forward. As Gail said, in terms of the amount of medical spend that we penetrate, we'll talk more about that at Investor Day, but we're really encouraged with our trajectory right now. We feel like we can continue to grow pretty significantly. There's a lot of white space internally. So a lot of opportunity there. But to your point about external growth, we did establish some new leadership. We've got a new infrastructure in terms of external growth. We're very focused, as Gail said, you've heard a lot about the Blues and Blue partnerships, and we're very encouraged of what we're seeing in terms of the Blue opportunity. So we do think we can see nice growth externally as well. But again, our first focus is on the affiliated health plans and creating value there first. Hi. Thanks. Good morning. Just I had two follow-ups on the Blues topic. The first is if you can maybe give us some color on the incremental revenue you expect to drive from the BCBSLA Louisiana acquisition because obviously, you already have some revenues that you're generating off of Healthy Blue. Then also maybe just an update on the Blue Cross Blue Shield of Minnesota situation, I think that, that relationship on the Medicaid side will term at the beginning of 2024. Just any update on membership or financial impact that you expect from that situation as well? Thank you. Yes, sure. Thank you, Scott, for the question. So associated with Blue Cross and Blue Shield of Louisiana. As we had stated, we're not expecting that to close until later in [Technical Difficulty] impact on 2023 will not be material, really data line items. However, assuming it does close in 2023 -- in 2024, what we should see is an incremental 1.6 million members after you eliminate the various double counts and you referenced the significant partnership we have with them already. So it's an incremental 1.6 million members. And it's really -- it's an incremental $4.5 billion in revenue on top of what we have now. So that's really about the high-level economics that we would expect to inure in 2024. Yes. Good morning, Scott, and thank you for the question on Minnesota. We operate over 27 Medicaid plans across the country with over 11.5 million members. And when you think about what we do, we bring very deep expertise in this business and a relentless focus on our whole health strategy, health equity and improving health outcomes. The expertise we bring to the table has been recognized by our external partners, and we really look forward to continuing to bring that experience to other Blue partners and alliances, not only in Medicaid, but in Medicare as well. When I think about our alliance relationships, each of them is very different. And Blue Cross Blue Shield of Minnesota decided to end our administrative services relationship, which supported about 330,000 Medicaid members and provide back-office services in-house. We're going to work with them to make sure that there's a seamless transition, because at the core of what we do, we want to make sure our members are taking care of, and that's our highest priority. So we continue to value alliance relationships and really look forward to continued growth in this segment, with partners who value the deep expertise that we bring to the table for serving vulnerable and complex populations. Thank you. Thanks, very much. Good morning. I just wanted to follow up on utilization expectations for 2023. John, you made the comment that COVID is not going away, I agree that, that should be in the baseline. But, as we think about this, do you feel like there's any level of pent-up demand or potentially higher acuity levels as we move into 2023? And would you call out any specific line of business? Thank you for the question Lisa and we're not discussing specific trend assumption for 2023, but really when you look at some of the cost drivers that we have relative to the expectations, emergency room has been favorable, in-patient has been favorable, pharmacy cost actually running a little bit higher than expected. And out-patient is running a little bit higher than expected. I donât know that we really see any pent-up demand as much as we see -- being as much as the new normal. But just to reiterate. The overall cost structure of the business is higher than if COVID had never occurred. COVID is here and it continues to be a cost driver. What I think is probably most important in all of this is that our pricing now reflects the underlying cost structure and our MLR guidance also reflects this higher cost structure. So we actually feel very well positioned going into 2023. Thank you. Great. Thanks. I guess, my question is going to be really on 2024. So if you can make a direct comment on that, that would be great. But if not, at least comment on the 2023 trajectory to give us a little bit of a sense, because it seems like the story here for 2023 is balanced portfolio improvements in commercial and Medicare are offsetting Medicaid. But obviously, the Medicaid pressure is one that builds throughout the year, both from a revenue and I would think, from an MLR pressure perspective, which begs the question about whether it's a bigger headwind in 2024 than it is in 2023 and whether there are similar opportunities in 2024 to kind of to offset that? Thanks. Yes. Thank you for the question, Kevin. And as you indicated in your question, we're not going to provide any specific details we did on 2024. Obviously, at our Investor Day coming up here in a few months, we'll provide a lot more long-term aspirations. But I think the way you've characterized 2023 is correct. It's really -- it's a year of optimizing our health benefits business, while we continue to grow and expand the capabilities within Carelon. And then you talk about, well, gee, could the headwind be greater? As you look at the Medicaid redeterminations, there's certainly a lot of variables associated with the pace and timing, on a state-by-state basis, where they go, which lines of business, they ultimately reside in I think one of the great things about the balance and resilience of our membership base is that we end up with the members somewhere. We have a product offering for every member regardless of age, regardless of employment status, with regardless of health condition, and feel very, very good. So we do expect approximately about half of the Medicaid members to be reverified here in this calendar year and the other half next year. So there is some balance there. But at the end of the day, we are very well positioned to retain much of that membership. Thank you. Yes, thanks, John. And Kevin, I think it's an insightful question because as you've heard us talk about, I think there's three core pillars of how we see our business evolving. Optimizing our health benefits business. It's highly scaled. We're very diversified in that business. And again, as you think about 2023, we have an opportunity for margin recovery, which is really we've been intensely focused on. But the other two pillars, I think, are really important about our future growth, which is investing in growth opportunities. And then third, accelerating services and capabilities, particularly through Carelon. And remember, as we think about Carelon, a lot of that is synergistic with our health plan business. We've continued to grow this and that allows the synergy to also occur with Carelon services as well as expanding capabilities that you've seen us, but through organically and inorganically. So overall, I think we've got more levers than we've ever had historically, and those positioned us well for the balance that John just shared. Next question, please. Hi. Good morning. It'd be great if you could expand a little bit on the dynamics you saw in Medicare Advantage open enrollment this year. And how you think those trends might play out over the next couple? And then specifically, hoping to clarify the enrollment expectations there. I think you said 75,000 to 100,000 membership growth. Is that a sequential Q1 figure or year-end figure just trying to realign versus some of the previous expectations you've shared here. Thanks. So, good morning and thank you for that question. When we think about Medicare Advantage, as Gail mentioned in her early remarks, we took a very strategic approach as we thought about our bids for 2023, and we expect to deliver good performance in terms of growth, not just in individual, but also in group. As John referenced, we plan to grow between 75,000 and 125,000. But we did end up encountering a very competitive. On the other hand, we had very solid growth in our D-SNP business, which is where we've had a focus for some period of time. And I think that positions us well for the rest of OEP in the remainder of 2023. As we think about our competitiveness, we have a very strong benefit portfolio, and we believe that we're positioned well in order to continue to grow this business. So at the end of the day, a competitive environment, which it always will be in Medicare Advantage, but still an opportunity to grow in a business that we feel very good about. And most importantly, the opportunity is we are in 2023 to deliver very strong margin recovery and operate squarely within our 3% to 5% pre-tax target margin range in this business, so solid growth and solid margins in 2023. Hi. Thanks. Good morning. I was wondering if you could provide an update on some of the trends you're seeing in value-based care. I heard some of the comments earlier. But as you go into 2023, are there any changes in the dynamics of the industry? Any changes specify in contracting terms that either the providers are looking for or that you're trying to push? And then, maybe any updated views on the employment or ownership of physicians or physician groups. Well, thanks for the question, Josh. In terms of -- a little bit consistent, I guess, with what I shared before on value-based care, I mean, we've been -- we continue, quite frankly, to refine and improve our strategy. We feel we're making really good progress on it. What we're seeing is a lot more interest in sharing up and downside risk. Historically, value-based care was more upside risk and we've gotten about 63%. We've gone -- we've continued to refine that to now include much more downside risk. And also, I think one of the biggest differences is the sharing of data bilaterally and much more timely. So that action can be taken in -- I think, in a much more integrated way. And we're doing a lot of work with that with our care providers. It's embedded. And also, what happens, like, post primary care. So how do we manage all the specialty services? That's a big part of the Carelon strategy in terms of what Pete is doing in his business. So as I think about that, I would say, structurally, we're seeing a lot more interest and a lot more conversation as this takes several years for, I think, physician practices to get comfortable with value-based care. And so, we're building credibility with that. We're getting better at our reporting and our engagement. And we're not only doing it across Medicare Advantage, and I think that is one of the changes. Some of our relationships are specific to commercial, for example, and that's a very different approach, including with some fee-based customers. So that would be a trend. In terms of the ownership of physicians, I think, we've been very consistent about that. We do own physicians in terms of our integrated health plans, and those have performed very well in MMM and health fund in Florida. I think, CareMore is beginning to become even more integrated with the work we're doing. So I think our strategy has stayed very consistent there. So I don't really have any significant updates, other than I think it's all embedded and our ability to drive more downside risk integrate data in a much more real-time basis. And then, really become true partners and train each other and how do we work in a value-based care environment. As, I think, you know well, this doesn't happen overnight, and it takes quite a bit of work for us on both sides to be committed to the long-term partnership, but we feel good, and we're seeing more enrollment in those partnerships. And the results have been good. We see differentiated quality and cost outcomes. So thank you very much for the question. Next question, please. Hi. Good morning. And thanks for taking my questions. Just on the CarelonRx or PBM, how should we square the high single-digit outlook for 2023 relative to your long-term 2025 low double-digit outlook? And then also, can you provide a bit more color on what Carelon's role will be within the synergy collective? Thank you. Yes. Thanks. In terms of the short-term, if you're referencing the script growth, overall, we're going to see nice script growth in Medicare and commercial. In terms of the headwind to that, really, that's due to the Medicaid dynamic around reverifications, or redeterminations. And then overall, we're going to see lower COVID vaccination. So that doesn't impact operating gain, but that is really the reason for the difference in the numbers in terms of what you're seeing short-term, long-term. In terms of overall growth, though, we feel really good about how we're doing in the pharmacy business. There continues to be a lot of interest in our integrated value proposition. In 2022, we're coming off a good year. We saw a 300% improvement in net membership growth. So that was good in terms of penetrating our self-funded business. And we're seeing that continue to play through into 2023. We're obviously through a lot of the selling for the beginning of the year, what we did see is we saw a lot more activity and penetration in the 10,000 or less business. We saw RFPs up by about 6% year-over-year. And again, I'll reiterate, but this is a segment an area that we perform really, really well in. I think you referenced a synergy at the end of your question. And again, to Gail's point in our commentary, our focus, a big part of our strategy is overall affordability and choice and this creates an opportunity for us in the context of medical specialty to create more affordability for our members. Again, by working in conjunction with the Blues across 100 million Americans, those that are utilizing specialty on the medical side, we have an opportunity to create much greater affordability. So we look forward to that. That work is in earnest right now in 2023 with value potentially playing through into 2024. Hey, just on the topic of health plan optimization and commercial repricing initiatives. Can you comment maybe more specifically on stop loss? I think, you guys are beginning to anniversary some of the challenges in the creep and high-cost claims last year, just how you feel about trends in the business margins, just maybe broadly, any comments about the overall stop-loss market? Thanks. Hi, there, and Whit, thank you for the question. Regarding the stop-loss business, that's certainly an area that was underperforming priorly and we began that journey to recover the margins in that business back in January of last year. It started with some of our integrated -- our external business rather. And then year progressed further, we had our July cohort, which John mentioned earlier, which was about 25 [ph] to some of our integrated business, both stop loss and risk-based business. Both of those went through a repricing exercise midyear, and then that concluded with January. So regarding the stop-loss market, we feel very good about it. We've got continued strong penetration, but opportunity to continue to grow that, both on our internal integrated business as well as our external. And we feel at this point in time, we have right-priced our business based on risk and we'll continue doing that so very fastidiously as we move through in 2023. Hi. Thanks for taking my question. Good morning. You called out a headwind to the MLR this year from the growth, the outsized growth in Medicaid did not call out a benefit to the SG&A ratio in 2022 from that. I'm wondering if there was one. And then more importantly, as that -- as the direction of those books reverses and Medicaid shrinks in 2023 from redetermination. Does that create a headwind? And what levers are you pulling to offset that headwind for SG&A ratio? Thanks. Thank you for the question, Dave. As you can imagine, there's a lot of puts and takes associated with SG&A ratios and by the ability to invest and the fact that we have been investing quite heavily in various digital capabilities, things that are member facing and can actually improve the member experience. The other aspect is that, we've really enjoyed a lot of fixed cost leveraging. Our premiums grew at 13.5% year-over-year, which obviously allowed the SG&A ratio to decline from that aspect as well. So, we do expect a reduction in our operating expense ratio in 2023, driven by the leverage of top line growth, as well as improved operating efficiency, partially offset by the reinvestment and strategic initiatives in support of our growth. So, while certainly, the mix of business does matter. And as we said in the guidance, Carelon services carries a higher SG&A ratio than the rest of the company in general. And we expect Carelon Services to grow faster, a lot of puts and takes. But fixed cost leveraging and investment in capabilities are probably two of the most significant drivers year-over-year. Thank you. Yes. Great. Thanks. Good morning. Appreciate the color on the 2023 membership guidance, particularly in the -- your commercial segment with the repricing strategy. You may have touched on this a little bit, but I guess, you previously talked about your goal of narrowing the profitability gap between the fee-based and risk-based commercial customers. I'm just curious, if you can just provide a little more color on your expected progress on that profit gap in calendar 2023 in particular, just in light of all the pricing and growth trends you talked about for the risk and fee-based books of business in commercial. Steven, thank you for the question. And we had a very successful selling season with CarelonRx, as Pete indicated, and we grew our specialty lines of business rather materially, and we continue to make steady progress towards our goal of improving that revenue gap between risk and fee-based business. One thing of note, when you think about in 2022, retrospectively looking back, which will take -- carry us forward as well, admin fee revenue grew nearly 8% compared with 4% in our fee-based membership growth. So this alone is certainly clearly indicating that we've got an expansion in revenue and product per sold member. I would say, this is driven by not only our Carelon assets, but it's also driven by strong growth in our clinical buy-ups. Again, noted specialty products and our aligned incentives Carelon services products. And, again -- so we feel good about that trajectory. We feel good about that gap continuing to close. And as John had indicated earlier, this isn't about any one segment. This is around actually growing that fee-based business. Many -- much of that business is moving to the fee-based schedules, but also the pull-through of the Carelon asset that we're working jointly with Pete and his team on. Thank you for the question. Yes. Thanks for the question. I think, as Morgan just shared, we're making really nice progress on really improving the -- both the revenue per member and the profitability per member in our fee-based business. And the example he gave, I think, helps demonstrate that. And so overall, we feel it's been strong and we have a lot of confidence in that. So thanks again for the question. And it's, again, part of optimizing our health benefits business that we've talked about. Next question, please. Hey, good morning. And thanks for taking the question. I ask, kind of, a question on the future state of the CarelonRx business, because you guys announced the BioPlus acquisition, you've got the synergy initiatives. You've got the JV with SS&C on DomaniRx. So I guess it's probably a question for 2024 or beyond. But I guess can you talk about how much of the vertical integration of the PBM business that you think that you need to do, given the outsourced relationship with CVS and the other initiatives that you have going on? Thank you. Yes, George. Thanks a lot for that question. And I think it's helpful to sort of step back and think about our overall strategy and where we started in this regard. When we started a few years ago, we always talked about being a different kind of PBM and our strategy has been keenly focused on whole health and integration of medical, pharmacy, behavioral and social. And that's been core to what we've been doing. And we've also said, and we've been very deliberate about this, that we want to own the strategic levers that matter. Those that, quite frankly, drive the greatest affordability choice, and of course superior patient experience. And that's the journey we're going on. I think what you're seeing in BioPlus and what you're seeing in synergy are really good examples of that and what we prioritized. If you look at specialty pharmacy, it's 40% to 50% of the overall drug spend right now. And it's a critical driver of value for patients. And so that's where we started. And we'll continue on this journey, again, through the lens of greater affordability and superior patient experience. So over time, you will continue to see us take ownership of the strategic levers that really matter. Hi. Good morning. Actually I had a quick question about BioPlus as well. I was just wondering a couple of things. If you could give us a sense of annual revenue there, geographic reach and someone I think Pete earlier said in the future would bring specialty fulfillment in-house. And I thought that's what BioPlus was. So I just want to make sure I understand the business model there? Yes. Thanks for the question, Gary. We feel really good about adding BioPlus to the family. It hasn't obviously closed yet. We think it will likely close in the first quarter. And in terms of their breath, I won't get into all the specifics about it, but they are the largest independent specialty pharmacy out there that remains with a broad range of services. They cover over 100 of the limited distribution drugs. So we feel really good about that. And their footprint is covering all 50 states. So we believe it's a really great platform. The other thing I would say that we're really impressed by two things, quite frankly. One is really great talent over there with a lot of experience, long-standing experience. And then the other real differentiating factor around BioPlus is their differentiated service model. Time to therapy, the speed to which they're providing services is really differentiating and we'd like to build upon that. So we're excited about this. And when it closes, we're obviously going to be very focused on building the scale to be able to take on all our specialty pharmacy. Hey, thank you for the question. Just wanted to dig a little deeper on commercial margins. I know you mentioned you're still targeting 10.5% to 11.5% by 2025 I think John might have mentioned 125 bps better commercial margin in 2023. Was that right? And if so, that would be slightly more than 8% for 2023, which means there's still a considerable gap to your 2025 target. And I was expecting a majority of that improvement might happen this year just given your repricing experts, but if you're seeing 125 bps in 2023 and the following two years, would need at least 225 bps of improvement. So I was wondering if you could just talk a little bit more about the path and progression of that improvement in 2024 and 2025. If you could help us break down the drivers we can better envision that path? Like what percent of that improvement is coming from up-selling your fee based business or the shift to higher margin small group or just any other contributors, maybe potentially more of a pricing efforts beyond 2023? Yeah, thank you. Yeah. Thank you for the question, Michael. I'm not sure where your 125 basis point comment came from. But that was not part of our prepared remarks. What I can share is that if you look at the press release and you can see on a reported basis, the third quarter of 2022 versus the third quarter of 2021, commercial margins increased by 120 basis points. And then in the fourth quarter of 2022 versus fourth quarter of 2021 on that reported basis, the commercial margins increased by 180 basis points. In terms of the margin improvement, as we have said historically, it is not going to be pro rata. If we've got three more years, 2023 through 2025 to get to those target margins that it will -- there will be far more of the improvement here in 2023 for the reason that you noted. And then there will be continued improvement in 2024 and 2025. Obviously, we're going to continue to optimize our fully insured block together with the fee based selling strategies that Morgan talked about, overall, we're still standing behind that margin target through 2025. Thank you. Thank you, John, and thank you for everyone for joining us. In closing, we're pleased to have delivered another strong year in 2022 and are confident that the ongoing execution of our strategy positions us well for 2023. We look forward to discussing our long-term strategy in greater detail at our 2023 Investor Conference, which we said we plan to host in New York City on March 23, 2023. Thank you for your interest in Elevance Health, and have a great rest of week. Thank you. Ladies and gentlemen, a recording of this conference will be available for replay after 11:00 a.m. today through February 24, 2023. You may access the replay system at any time by dialing 800-396-1242 and international participants can dial 203-369-3272. This concludes our conference for today.
|
EarningCall_1157
|
Good afternoon, and welcome to the Alexandria Real Estate Equities 2022 Fourth Quarter and Yearend Conference Call. All participants will be in listen-only mode. [Operator Instructions] After todayâs presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. Thank you, and good afternoon, everyone. This conference call contains forward-looking statements within the meaning of the federal securities laws. The companyâs actual results might differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the companyâs periodic reports filed with the Securities and Exchange Commission. Thank you, Paula, and welcome everybody. With me today, are Hallie Kuhn, Peter Moglia and Dean Shigenaga. Want to thank you for joining Alexandria's fourth quarter and yearend 2022 earnings call and wishing you a safe and healthy new year. And thank you to our Alexandria family team members for their continued operational excellence across all facets of our unique business platform. A truly mission-driven, one-of-a-kind company. We have truly exceptional fourth quarter and 2022 yearend results and by any and all metrics, we're very proud, thankful, and humbled, while many public recording companies ever really struggled mightily during this past year. I'd like to take a moment to tick off what I consider to be some of the most notable news for Alexandria. Truly amazing that Alexandria has delivered approximately 8.5% FFO per share earnings growth while continuing to strengthen our fortress balance sheet, the strongest in our history and Dean will give you more details on that. Against the backdrop of a very deleterious macro-market in this 2022 year and really again, nothing short of operational excellence to the team. With our highly leased development pipeline and continued strong leasing and Peter will comment on that, Alexandria is well positioned to deliver strong earnings growth again in 2023. We have continued to create long-term shareholder value with a total shareholder return from IPO through the end of this -- end of the year, December 31, 2022 of 1673% compared to the MSCI read index of 684%, S&P 500 of 628% and NASDAQ 838%. So a wide margin upbeat. Alexandria continues to produce stable, increasing, long duration cash flows and an increasing dividend. We're very proud of our approximately 1,000 client tenant base, a one of a kind treasurer that continues to generate remarkable demand for our Alexandria lab space and Peter and Dean will highlight more on this, but again, two million square feet leased in fourth quarter, over eight million for the year and almost 18 million for the last two years with rental rate increases last year of about 22% on a cash basis. Pretty amazing stats and we're very proud of our own tenant base, which is generated by far and away the majority of that lease space. 4Q '22 and yearend 2022 was another strong quarter by all fundamental financial metrics and a few others and Dean will highlight some of this, almost 100% -- almost a 100% on collections from a very strong and durable tenant base and very proud of almost 95% occupancy and we put in I think very strong same-store performance both for the quarter and the year. Innovation in medicine is but must continue to be a national imperative. One in four of us will develop a neurodegenerative disease. Nearly 40% of adult men and women will be diagnosed with cancer during their lifetimes. One in five in the nation's population suffers from mental illness and we're continuing to see over a 100,000 deaths due to overdose last year, despite all of the efforts that certainly this company has made with our Dayton project, but just a literally a war out there, which does not seem to be in check and governments at the federal, state and local level need to double down with the vast amount of resources that have been appropriated over the last few years and really focus on this mental health issue. A comment about our successful and continuing value harvesting and recycling of our precious capital, Peter will detail that, but amazingly stellar 2022 with $2.2 billion successfully harvested and then reinvested in a highly disciplined, disciplined manner and Peter and Dean will also comment on the excellent and steady progress we've made year to date, just one month in to our 2023 business plan for value harvesting and capital recycling and we're very optimistic about that. And then before I pass it over to Hallie, want to particularly call out and thank our particularly call out and thank our finance team and all those who had a hand in the impressive balance sheet accomplishment set forth on Page XB of our supplement. I am very proud that we once again have the strongest balance sheet in the company's history. Thank you, Joel and good afternoon, everyone. This is Hallie Kuhn, SVP of science and technology and capital markets. Today, I'm going to provide a recap of the life science industry coming out of 2022 and now into 2023 and how our highly unique approximately a 1,000 tenants remain resilient through the volatility of the current macroeconomic environment. As Joel mentioned, and as we often talk about, the 90% of 10,000 diseases remains an incredible opportunity and unmet need. And the fact is, many of these that do have treatments are far from solved. Take type 1 diabetes. While it was a death sentence before the discovery of insulin over 100 years ago, it still carries an immense burden. A person with type 1 diabetes makes on average 180 health-related decisions a day, some of which have life or death consequences. Now looking back at 2022, the stats truly speak for themselves regarding the enduring strength of the life science industry, of which I'll highlight 3. First, despite widespread commentary that VC funding hit the pause button in 2022, life science venture deals totaled nearly $58 billion. Other than 2021's record year, it was the second highest amount of capital ever deployed. Of note, over 70% of VC dollars deployed went into an Alexandria cluster, and with VC funds across tech and life science raising nearly $160 billion in 2022, a record eclipsing 2021 is $150 billion, significant dry powder is on hand to deploy over a multiyear time horizon. Second, large pharma continues to be 1 of the best performing sectors in the market. In a year where total returns for market indices such as the NASDAQ and Dow ended the year down 10%, the top 20 biopharma ended the year up an average 12%, with 8 of the top 20 pharma ending the year with total returns over 20%. With historic levels of cash on hand, over $300 billion to deploy into R&D and M&A, biopharma has the firepower to continue to innovate and grow. And last, the pipeline of early innovation to commercialization continues to deliver to patients, with 37 novel FDA small molecule and biologic approvals, three gene therapy approvals and a novel cell therapy approval, of which nearly half were developed by Alexandria tenants. Moving to Alexandria's unrivaled life science tenant roster; we wanted to provide additional color on our business segments and some examples of Alexandria's tenants at the forefront of life science innovation. Starting with large pharma, $260 billion was reinvested into R&D in 2021, and analysts estimate that, including leverage, pharma has over $600 billion to deploy into M&A and partnerships. The next several years, indeed decade are going to be framed by large pharma's continued pursuit of innovation as product patents expire and new types of medicines such as mRNA and cell therapies transition from large preclinical and clinical pipelines to commercial stage. Alexandria tenant Pfizer is a great example, with preclinical and clinical -- sorry, with over 110 programs spanning early to late clinical developments, and an estimated 19 products launching in the next 18 months. The company also noted in their 4Q earnings this morning, they are targeting an additional $25 billion in revenue to come from M&A activity by 2030. Transitioning to public biotech, our tenant base includes the majority commercial stage companies, which brought in nearly $150 billion in revenue in 2021. Tenants such as Amgen and Vertex have large diversified pipelines, driving long-term growth. As a note, Vertex is also leading the next generation of type 1 diabetes treatment with a novel clinical stage cell therapy that addresses the root cause of diabetes. For clinical-stage biotechnology companies, data is king. And those that have met and will meet clinical milestones in 2023, continue to see stock recovery and ability to access capital through follow-on financings. While the public markets are still recovering, life science follow-on financings reached nearly $17 billion in 2022, which is right on par with the average life science follow-on financings over the past decade. With respect to life science products, service and devices, this segment largely consists of commercial stage tenants. While not immune to higher interest rates and supply chain challenges, this is a big business segment that both drives and responds to the needs of researchers across academia, biotech and large pharma, which continue to grow and innovate. A notable development in the space is the rapid drop in the price of genome sequencing, driven by a healthy increase in competition. Costing $100 million to sequence a genome in 2001 and diving to $1,000 per genome in 2020, we are now looking at the $200 genome, enabling access to critical sequencing data that saves lives. So where are we headed in 2023? In the face of persistent economic headwinds, all industries are forced to double down on the areas of greatest value. As part of the reset, there are companies that won't make it, and we'd argue that this, in the long run, is healthy as capital is deployed more efficiently. There will continue to be further separation of haves and have nots, but companies like those on Alexandria's tenant roster with differentiated technologies, a clear road map to key inflection points such as generating clinical data and tenured management teams will continue to raise capital. As history has shown time and time again, some of the most successful companies are those created in the depths of a financial downturn. Ultimately, the life science industry is not built on technologies looking for a problem, but instead thousands among thousands of devastating problems, i.e. diseases that this incredibly innovative industry is poised to address over decades to come. To end on a note of hope from former FDA Commissioner, Scott Gotland. Our ingenuity drives our hopeful innovation, but it's our compassion for each other that inspires us to apply these advances to the purpose of reducing human suffering. Thank you, Hallie. 2022 was quite a volatile year in the macro markets, a reminder that all businesses are subject to cycles, some more than others. The pruning we see in the tech industry today is not a surprise to anyone who's been around since the turn of the century. However, much like a broken bone, it will come back stronger after it heals. Unlike tech, developing products and services to address disease is hard and takes a lot of time, much harder and more time consuming than creating the next app to book a reservation or share recipes. Because of that, there is more discipline in life science investment, a discipline Alexandria has mirrored in our real estate strategy, which is why through the dot-com bust to the financial crisis, to whatever you want to label today's conditions, our business remains sound, as you can see in our results this quarter and during those historic down cycles. Despite the macro headlines, we remain optimistic and excited for our business as we are in the early innings of the Golden Age of Biology. We have only had the blueprint of the human genome for 20 years. And in that time, we've developed more new modalities to attack disease than in the previous 100. It's going to be hard, and it's going to take time, but the industry is going to have options for people with Alzheimer's. It's going to perfect technology to detect pancreatic cancer in time to save lives and much, much more. So let's all remember, it's hard, it takes time and patience, and then you will understand why life science research and development continues through the proverbial thick and thin of economic cycles, making our business resilient and essential. With that said, I'll briefly touch on our development pipeline progress, update you on construction trends, discuss our leasing and update you on investor demand for life science real estate. In 2022, our best-in-class development teams continue to deliver high-quality, purpose-built laboratory space to our tenants on time and on budget in a very challenging construction environment, which I'll touch on in a moment. During the fourth quarter, we delivered just shy of 500,000 square feet, with $28 million in annual NOI commencing during the quarter. For the year, we delivered 1.77 million square feet spread over 15 development and redevelopment projects, with annual NOI of $119.2 million commencing during the year. Initial stabilized yields for recent deliveries averaged 6.8% and 6.3% on a cash basis, reflecting the healthy contractual annual increases embedded into our leases. As of year-end, projects under construction and near-term projects expected to commence construction over the next four quarters totaled 7.6 million square feet and are 72% leased. Approximately 77% of that leasing has come from our approximately 1,000 existing tenant relationships. New projects added this quarter include 1450 Owens, which is approximately 213,000 square feet and will be 100% funded by our joint venture partner; and 10075 Barnes Canyon Road in Sorrento Mesa, which will be 50% funded by our joint venture partner. Both projects are under active leasing negotiations. Deliveries primarily commencing from the first quarter of '23 through the fourth quarter are expected to add $655 million in annual incremental NOI, reflecting a strong pipeline driven by consistent demand even in this volatile time. Transitioning to leasing, the fourth quarter results continue to demonstrate the strength of our unique one-of-a-kind company, with leasing volume of 2,322 square feet leased in the quarter, the fourth highest total in company history. The 8,405,587 square feet leased for the year is the second highest annual total in company history. And as you can see in the supplemental, the -- our guidance for strong mark-to-market growth remains unchanged from Investor Day with a range of 27% to 32% on a GAAP basis and 11% to 16% on cash. These results are certainly reflective of Hallie's commentary on the strength of VC funding and the stellar 2022 performance of large pharma. With $300 billion in cash on hand, we anticipate further investment in growth from this high-credit tenant sector in 2023. And the successful conversion of early innovation to commercialization reflected in the 37 FDA approvals in 2022 will incentivize continued investment in new and existing companies that have sound business models and underlying science, a cohort of companies Alexandria has a unique ability to identify. The highest quality life science tenants always consider occupancy in the best assets as an imperative. Their facility and campus are not only used for research and development, but is a critical tool for them to recruit and retain the best scientific and management talent in the world, which is by far their greatest asset. Therefore, demand for Alexandria facilities and our unrivaled mega campuses remains healthy as the facilities are A+, and our operational excellence is highly sought after. Moving to construction cost trends. At a high level, it appears the construction industry is on the cusp of slowing down. One of the leading economic indicators of the industry is the AIA Architectural Billings Index that leads nonresidential construction activity by nine to 12 months. Design work is at the front end of projects, so architects are the first consultants to slow down. Recent numbers show the 3% moving average heading towards no growth in billings, and commentary from the AIA was that fewer clients are expressing interest in starting new projects. For the first time since the postpandemic restart of construction projects, which was the genesis of significant cost inflation and supply chain problems, we're starting to see some signs of materials pricing flattening out and general contractors and subcontractors looking for work. That said, there are still items such as aluminum, rebar, copper and glass of 16% to 21% over this time last year, and it's still very difficult to obtain electrical switchgear, emergency generators, building controls and smart air handling units because despite an improvement in availability of chips, there are more products using chips than ever before so demand for them is still ahead of supply. Laboratory buildings are heavy consumers of these hard-to-get items so to keep a laboratory construction project on time and on budget is a difficult task. Alexandria has the Intel and experience needed to make quick decisions and relationships with critical vendors to ensure we have access to the materials and labor needed to meet our schedule and budgets. Despite the continued construction market pressures, as mentioned, we do believe the industry is on the cusp of slowing down, and we do expect cost escalations to reflect that in 2023, reducing from 9% to 10% -- from the range of 9% to 10% experienced in 2022 to 4% to 6% in 2023. However, the $2.3 trillion infrastructure spend over the next eight years will continue to put pressure on costs and labor so we will continue to conservatively underwrite and manage our value creation projects. As of the end of the year, 81% of our active development and redevelopment projects, aggregating 5.6 million square feet, are under GMP or other fixed contracts, which is consistent with the run rate we have maintained during these volatile times. Anticipating year-end volatility in the real estate investment markets, we completed our 2022 value harvesting and asset recycling efforts in the third quarter with impeccable execution as we laid out at Investor Day. Overall, we completed $2.2 billion of value harvesting, with the improved properties achieving a weighted average cap rate of 4.4%, realizing a total gain of $1.2 billion and a value creation margin of 107%. This is a tremendous achievement considering the volatile interest rate environment in 2022 with many real estate investors on the sidelines. It speaks to the desirability of our assets, which are in the best markets with high-quality tenants and managed with operational excellence. High-quality life science assets are scarce, and that is reflected in the pricing. We have started working on, and are making good progress on 2023 value harvesting and asset recycling, and we'll update you on that next quarter. But in the meantime, we'd like to report on three notable non-Alexandria sales that illustrate that there is still strong demand for life science real estate product. The first is the sale of 1828 El Camino Real and [indiscernible] in the Bay Area. Anchored by three non-credit life science tenants, the property is 98% leased, but is extremely low quality, with limited window line, no shipping and receiving, no backup power and venting through the windows to get adequate HVAC. Despite this, an investor paid $902 per square foot for this asset at a cap rate of 5.8%. The second trade was in the Route 128 submarket of Lexington, where a single non-credit tenant occupied 101,310 square foot manufacturing building at 20 McGuire Road sold in October for $878 per square foot and a 6.2% cap rate. The third comp, which closed last week, is an R&D campus known as the Gauge and Center Point in the Route 128 submarket of Waltham. It traded for $983 per square foot and a 5% cap rate. It was reported that some of that -- some vacancy existed at that property and that the stabilized return is likely to be in the high 5s. As the Fed continues to pull levers to battle inflation, we expect we will see cap rates move up, but much less on a relative basis to other product types, and thus we remain well positioned to fund our value creation pipeline efficiently and at a relatively attractive pricing by harvesting our value creation among other sources. Thanks, Peter. Dean Shigenaga here. Good afternoon, everyone. We'll jump right in here. Our team is very pleased to have the strongest balance sheet in the company's history as of December 31. And this really is a result of disciplined execution of liability management year-to-year over the past decade. Our key highlights include, we really have earned our corporate credit ratings that rank in the top 10% of the REIT industry today. We ended the year with tremendous liquidity of $5.3 billion that provides us important flexibility in this macro environment. No debt maturities until 2025, a statement only a small handful of REITs can make today, and a weighted average remaining term of debt at 13.2 years. Net debt to adjusted EBITDA was 5.1 times on a quarter annualized basis, 5.2x on a trailing 12-month basis. The fixed charge coverage ratio was very strong at 5.0x, and 99.4% of outstanding debt is subject to fixed interest rates. Our team had outstanding execution in 2022 on our strategic capital plan. Key highlights include $1.8 billion of 12-year and 30-year bonds, with a weighted average rate of 3.28%, the term of 22 years completed in February of 2022. Outstanding execution by our team, as Peter had highlighted, on outright dispositions, partial interest sales, aggregating $2.2 billion, with an amazing $1.2 billion in gains or consideration in excess of booked value, a 4.4% cap rate on cash NOI, all exceptional statistics and significant value creation tap for reinvestment. We had disciplined issuance of common equity with proceeds aggregating $2.5 billion at an average price of $189 per share, including 105 million sold under forward equity sales agreements in December of 2022. On a blended basis for the year, we felt comfortable executing on the modest $105 million under the equity under forward equity sales agreements in December at roughly $150 per share. Now briefly on the bond market, the beginning of 2023 has been positive for high-quality issuers like Alexandria. Overall pricing for 10-year bonds for Alexandria has significantly improved, and as of yesterday, was in the upper 4% range or just below 5%. For 2023, we will continue to focus on execution of real estate dispositions and partial interest sales or joint ventures for a significant component of our 2023 capital plan. Two transactions are under executed LOI to bring in a partner on a portion of each asset. These transactions will provide approximately $370 million of equity-type capital in 2023, and there are other transactions that we expect to complete this year. Turning to operating and financial results, really, congratulations to our entire team for outstanding execution this year or in 2022 during a very challenging macro environment. We reported total revenues of $2.6 billion, up 22.5% over 2021, with FFO per share as adjusted of $8.42, up 8.5% over 2021, and outperforming our initial outlook for 2022 of $8.36 by $0.06, and ahead of consensus, both for the fourth quarter and the full year of 2022. Now diving into key highlights from our truly amazing operating and financial results for 2022. Strong rental rate growth, leasing volume and occupancy growth drove record same-property NOI growth in 2022 of 6.6% and 9.6% on a cash basis, exceeding our 10-year average same-property NOI growth prior to 2022 of 6% and 2.9% on a cash basis. The last four years of rental rate growth on lease renewals and releasing the space have been the highest in the company's history, including rental rate growth of 31% in 2022. Over the last two years, cash rental rate growth has been the highest in the company's history, including 22.1% for the full year of 2022. Leasing volume in the fourth quarter was robust relative to the quarterly average volume in recent years in the range of 1.1 to 1.3 rentable square feet per quarter, highlighting the continued demand from our client tenants. Now the last two years have generated the two highest annual periods of rentable square feet leased, including 8.4 million rentable square feet in 2022. three out of the last four quarters represented the highest quarterly periods of rentable square feet leased, including two million square feet in the fourth quarter. Now turning to occupancy, occupancy was up 80 basis points since the beginning of 2021 to 94.8% as of December 31. Now looking forward into 2023, we expect a slight decline in occupancy in the first half of the year, with recovery expected in the second half of the year. We had a similar dip in occupancy in 2022, specifically overall strong occupancy in the year, but we did have a 40-basis-point decline from the first quarter of '22 to the third quarter of '22. For 2023, we expect temporary vacancy beginning in the first quarter related to spaces that, on average, are expected to generate significant rental rate growth, greater than 60% on a cash basis. Now these spaces are forecasted for occupancy over the next five quarters. This includes a mix of small redevelopment space, i.e., the first time conversion to lab space, normal lease expirations and a few early tenant departures. Importantly, consistent with our general quarter-to-quarter growth in FFO per share for many years, we expect quarter-to-quarter growth in FFO per share in 2023. Now a few other key highlights. 90% of our annual rental revenue is from investment-grade or large-cap publicly traded companies within our top 20 tenants, highlighting the high-quality list of client tenants that our team has curated over the years. 99.4% of collections of January rent through January 27, just highlighting the continued strength of rent collections. And we had a very strong adjusted EBITDA margin of 69%, highlighting execution of operational excellence by our team. Cash flows from operating activities after dividends for 2023 is expected to be very strong at $375 million at the midpoint of our guidance, and will continue to support growth in our annual common stock dividends per share. Our FFO payout ratio was very solid at 58% for the fourth quarter. And at this pace, cash flows from operating activities after dividends, over the next three years, should generate over $1 billion and that's an amazing statistic and very efficient capital for reinvestment. Now turning to a couple of important real estate highlights. Construction in progress, otherwise known as CIP is forecasted to peak in the first quarter, then declined slightly through 2023 as the dollar amount of deliveries are expected to exceed additions to CIP quarter-to-quarter, highlighting the significant volume of deliveries over the next couple of years. As Peter had highlighted, we have 7.6 million rentable square feet of projects that are 72% leased and projected to generate $655 million of incremental net operating income over the next three years. In the fourth quarter, we recognized impairments aggregating $26.2 million on real estate, primarily related to a few assets we plan to sell in 2023. Each asset is small and represents noncore assets no longer strategic for Alexandria to own. And to put this into perspective, the book value of assets held for sale was approximately $120 million as of December 31. The key takeaway is that from time to time, we review our asset base and proceed with selective sales that continue to enhance the quality of the remaining asset base. Briefly on venture investments. FFO per share as adjusted over the last 2 years has included an average of $103 million of realized gains each year from venture investments, or approximately $26 million per quarter. Now quarterly gains from venture investments in 2023 are expected to be up slightly in comparison to this recent quarterly run rate. As of December 31, 2022, we had gross unrealized gains of $506 million on a cost basis of $1.15 billion, highlighting significant value in our venture investment portfolio. Now investments in our venture portfolio have been very modest, at less than $70 million in aggregate over the last five years, including $20.5 million that we recognized in the fourth quarter. Turning to guidance. We reaffirm guidance for 2023 that was initially provided in connection with our Annual Investor Day on November 30 with 1 minor update. We updated excess cash held from bond proceeds to $300 million, representing a $50 million increase from the midpoint of our prior guidance. Our 2023 guidance for EPS diluted is a range from $3.41 to $3.61, and FFO per share as adjusted diluted is a range from $8.86 to $9.06 with no change in the midpoint of $8.96. Now under the current common stock distribution agreement we have in place, otherwise known as our ATM program, we have approximately 142 remaining available. We expect to file a new program in the first quarter of '23. Please refer to Page 6 of our supplemental package for detailed underlying assumptions included in our strong outlook for the full year of 2023. I guess I wanted to just circle back to some comments, Dean, you made about some of the pending sales and joint venture interest. I'm just wondering if either you or Peter could provide a little bit more color on what the institutional market is sort of looking for? Maybe how pricing has changed over the past six months? And can you give us any sort of flavor on the timing of when some of these transactions make it over the finish line? Yes. This is Joel. I think we'll try to be general in that given that we have -- we're at the letter of intent stage on a number of transactions. But maybe, Peter, you could give kind of a topside view. Sure. Obviously, there's only a few product types out there that people are comfortable in investing in right now. And obviously, life science real estate is 1 of them. So we are -- I mean, been receiving calls on a fairly regular basis from some existing partners that are excited to see what we have going this year. As I mentioned during my comments, cap rates are expected to rise from the peak. But as I've also said in the past, we don't anticipate, on a relative basis, to be very high. And I'm not going to speculate right now on where they'll be. We'll start reporting once we have more data, but they will be sticky given the scarcity of opportunities for life science real estate. Okay. And then just a second question, Joel. I know acquisitions are not a huge part of the plan right now, it's mostly development. But maybe could you just comment on the 2 deals that you did announce in the quarter and kind of the strategic rationale for both of those projects, and how you think about pricing on those versus your development opportunities? Yes. So each one of those was unique in and of itself. I don't want to get too granular, but I think the one in the Route 128 corridor really enables us to piece together three different projects into a more than 1-million-square-foot mega campus, and we have some great activity from our 1,000 tenants to help fill that. So we're very optimistic on that and feel like that was very strategic. It's also under lease back for a number of years, so it will be continuing to cash flow. The other acquisition was a unique acquisition in downtown Austin. We felt that it was a superb location. It's also under a lease back for a period of time. So we'll continue to generate good revenue, and I won't comment on what our future business plan is for that, but we think there's a really great opportunity to do something unique in that spot, if that's helpful. So I was wondering what are your thoughts on the sublet market in the sector? And have you seen an uptick with more companies subleasing space across the board and specifically in your markets? And could you please remind us what percentage, if any, of your portfolio is currently subleased? Yes. I've got some sublease statistics so I will -- for our larger markets. I will say that the amount of sublease space overall has come down in the -- over the last couple of quarters. One of the reasons for that is built out lab space is very attractive, especially for companies today that want to try to limit their out-of-pocket investment in the space. So Boston is at about 4.7% right now sublease. And again, anything of quality and that's built out is moving fairly quickly. San Francisco has been reduced to 2.3% and San Diego only has 2.1%. So these are all very normalized numbers for any cycle. Okay. And just my second question on Sanofi. We noticed that the square footage day rent dropped by about 30,000 square feet quarter-over-quarter. I was wondering if you could provide some more color on that. Maybe going back to the Route 128 acquisition. Peter, you touched on some pretty favorable pricing it seemed like with transaction comps. I feel like that's probably 1 submarket that maybe there's been more worries around supply with. So maybe you can expand on sort of what you're seeing out there, has sentiment changed for that suburban market? I mean, obviously, when we think Boston, we think Cambridge being the highest quality market there, but maybe has a sentiment shifted in more of those suburban product? Yes, this is Joel. Let me make a topside comment, and then I'll turn it over to Peter. I think you have to -- if you're asking about general sentiment, Peter will comment if you're asking about our sentiment it's different because we generally have a certain targeted demand from our existing client base, and therefore, by making, say, the acquisition we did or doing things that we do to create an environment where companies want to go, it really is focused on our kind of game plan. Well, Waltham, the other surrounding areas, I think the sentiment is still positive. The group, that last comp, I talked about the campus that sold for a five cap, it was reported -- I think it was [indiscernible] that had the article that the group that sold it made $200 million on it. They only owned it for two years. So pretty good outcome. And obviously, if somebody is paying $200 million more than somewhat bought it for two years ago, maybe it was three years ago now, that -- they're a believer in the rent growth in the market. So the other reason that the comps are weighted towards the suburbs is very likely because there's just not a lot of available product to buy in Cambridge or the Seaport or Watertown. So the opportunities were just there. And I don't know if it says anything about the sentiment and probably just more about the availability. And keep in mind, there will always be demand among more R&D-light companies for Route 128 in Waltham than in the heart of Cambridge. That's just how it's been for decades now. Great. That's helpful. And then on the $1.4 billion of commitment costs from joint venture partners, I'm curious, are there any kind of restrictions around how that can be drawn down, how much these partners can fund? I think you've got some portion of that in your capital plan for this year. But anything you can expand on that would be helpful as well. Yes. I think the high-level concept on the $1.4 billion of commitments for funding from our JV partners, generally speaking, these are funding requirements related to our value creation pipeline, so construction funding commitments. And these commitments do extend out over multiple years out, two to three years depending on the joint venture. But given the recent increase in projects with joint ventures over the last, call it, four to six quarters, we just wanted to be sure that the investment community understood the significance of the commitments coming from our partners on just a handful of construction projects. So we'll continue that disclosure going forward. I saw in your top 20 tenants page in the sub. It looks like there's a footnote on 270 Bio saying the in-place cash rents are 20% to 25% below current market. Looks like that last quarter was 5 just 10% below current market. Just curious on what's driving that update? Yes. So it's Dean here, guys. So what we did was we looked more carefully at the actual space. I believe the prior quarter was slightly lower or showing a modest mark-to-market opportunity and it was reflective of looking at that specific property overall, but we realized we had to dive into the details a little bit further because it didn't make sense as we were looking at it for the current quarter. And as we looked at the space specifically, so a portion of the building and the specific space that they're occupying, there's a bigger mark-to-market opportunity. So we wanted to be sure we updated that number in the current quarter. So nothing changed from a real mark-to-market, but previously, it was the overall building. And today, it's just specifically, or this quarter it's specific to that space that they occupy. Okay. And then just -- since I'm newer to the story, just kind of curious why the disclosure on that type company. It looks like it has a small market cap. It's really due to that. Some -- occasionally, there's a tenant in the top 20 list of tenants that we did not curate ourselves or has a modest market cap, and we just want to provide some incremental color to some investors who don't need to research the details on their own. I totally was, sorry about, Joel. So Peter, you talked about cap rates in your opening comments, and I think, Dean, you mentioned some partial interests that are far along and may be announced shortly. How would you characterize the quality spectrum of what you're looking at for partial interest? Are we talking very high-quality assets like the Binney Street transaction a while back or more middle of the road is a mechanism to minimize the cap rate, but also keep hold of your best assets and not relinquish too much of that opportunity going forward? I'll start, Rich. The profile of what going on is good quality. We don't have much of anything outside, I think, of high quality. I mean, certainly some workhorse assets that we still hold, we've sold a lot of those. So the partial interest sales just because of the profile of our portfolio are typically going to be higher quality assets, and that's what we're working on now. I mean I don't think it does any good really to talk about pricing because we're still negotiating with people. And so better strategy to keep that to ourselves at this point. Fair enough. And then second question for me is for Dean. You have an average debt exploration, I think, of 13 years, you said, I think your average lease term expires in 7 or 8 years. I'm wondering if that provides you any opportunity in the future in the interest of matching liabilities with assets, your way conservative in that comparison as it stands today. Do you ever see that, that gap shrinking whereas maybe the opportunity to raise shorter-term debt or lengthen lease term would make sense for the company? I'm just curious if that spread that you have in place now is something that could wiggle around a little bit in the future? Rich, I guess the way to answer the question is I think we find significant value in the longer maturity profile given the size of our company and -- we have a meaningful maturity profile for a big company, right, or that matches a big company is maybe a better way of describing it. So the longer average debt term gives us a lot more flexibility to manage the overall maturity profile, right? Because if that was more like five years, with that much debt outstanding, it will be a lot to manage year-to-year on top of any growth capital. So I think strategically, the longer term of remaining maturity is a real positive for us. Appreciated Hallie's comments at the outset about tenant health and funding and commentary around Pfizer M&A really jumped out. Maybe, Peter or Joel, during prior M&A cycles in the biopharma industry, what was the read-through for real estate usage? Did acquirers tend to consolidate the footprint of their portfolio companies or were there further expansions? Yes. I can give you my thoughts, and Peter can share his. I think it's hard to compare past cycles because the level of technological development in biotech was so different. Today, it's much more sophisticated new modalities. So when you have M&A today, it used to be oftentimes you're buying a company for maybe a pipeline and you like to hold on to the people, but maybe space is less valuable going back maybe a decade or two. Today, that space is pretty critical, especially if it's located in a top-tier cluster market like Cambridge. Not only do you want the people for recruitment, retention and just working on the projects, but you've also got probably built into the space some pretty sophisticated new modality technologies, both at the lab side and in the R&D manufacturing, which is kind of integrated so closely. So I think it's harder to tell. I think, again, there's going to be a whole series of different types of uses of capital. A lot of it will be partnering, which has historically been probably the favorite approach of pharma. There will be some acquisitions. You've got a Federal Trade Commission that's pretty hostile to any acquisition in any industry these days. So you'll probably see bolt-on acquisitions where people will want to keep that group and that technology in tow. But I don't think it's is easy to look at, say, big mega mergers in the past and think that, that has any relevance to today. And I think the key buy line for life science in 2023, in addition to what Hallie kind of framed out is what will be the velocity, the depth and the focus of this large cash hoard $300 billion. And if you leverage it, you could be as much as $500 billion to $600 billion. But Peter, you could comment just historically and what you've seen. It used to be if you were like a one-trick pony, it was an acquisition and then you shut it down. I mean, a good example is company called ICOS in the Seattle area was bought by -- they developed Cialis, they were bought by Lilly, and they completely shut down. But with the rise of platform technologies, a lot of the M&A, were super beneficial to the growth of our clusters. Companies realized that these teams that they were buying -- or these companies were much more valuable than just the pipeline, but the teams were extremely important. So there were a number of companies. I mean I remember when I was in Seattle, a company got bought by Gilead It was a -- it was called Corus Pharma. They were a 5000-square-foot tenant. And right after that, the Gilead approached us, and we ended up doing a huge over 100000-square-foot deal with them so that they could expand the capabilities of the team. So as Joel said, it ebbs and flows. But I think if you look at the fact that, I think about 75 -- or in certain years, about 75% of products that have hit the market have started from external innovation that end up on -- in pharma's hands, it's pretty telling that, that is a long-lasting strategy to cone the biotech world, to buy the companies and to keep the teams in place because they generally have platforms and other products behind their initial ones. So I think the general trend in recent years has been to keep them in place and to expand. That would be my... Just to say that every acquisition is going to be very unique in terms of the types of products being acquired, the talent base that comes along with it, the market that it's in. And so we very much are acutely aware of kind of the one-off nature of every acquisition. And ultimately, for acquisitions where they may tuck it into the company, we see a net positive in the ecosystem. If it's a small company that does get folded in, those executives go on to create 1 more or multiple companies after that. So we've had some great examples in the past of a company gets acquired and then that CEO goes on to build a bigger and even larger company. So altogether, it's a net positive for the ecosystem, I would say no matter what the outcome is. And a great example in Seattle, as Peter mentioned, another great 1 is Celgene's acquisition of Juno and then the acquisition by Bristol-Myers, that's really one of their most critical advanced cell therapy outpost. So again, it's almost case by case, Rich. Great. I really appreciate the thoughts there. Maybe sticking with Pfizer, we did notice that in New York, 219 East 42nd Street moved from future developments to intermediate developments. If memory serves me, I think there was a 6-year sale leaseback on that asset. What are your current plans, if any, on that building in a potential project? Yes. So that building, which we acquired had a leaseback to Pfizer. Remember, it's an office building for Pfizer, but it unique in New York, very few buildings have the bones to be converted to lab. They are moving to Hudson Yards, as you know, and their lease is up, I think, out about 2 years or so. But we do have some internally generated demand for that from our current client base, and so we're moving that along. I know demand for fully built-out lab product is pretty high. But have you noticed any difference in the level of demand you're tracking in your development pipeline where tenants do need to invest a significant amount of cash outlays to build out that space? I mean has that dropped off noticeably over the past 6 to 12 months given the disruption in the capital markets? Yes. one of the reasons the sublease market has stayed in check even when there's been some disruptions to companies is the fact that -- and as we've talked about for now almost 2 years, the high cost of construction has just created a much more expensive proposition when you have to build out lab space. The news, though, is that there's just not a lot of sublease space to satisfy all the demand. So deals where the tenants have to invest space, such as our development and redevelopment deals do continue to go. But I mean, there -- if you're a Board and your company wants to expand and they can go into 25,000 to 35,000 square feet of existing space, even though it might be in a different building and even the different neighborhood, they're going to consider that today just given the costs. We're still doing fine in our leasing of our development and redevelopment portfolio. But there is a sentiment that if there's an existing available space just try to grab it. Okay. Dean, do you know if you're like competitors on the development pipeline? I mean, is that where the drop-off in demand is coming from is that first-generation type space? Well, I think that the reason that others aren't as successful just because they don't have our brand. I mean it's -- we've talked about it for years and years. And there's a lot to be said about the operational excellence we bring, the management of the facilities to the design of the facilities. I think -- to the extent that there's projects out there that are pausing even after they've gone vertical or remain vacant, it's a number of things. One is that the location isn't comparable to ours; two, they've underwritten very high rents because they need to, their basis isn't very good; and three, they don't have a reputation to manage these critical infrastructure building. So I would say that, that's really the reason behind a lot of the competitive buildings not... And major overruns on budgets, I can think of 1 project in Boston where a client went there because we didn't have exactly the space that they needed, and then they came back to us when the developer had a huge overrun on costs. So that goes on all the time. Okay. And then just last 1 for me. I was looking at your current tenant roster versus the prior quarter, and it looks like Maxar Technologies dropped off the list. I mean is that a fair read? Am I looking at that correctly? And can you give us a sense of what happens there? Yes. That is a project that we own where they're rotating out of that, and that will be a future development project -- redevelopment and development. Maybe this is for Dean. But I wanted to talk about the leasing spread. When you excluded the 2 leases in the quarter, obviously, very strong performance for the company overall. Curious about the guide for this year, which you gave in December, reaffirmed last night. But at the 11% to 16%, I think you had said that there was some incremental component of that that was non-life science maybe. But can you give us a sense of kind of that 11% to 16%. Is that more a function of kind of market rents may be slowing down? Or is that just a function of kind of more different leases that have been added to that pool? Dave, its Dean here. Lab rents remain healthy as you can tell from leasing statistics in the fourth quarter. Hard to really look out well as you go out into the future, and lab rents are trending well, as we noted from our results. There is a slight mix at play in '23 with certain expirations coming up and certain leasing activity we expect to accomplish, call it, non-lab product. But that product is a small percentage of the portfolio. Rental rates overall, even when you blend it all together, will remain very strong. That's fair. And then maybe to follow up, Peter, in your last question in terms of kind of market rent growth, it sounds like it's bifurcating even further, probably between kind of the higher-quality and lower-quality assets. What does that spread look like today maybe across the portfolio or maybe pick the top three clusters in terms of kind of where replacement rents might be going versus where maybe a more traditional kind of A- asset might be performing today at a market rent level? I can really only speak to our rents. I just don't have a lot of visibility to outside of the asking rents that we are hearing from competitive buildings. Our newer product and our -- in our older product, there's not much of a spread between it. Typically, you might see even a 10% to 15% premium for new buildings over older buildings. I think probably the availability of existing space makes the existing space more valuable today. But it also, I think, speaks to just the quality of our overall portfolio. We don't have a lot of B assets that you would -- that you could say that out in the suburbs, the single-story stuff that's not amenitized. Still, the rents, I can -- in the greater Boston, I mean, the rents out there for that type of product or are in the $60 to $70 range. Compare that to the $100 to $120 in Cambridge and maybe the $85 to $100 in Seaport. It's still fairly close, but you do the math and that will give you the premium. I think overall, though, I would say that rents for lab space have not regressed at all and are still fairly strong, and the has not been a big movement in concessions like you might be seeing in the office market. I know I read a lot about the office market, and I know that rents for high-quality buildings have held there, but concessions have gotten really, really high. And that's not the case with us. Our rents have held well and concessions have remained constant. And I appreciate the color on some of the transactions that have happened lately. But just curious, when we look at cap rates for purpose-built lab product versus converted product, have you guys seen any cap rate differential between the 2? I don't have any specific examples other than maybe what I just talked about and the comp in is a really just terrible conversion. Burlingame is on the Peninsula. It is very close to South San Francisco. So to get a fully leased comp at an almost 6% cap rate, I think, probably illustrates that conversions aren't that appealing. I would expect good quality, purpose-built lab in Berlingame to be at least 100 to 150 basis points lower than that. Okay. That's helpful. And then, I guess, just looking at the supply picture, are there certain markets or submarkets where you're starting to see supply pick up and maybe become more of a risk here? The numbers are -- the numbers for availability are still kind of where they've been over the last few quarters. I mean, the biggest supply overhang in any of our markets is in South San Francisco, and it remains that way. That is -- that has not really changed. We -- there's a lot of talk about supply in Greater Boston. Majority of what's talked about hasn't broken ground, some assets have. A lot of them are in the Summerville area, which is not competitive to where our product is. So we're not too concerned about it. But yes, I think that the supply story is always 1 that we have to talk about. People are trying to get involved in the business. But the best locations are very difficult to get. And some people have tried to fan out in other areas such as Summerville with limited to no success, I think, at this point. Thanks for taking my question. So I know you spoke a lot about how differentiated AllexInterest portfolio is and leasing demand is. But if you look at the market that it does kind of show in some of these markets, you're seeing flattish rents and concessions rising and net effective rents been declining month-over-month or maybe quarter-over-quarter. Are you seeing that at all in your portfolio? I mean, are you still pushing rents? And I know you said the concessions haven't grown a lot, but can you just provide some more color on how that really looks for your business versus maybe what we're seeing overall in the market? Jamie, it's Dean here. Net effective rents have been positive over time for our business. So it's not declining, it's increasing. Can you say maybe by how much like quarter-over-quarter? Do that like a same-store basis, how much you're pushing net effective rents? I don't have it right in front of me, Jamie, but I don't have the exact statistic, but we recall reviewing it over the last month and it was a very solid positive trend. I mean it's -- look, our rents, cash and GAAP rents are up. Those are significant increases period-over-period. Net effective is just trailing out a little bit, but still directionally very substantial, right? Because their base net effective is based off your GAAP rents, right? Very strong. Yes. I wouldn't doubt, Jamie, that other developers are offering concessions to try to bridge the gap between the quality and reputation that we have and what they offer. Our numbers are still stable at this point. Okay. That's great news. And then I saw -- I noticed you did the $105 million forward equity agreement in the fourth quarter. Typically, this time of the year, sometimes you'll do a much larger one. Can you just decide -- can you just discuss the decision to do equity at all this quarter? And just how you think about why you didn't do something bigger? Jamie, it's Dean. As we looked at our wrapping up the year, there was an opportunity to raise a very modest amount, as you've mentioned, $105 million. And as we looked at our overall capital that we raised during the year, which I commented on, it blended in very attractively. While, it was done at $150, I think the overall blended common equity proceeds were about $189 per share. So just keeping things in perspective, there's a modest amount that we raised. And Jamie, going back to your other question, I just needed a second to pull it, but 1 second, I just lost the page. But on rental rate growth, we were at -- so 31% GAAP, '22 cash for the year. Net effective for the year was something around 37%. I guess I was thinking more in terms of just in the market today. I mean, you have a nice baked-in mark-to-market that's going to show up in leasing spreads. But are you able to still, versus last month, keep pushing rents? It sounds like you think you are on a net effective basis, but I was just hoping to get color on that. It sounds like you're asking what the first quarter is going to look like. Look, Jamie, in the fourth quarter and the year for 2022, we are very strong. So I don't have an outlook going into the first quarter for net effective, but again, 2022 is up 37% on a net effective basis. Okay. That's great. And I guess just going back to the equity raise. So it sounds like you kind of think about it on a 12-month view, like that kind of cleaned things up for '22 and then '23 kind of is a fresh start in your -- how you would raise equity? Well, maybe I think probably what's more important, Jamie, on the broad bucket of solving for equity-type capital, as I mentioned, we remain focused on dispositions and partial inter sales JV capital for a significant component of our capital plan for 2023. And we've got a couple of transactions that are fairly advanced right now executed LOI and moving through. So it's only January 31, and we feel like we're in a good spot moving on our capital plan there. And so we got to keep in mind that, that's an important component as well, Jamie, as it has been for many years now. Just a quick question on capitalized interest. I think there was a comment made earlier on that CIP would peak in first quarter and then slowly start to decline as you have deliveries. But I believe the CIP guidance is meaningfully above last year. Can you just help us kind of reconcile the difference? Just higher cost of capital being used to capitalize the CIP? Or how do we think about that? The year-over-year growth is more just a function of the size of activities undergoing construction today. As you know from our disclosures we have 7.6 million either under construction or near-term starts on average, 72% leased. If you look at the fourth quarter capped interest, which is reflective of the average basis under construction, it was $79.5 million of cap interest for the quarter. it was $73 million in the third quarter, so I'll call it up about $6 million. It was $68 million in the prior quarter, so up about $5 million quarter-over-quarter. If you were just to continue to project out that $4 million or $5 million increase quarter-to-quarter, you can kind of project out what half of the year would look like. And just double that from that point forward, you're now at the bottom end of the range of our guidance. So directionally, it should make sense if you look at it from a run rate perspective. This concludes our question-and-answer session. I would like to turn the conference back over to Joel Marcus for any closing remarks.
|
EarningCall_1158
|
Ladies and gentlemen, thank you for standing by, and welcome to NetScout's Third Quarter Fiscal Year 2023 Financial Results Conference Call. At this time, all parties are in a listen-only mode until the question-and-answer portion of the call. As a reminder, this call is being recorded. Tony Piazza, Senior Vice President of Corporate Finance and his colleagues at NetScout are on the line with us today. [Operator Instructions] Thank you, operator, and good morning, everyone. Welcome to NetScout's third quarter fiscal year 2023 conference call for the period ended December 31st, 2022. Joining me today are Anil Singhal, NetScout's President and Chief Executive Officer; Michael Szabados, NetScout's Chief Operating Officer; and Jean Bua, NetScout's Executive Vice President and Chief Financial Officer. There's a slide presentation that accompanies our prepared remarks. You can advance the slides in the webcast viewer to follow our commentary. Both the slides and the prepared remarks can be accessed in multiple areas within the Investor Relations section of our website at www.netscout.com, including the IR landing page under Financial Results, the webcast itself, and under Financial Information on the Quarterly Results page. Moving on to slide number three. Today's conference call will include forward-looking statements. Examples of forward-looking statements include statements regarding our future financial performance or position, results of operations, business strategy, plans and objectives of management for future operations, and other statements that are not historical facts. You can identify forward-looking statements by their use of forward-looking words such as anticipate, believe, plan, will, should, expect, or other comparable terms. We caution listeners not to place undue reliance on any forward-looking statements included in this presentation, which speak only as of today's date. These forward-looking statements involve risks and uncertainties and actual results could differ materially from the forward-looking statements due to known and unknown risks, uncertainties, assumptions, and other factors, including, but not limited to, those described on this slide and in today's financial results press release. For a more detailed description of the risk factors associated with the company, please refer to the company's annual report on Form 10-K for the fiscal year ended March 31st, 2022, on file with the Securities and Exchange Commission. NetScout assumes no obligation to update any forward-looking information contained in this communication or with respect to the announcements described herein. Let's now turn to slide number four, which involves non-GAAP metrics. While this slide presentation includes both GAAP and non-GAAP results, unless otherwise stated, financial information discussed on today's conference call will be on a non-GAAP basis only. The rationale for providing non-GAAP measures, along with the limitations of relying solely on those measures, is detailed on this slide and in today's press release. These measures should not be considered in isolation from or as a substitute for financial information prepared in accordance with GAAP. Reconciliations of all non-GAAP metrics with the applicable GAAP measures are provided in the appendix of the slide presentation, in today's earnings press release and on our website. Thank you, Tony, and good morning, everyone. Welcome and thank you all for joining us today. Letâs now turn to slide number six for a brief recap of our non-GAAP financial results in the third quarter and first nine months of our fiscal year 2023. In the third quarter, we delivered solid financial results with Q3 revenue of $269.5 million, representing year-over-year growth of approximately 3%. This revenue increase was driven by product revenue growth of 3.5% and service revenue growth of 2%, both on a year-over-year basis. As a result of this top-line growth and our healthy operating leverage, we delivered $1 of diluted earnings per share in the third quarter, representing a growth rate of approximately 12% year-over-year. Our service assurance performance was strong and was supported by the acceleration of service provider orders previously forecasted to occur in our fourth quarter. As such, we achieved higher quarterly sales, margins, and profitability on a year-over-year basis. Now, moving to the first nine months of fiscal year 2023. During the period, revenue was $706.4 million, growing by more than 6% year-over-year. On a year-over-year basis, product revenue grew nearly 10% and service revenue grew approximately 3%, while service assurance revenue grew by more than 8% and cybersecurity revenue grew by more than 1%. Additionally, we delivered $1.81 of diluted earnings per share in the first nine months of fiscal year 2023, representing approximately 16% year-over-year growth, more than double that of our revenue growth rate over the same period. Now, letâs move to slide 7 for some further perspective on market and business insights. In our service provider vertical, revenue grew by more than 9% year-over-year in the first nine months of fiscal year 2023. This increase was primarily driven by higher revenue related to radio frequency propagation modeling projects from Tier-1 carriers in North America. In addition, as mentioned earlier, we received some service provider customer orders in our third quarter that we had previously forecast to occur in our fourth quarter. Overall, both domestically and internationally, we continue to see carriers invest in their 5G-related network deployments. In our enterprise customer vertical, revenue grew by approximately 3% year-over-year in the first nine months of fiscal year 2023. This expansion was driven by growth in both our service assurance and cybersecurity business lines during the period. Notably, enterprises continued to require those solutions capable of helping them to better protect their systems and accelerate their digital transformations. To better address these market trends, we are focused on leveraging our growing suite of comprehensive offerings to provide customers with an integrated platform for service assurance and cybersecurity solutions. As the market for these solutions grows and converges, we are pleased to see that this approach is resonating with our customers. Michael will provide more insight regarding customer wins within our verticals during his remarks. Now, letâs move to slide number 8 to review our outlook. NetScout continues to play a mission-critical role for organizations around the globe. As Guardians of the Connected World, we provide our customers with what we believe to be unparalleled visibility into the performance and security of their digital operations. We are a trusted brand with more than three decades of operating experience, and our customers utilize our solutions to navigate and capitalize on the opportunities and challenges of todayâs digital landscape. Given our solid year-to-date performance, along with the acceleration of service provider orders, we now have increased visibility into our full fiscal year outlook. As such, we are updating our fiscal year 2023 outlook, which most recently -- which we most recently shared on our second quarter earnings call. We are narrowing our target total revenue range to be between $905 million and $915 million, from the prior range of $895 million to $925 million, with the mid-point of both ranges remaining the same. In addition, we are increasing our non-GAAP diluted earnings per share range to $2.06 and $2.10, from the prior range of $1.97 and $2.03. Jean will provide additional color on our outlook in her remarks. As we continue to closely monitor todayâs macro environment, we recognize that the current landscape remains dynamic. Nevertheless, we believe that we are well-positioned for the future and remain focused on achieving our long-term objectives. In addition, we plan to continue managing our operations prudently, with a balanced approach to revenue growth and profitability. Before I close my commentary, I wanted to mention for those that may have missed it, that we announced yesterday the addition of Shannon Nash and Marlene Pelage to the NetScout Board of Directors. Shannon and Marlene are two accomplished professionals who will bring additional financial and operational expertise, as well as other valuable experience to the Board. We are confident that they will play an important role as we advance our business. I personally look forward to working with them both. Thank you, Anil, and good morning, everyone. Slide 10 outlines the areas that I will be covering today, starting with customer wins. Customer Wins: in our service provider customer vertical, we remained focused on supporting providers as they further advanced their network build-outs. Through this focus, our robust portfolio of offerings, and established incumbency, we continued to expand our installed base. During the quarter, for example, a long-standing, Tier-1 North American carrier customer placed orders with us amounting to close to mid-eight figures. Consistent with Anilâs earlier comment, we had expected to receive a portion of these orders in our fourth quarter. Orders from this customer were for a combination of our service assurance and cybersecurity solutions, which included 5G core and RAN service assurance, additional radio frequency propagation modeling, and our CyberStream and Omnis Cyber Intelligence solutions, with this being the first time this customer purchased certain cybersecurity solutions from us. Importantly, these orders represented successful expansion within and outside of our traditional projects and in certain cases, we replaced competitorsâ products. Today, this customer is utilizing our solutions within both its mobile business and corporate IT systems, and we remain excited about this collaboration as a model for additional customer engagement going forward. Now, turning to our enterprise customer vertical. We received two notable mid-seven figure orders during the quarter. One was from a financial institution, while the other was from a healthcare organization, both of which are large-scale and long-standing customers. These wins represent an expansion of our service assurance footprint to new, mission-critical applications that are directly relevant to these customersâ success in their markets. Our ability to win these deals and continue expanding our footprint with our customers is a testament to the strength of our platform offerings, established incumbency, and ability to expand further within our existing customer base. Now about go-to-market activities. We also remained focused on driving business performance through go-to-market activities. During the quarter, we continued to attend more in-person events and collaborate with our partners. In November, we attended the AWS re:Invent conference, where we showcased NETSCOUTâs platform as well as our collaborations with AWS. At the event, we announced the successful interoperability between our Omnis Cyber Intelligence and Amazon Web Servicesâ Amazon Security Lake. By providing comprehensive network visibility, contextual cybersecurity investigation, and smart detection, Omnis Cyber Intelligence can pair with Amazon Security Lake to deliver advance network detection and response insights, ultimately allowing companies to better manage threats across complex hybrid-cloud infrastructures. In line with this progress, we also continued to capture mindshare with industry publications, winning two prestigious awards in recognition of our service assurance and cybersecurity solutions during the quarter. For service assurance, we received Frost & Sullivanâs 2022 Global Company of the Year Award for our wireless network monitoring and service assurance solutions. Frost & Sullivan presented us with this recognition based on our compelling customer value proposition, customer experience, strong brand equity, and overall solid performance. In addition, we received Security Todayâs 2022 CyberSecured Award for Network Security. This recognition was based on the Arbor Edge Defense solutionâs ability to effectively stop both inbound and outbound threats, and in doing so, to serve as both the first and last line of defense for organizations. Finally, I'd like to touch on our Annual Engage Technology and User Summit. Usually, this event is held in April, and I provide everyone with an event preview on our third quarter call this one. However, this time, to better align with our customer's planning and budgeting cycles, we plan to hold our Engage 2023 Summit in October. Thus, I will provide everyone with an update on this event later this year, as we move closer to its arrival. Thank you, Michael, and good morning, everyone. I will review key metrics for our third quarter and first nine months of fiscal year 2023 and provide some additional commentary on our fiscal year 2023 outlook. As a reminder, this review focuses on our non-GAAP results unless otherwise stated, and all reconciliations with our GAAP results appear in the presentation appendix. Regardless, I will note the nature of any such comparisons. Slide number 12 details the results for the third quarter and first nine months of our fiscal year 2023. Focusing first on our quarterly performance, total revenue grew 2.8% year-over-year to $269.5 million. Product revenue grew 3.5%, and service revenue grew 2%, both on a year-over-year basis. At the end of the third quarter, our backlog was approximately $54 million, consisting of approximately $31 million of fulfillable orders and approximately $23 million of radio frequency propagation modeling projects, with most of the radio frequency propagation modeling amount categorized as deferred revenue from a financial reporting perspective. As a reminder, while fulfillable orders are those we consider ready and available to be converted into revenue upon shipment or fulfillment, the radio frequency propagation modeling projects require certain execution steps, in conjunction with the carrierâs timing, before they can convert to revenue. Gross profit margin was 80.5% in the third quarter, up 1.7 percentage points year-over-year. This quarterâs gross margin was impacted by the acceleration of a high-margin radio frequency propagation modeling project that was expected to occur in our fourth quarter. Quarterly operating expenses increased 1.7% year-over-year, mostly due to the return of pre-pandemic activities, such as travel and events. We reported an operating profit margin of 35.5%, compared with 33.2% in the same quarter last year. Diluted earnings per share was $1 compared with $0.89 in the same quarter last year, representing an increase of 12.4% year-over-year. Turning to slide 13, Iâd now like to review key revenue trends by customer verticals and product lines. Please note that all comparisons here are on a year-over-year basis, consistent with our other remarks. In the first nine months of fiscal year 2023, our service provider customer vertical revenue grew 9.3%, while our enterprise customer vertical revenue grew 3.2%, both on a year-over-year basis. During the same period, our service provider customer vertical accounted for approximately 52% of our total revenue, while our enterprise customer vertical accounted for the remaining 48%. Now, turning to our product lines. For the first nine months of fiscal year 2023, our service assurance revenue increased by 8.1%, while our cybersecurity revenue increased by 1.4%, both on a year-over-year basis. During the same period, our service assurance product line accounted for approximately 75% of our total revenue, while our cybersecurity product line accounted for the remaining 25%. Turning to slide 14, which shows our geographic revenue mix. In the first nine months of fiscal year 2023, our revenue was more concentrated in the US year-over-year, primarily due to the increase in revenue related to radio frequency propagation modeling projects from Tier 1 domestic carriers. Additionally, one customer represented 10% or more of our total revenue in the third quarter and first nine months of our fiscal year 2023. Slide 15 details our balance sheet highlights and free cash flow. We ended the third quarter with $416.2 million in cash, cash equivalents, and short- and long-term marketable securities, representing an increase of $49.1 million since the end of the second quarter of fiscal year 2023. Free cash flow for the quarter was $43.2 million. During the third quarter of fiscal year 2023, we concluded our Accelerated Share Repurchase transaction, receiving the final 1.3 million shares, which resulted in a total repurchase amount of $150 million or approximately 4.6 million shares, at a weighted average price per share of $32.97. From a debt perspective, we ended the third quarter of fiscal year 2023 with $200 million outstanding on our $800 million revolving credit facility, which expires in July 2026. To briefly recap our other balance sheet highlights, accounts receivable, net, was $215.8 million, representing an increase of $67.6 million since March 31st, 2022. The DSO metric at the end of the third quarter of fiscal year 2023 was 69 days, versus 76 days at the end of the third quarter of fiscal year 2022 and 64 days at the end of fiscal year 2022. Letâs move to slide 16 for commentary on our outlook. I will focus my review on our non-GAAP targets for fiscal year 2023. As Anil noted earlier, we are updating our non-GAAP outlook for fiscal year 2023 that was last presented on October 27th, 2022, during our second quarter fiscal year 2023 earnings call. We now anticipate revenue in the range of $905 million to $915 million. The midpoint of this range remains the same as that of our prior range and continues to imply a mid-single-digit topline growth rate. In addition, we now anticipate non-GAAP diluted earnings per share to be between $2.06 and $2.10, increasing the midpoint by $0.08 and implying a low-double-digit year-over-year growth rate for our bottom-line. This forecast utilizes an anticipated effective tax rate in the range of 20% to 22%. It also assumes between 73 million and 74 million weighted average diluted shares outstanding, which includes the impact of the $150 million accelerated share repurchase program, with a partial offset for stock compensation dilution. The increase in our non-GAAP diluted EPS outlook is primarily attributable to the recent large radio frequency propagation modeling project leveraging library data, which has an above-average gross margin when compared with similar projects. It is also due to the slower return of pre-pandemic travel-related costs than was originally anticipated, as well as continued cost management efforts. That concludes my formal review of our financial results. Thank you and Iâll now turn the call over to the operator for Q&A. Great. Thanks for taking my questions. Anil, strong results in the quarter, particularly service assurance. There's obviously a lot of concern about just general IT spending patterns for calendar 2023. Can you start just by talking about your conversations with customers and executives? And how do you think about prioritizing new projects this year? Well, so far, Matt, thanks for your question. So, right now, we are still getting -- gathering data and we are confident about our guidance for this year. And by the time we reach April on the next conference call, I think we'll have a lot more detail and that will obviously influence some guidance for next year. Right now, we are not getting any direct indication from the customers about slowdowns and budget controls, but we hear other releases from NEMs and other players which indirectly point to that. So, right now, we have sort of a wait and see attitude. Our customers are still very interested in our solutions. Sometimes in slower times, there is more tool consolidation. So, right now, we are not in a position to really say how that next year is going to work out. Fortunately, we have three months to assess that and then we'll project our guidance accordingly. Got it. Thanks. And then maybe on your cyber business, growth is slowing a bit there, which candidly is consistent with a lot of the field work that we've done. Can you talk about why this might be? And are there any things like a new product front in calendar 2023 that might help that growth profile? Yeah. So in the cybersecurity area, we have -- I mean, we introduced a new product about nine months ago. And it has a slow uptick, and there are some learnings from there. And also, you will see that there will be some pickup when we do year-over-year number, the percentage will come slightly higher after Q4 in cybersecurity. But really, the new product, which we announced has a slower traction and we got a lot of customer input, and I think it's going to pick up slightly more in Q4. But I think next year, we should see much better results in cybersecurity. Hey guys, congrats on the quarter here. I just wanted to touch on that mid eight-figure service provider order a bit. You guys mentioned a little bit of a pull-in from fiscal Q4. And we're backing in roughly based on your guide for the year, about $90 million of product revenue for fiscal Q4. Is there any way to think about that pull in and normalizing for that at this point? Okay. I think Jean is looking into that. But I don't know whether your question is that, I mean, obviously, that pull-forward was not there then our Q4 would have been bigger than what we are projecting. But on a full quarter basis, I think it was just normalized. So we got some advanced orders in Q3, once we got advanced order in Q3, which made the Q3 bigger than expected. Yeah. Maybe just looking that up for you. You mentioned long-term objectives here. Can you just refresh us where we are on those long-term objectives and how you're thinking about those? And additionally, you mentioned on that deal that it's the first time that this customer purchased cybersecurity from NetScout, do you have any sense to what the white space opportunity is, or your current penetration of accounts is with security? Yeah. So I think basically, we have current -- so cybersecurity is a little bit continued. We have an ongoing business with Arbor, which is roughly 25% of the total business. This other stuff, which we talked about today, was the new product we announced Omnis Cyber Intelligence and CyberStream last year and which was a slow uptick notwithstanding this big order or a couple of big orders. And so in terms of number of customers, I mean, less than 5% of our service assurance customers who can use our cybersecurity product has been sold the cybersecurity product. So, there's a lot of scope, and this is only first nine months. And so we are counting on much bigger growth from that source and from the DDoS business, flat to single digit up and then additional stuff coming from the Omnis Cyber Security. And that's what we are saying that, while we did get a couple of big orders on this from existing customers, the penetration rate has been slow and we are putting more resources and creating a -- relaunching that product in April, which will have a big, I think, impact next year. Hi Jim, this is Jean. So, in reference to the question that you were asking about the effect of orders that we received in Q4 versus -- Q3, I'm sorry, versus Q4. I would say that the pull-forward was probably close to $25 million with a little more than half of that being a radio frequency calibration modeling projects that gave us the higher gross margins. So, you're looking at the math that is at the midpoint of our guidance, which is $910 million, the number of -- I think you said $92 million in Q4 for product revenue would be accurate. That would represent still a 12% year-over-year growth from Q4 of 2022. And at the midpoint of guidance, we would have about a 6% year-over-year growth from FY '22. Good morning. I just wanted to get some of your thoughts around kind of the CapEx cycle from the large Tier 1 providers in North America. Could you just comment a bit on if you think NetScout has benefited disproportionately from kind of the outside spend they had on Seabed [ph] spectrum deployment this year? And then, whether there are any sort of emerging 5G use cases that you think will continue to carry the business forward on the service assurance side? Yes. So we are relying a lot, Kevin, on our incumbency with the top end carriers around the world. And there were some challenges two years ago, where slow spend on 5G or competition from other sources, and that has all settled down, and we started seeing a lot of business initially in the calibration area, some of it was in the backlog starting this year, , which helped the revenue and other is just more 5G spend. So, we think that there is still a lot of spend to be done in the -- with the same customers to put additional capacity in 5G area. But given some recent announcement of some NEMs and infrastructure companies, potential slowdown CapEx spending, we are just having this wait-and-see attitude until April. So I think we'll be in a better position when we have -- we'll have -- weâll know much more about the budgets. Fortunately, our fiscal year is three months later than some of the other people fiscal year, our customers. So at this point, I think we really -- we did benefit from all the investments we made. I mean, almost 100 maneuvers were spent on 5G technology over the last three, four years by us. And so that's what -- that beginning to pay off. But how does this impacted by the macro environment next year remains to be same. Understood. And then just on fiber, I was hoping you could elaborate on some of the learnings you've had as you've rolled out the new solution. Is it more kind of additional product features that need to be added integrations. I'm just kind of curious what the customer feedback has been? Yes. So I think basically, as happens in the first year of the product, I mean, we gather a lot of information and competitive information. And I think maybe our expectation was too high in the first year. I mean, we're going to do over $10 million to $15 million in the nine months of introduction so far. So I think overall, that's the main thing. We are just fine-tuning of our strategy at adding some feature set and some of the comments we have got from other customers. The integration with other security tools has actually gone very well, and that was not a reason for it just takes time. The sales cycle in the new product takes longer than the other products. And also sometimes, as I mentioned, the cybersecurity includes the new product as well as the traditional Arbor DDoS business. And some of it is seasonal, and there will be some improvement on the percentage growth year-over-year versus the first nine months as the fourth quarter closes. We have reached our allotted time for Q&A. I will now turn the call back over to Tony for any additional or closing remarks. Thank you, operator, and thank you all for joining us today. That concludes our call for the third quarter of fiscal year 2023. Enjoy the rest of the day.
|
EarningCall_1159
|
Good afternoon, ladies and gentlemen, and welcome to Richelieu Hardware Fourth Quarter Results Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session, which will be restricted to analysts only. [Operator Instructions] Also note that the call is being recorded on January 19, 2023. Merci. Thank you. Good afternoon, ladies and gentlemen, and welcome to the Richelieu's conference call for the fourth quarter and 12-months period ended November 30, 2022. With me is Antoine Auclair, CFO. As usual, note that some of today's issues include forward-looking information, which is provided with the usual disclaimer as reported in our financial filings. First, let's look at our fourth quarter where our sales benefited from both acquisition and internal growth. The sales increase was driven by a strong performance in the manufacturers market in the U.S., where the three acquisitions closed in the first quarter made the major contribution. Namely, Compi distributor; HGH Hardware; and National Builders Hardware jointly they operate nine distribution centers in six different states. As for the retailers and renovation superstores market, sales remained stable over the last year. We closed our fourth acquisition of the year in September Quincaillerie Deno, a specialty hardware distributor operating one distribution center in Montreal. Together, the four acquisitions closed in 2022, represent additional sales of approximately $125 million on an annual basis. As for 2022, it was another year of strong growth fueled by both internal growth and acquisitions. We are very pleased with the performance achieved in all our markets especially in U.S., where the growth was 42.2%, now representing 40% of our total sales. Our innovation and acquisition strategies, our focus on customer service, the diversification of our market segments and our successful website richelieu.com, all these trends contributed to bear fruit and be our best growth levels. Iâm also pleased to announce that the Board of Directors approved this morning a rise of 15.4% in our quarterly dividend to $0.15 per share. Thanks, Richard. Our fourth quarter sales reached $458 million, up 14.9%. Sales to manufacturers stood at $398 million, up 17.4% of which 7.8% from internal growth and 9.6% from acquisitions. In the hardware retailers and renovation superstores market, we achieved sales of $60 million in line with 2021. In Canada, sales amounted to $274 million, an increase of $13.4 million or 5.2%. Our sales to manufacturers reached $226 million, up 5%. As for retailers market, sales stood at $47.5 million, up 5.8%. In the U.S. sales totaled US$136 million, up 24.1% of which 2.8% resulting from internal growth and 21.3% from acquisitions. Sales to manufacturers reached US$127.5 million, up 29.4%. In the retailers market, sales were down by US$2.5 million. Total sales in the U.S. reached CAD184 million, an increase of 33.2%, representing 40.2% of our total sales. Total sales in 2022 reached $1.8 billion, up 25.2% of which 13.4% from internal growth and 11.8% from acquisitions. Sales to manufacturers reached $1.6 billion, up 28.9% of which 15.9% from internal growth and 13% from acquisition. These increases are the result of sustained demand in the renovation market in 2022, as well as higher selling price. Sales to hardware retailers grew by 6.3% or $14.9 million to $251.5 million mostly from acquisitions. In Canada, sales totaled $1.1 billion, up 13.7% of which 10.3% from internal growth and 3.4% from acquisitions. Our sales to manufacturers amounted to $877 million, up by 14.2% of which 11.7% from internal growth and 2.5% from acquisitions. Sales to hardware retailers and renovation superstores were $177 million, up 11.7%. In the U.S. sales amounted to US$562.5 million, up 42.2% of which 15.4% from internal growth and 26.8% from acquisitions. We reached CAD728 million, up 46.9% accounting for 40% of total sales. Sales to manufacturers reached US$521 million, an increase of 49.7% and sales to hardware retailers were down by 12.9%. Fourth quarter EBITDA stood at $76.7 million, compared with $71.3 million last year, up 7.5%. EBITDA margins stood at 16.8%. For the year, EBITDA was $287.4 million, up 22.6% and EBITDA margins stood at 15.9%. Fourth quarter net earnings attributable to shareholders totaled $44.9 million, compared with $44.6 million last year. Diluted net earnings per share reached $0.80, compared with $0.79 in 2021. For the year net earnings reached $168 million, an increase of 18.8% and $2.99 per share, compared with $2.51 per share last year. Fourth quarter cash flow from operating activities before net change in non-cash working capital balances were up 8.3% to $60.4 million or $1.07 per share. Net change in non-cash working capital balances used cash flow of $58.6 million. For the year, they were up 22.7% totaling $224 million or $3.98 per share. Net change in non-cash working capital balances used cash flow of $260.7 million, mainly from spike in inventory, which resulted from the higher product costs and the easing of the supply chain challenges, including the acceleration of delivery times, especially from Asia. During the year, we paid dividends of $29 million, up 50% over 2021, of which $7.3 million were in the fourth quarter. And repurchased common share of $12.3 million, we have thus distributed to a total of $41.4 million to our shareholders this year. We also invested $67 million during the year of which $44 million was for business acquisitions and $23 million for equipment to maintain and improve operational efficiency, including investment in ongoing expansion projects. As at November 30, 2022 Bank overdraft net of cash amounted to $112 million. Our working capital was $563 million for a current ratio of 2.6:1 and the return on average shareholders' equities stood at 22.7%. Thanks, Antoine. We are constantly looking to acquire new businesses in line with our [indiscernible] and integrate them by trading our value and developing synergies. Just recently, in January, we concluded four new acquisitions that will contribute to diversify our offering and our customer base, namely Quincaillerie Rabel, a distributor or specialty hardware with one distribution center in Terrebonne, Quebec. Trans-World Distributing, a distributor of industrial fasteners, with one distribution center in Dartmouth, Nova Scotia. Unigrav and Usimm, two companies offering custom products, including 3D scanning centres, for the architectural and industrial market, they are located respectively in Drummondville and Montreal. These four new acquisitions will add approximately $18 million in sales on an annual basis. Our expansion projects are progressing well, mainly in Atlanta, Fort Myers, Nashville and Pompano. Also, we just opened our new Carlstadt location close to New York City, and we will be up and running in Minneapolis for February. As for Chicago, our new location servicing retailers will be fully operational in the coming weeks. Other expansion projects are currently under review and U.S. sales will continue to be a strong driver of our growth. To conclude, Richelieu has a strong financial conditions, skills and expertise to service customers with a distinctive service approach, as well, we have a solid track record in product innovation and business acquisitions, which remain our two main growth driver. In 2023, we've continued to build on this momentum and our strength in order to achieve good results with the involvement of our great team. We will pursue our market development, innovation and acquisition strategies, while giving priority to service productivity, synergies and sound financial management. Thank you, Mr. Lord. [Operator Instructions] And your first question will be from Zachary Evershed at National Bank Financial. Please go ahead. So I was hoping you could give us a little bit more color on the inventory breakdown. Maybe paint a picture for us of where you want to get that number down to what's higher due to pricing? And then what's attributed to new distribution centers and acquisitions in your inventory? Yes, Zach, I will answer, itâs Antoine. The -- basically -- just product cost increase amounts to approximately $45 million to $50 million just from a cost increase and $30 million from acquisition and new extension. So basically close to $75 million on those elements. But they were pretty much at the highest point. In January, we were pretty much at the highest point, so you looked at the -- you have the November levels is going to increase in the December, slightly increase in January as well. We're going to be at the top of the mountain in January stabilize in February and it will go down substantially during 2023. That's helpful. Thanks. And then Richard, maybe you could give us some commentary on pockets of weakness and strength that you're seeing in your end markets and product categories? What do we see so far the market is still quite good even though the first quarter is always our lowest quarter as you can remember. But and also what we have seen this year more than ever than our small customers until January 15, they were still on vacation. But in spite of that, our sales is doing quite well, it's going to be hard. I don't think we can beat the performance that we had last year though. But the market is still good. We see the retail market being flat -- slightly down in the U.S., but it's only for timing, purchasing -- purchasing of timing for customers and speaking with our sales management and our salespeople, they see that our customer would be busy for at least the next six months to a very decent level. So basically all the product lines are doing pretty well, so far as well as most of our customer segment. And also I think our new acquisition was to contribute to a nice growth, because now they had access to more products, they have access to the distribution system and the distribution marketing trends. So basically, that should generate more sales and we have various program in order to increase our sales as usual in U.S., as in Canada in order to get more sales per customers and gain more new customers as well. So basically, whatever the circumstances might be or will be Richelieu is still doing everything in terms of many strategies in parallel in order to keep increasing our sales. Great color, thanks. And so I'm hearing you on gaining new customers and growing your sales per customer. And I noted that you flagged that gross margins were stable in the quarter. What are your thoughts on the extent of price deflation in your product categories in the year ahead? There will be a price depletion for certain products for a while. There is no doubt, because of the excess inventory, the higher cost that we have namely for some product for the retailers that should temporarily affect our gross margin, but especially for example, for the fastener and fitting business, because we had excess inventory and instead of it, we have direct import for certain of our customers from Asia directly to our customer this year we're going to use our inventory instead of selling product at reduced margin that coming directly from Asia. So we have to carry the cost of having this product of inventory, but we're going to use the product with is already into our inventory to shift our customers at a lower margin. That will affect temporarily our margin. We don't expect any disaster, but we're going to have certain decrease for certain product line that we don't see the effect as being dramatic in a [indiscernible] result, if we look at the next couple of quarters. Got you. Thank you. And previously you've given range of maybe 14% to 15% EBITDA margins in a post-pandemic world. Do you think that's still the case with what you're seeing in terms of inventory discounts and that kind of thing for 2023? Short and sweet. And then just one last one if I can on customers that you won during the disrupted supply chains, because RCH was able to keep inventory better then competitors. What do you think your retention rate is on that new business? The market share gains you made there? I think the retention is something higher than 80%, because this customer, they have discovered us, they see the larger value to product that we have. So and they will continue to buy from us, because they have experienced a good service and they see the large variety of products. The reason is of using our website and to reach for people just picking up the sales rep of the customer service people. So basically that keeps improving the whole thing and basically we're quite optimistic with this. We also have to [welcome] (ph) that regarding the sales that we have to keep in mind that before last year, our customers also bought more products from us they should have bought, because they were scared. They wanted to make sure that they have the right and the more inventory than they would really need in order not to lose anything of their projects. So our customers are in excess of inventory and they also know that we are in excess of inventory. So if they need something just as we speak now, is just by the quantity they need now, because they know that Richelieu has lot of inventory, so they are not scared as Richelieu could miss something in the near future. So basically, that does not help to create more sales. But as I said earlier though, whatever the -- those circumstances, we still do well compare even though we will not be close to the performance that we had last year. But sales are still holding, I would say, healthy. It was a pleasure to talk to you. Thanks again, and whatever you need to talk to us, we are here. Thank you very much. Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines.
|
EarningCall_1160
|
Ladies and gentlemen, thank you for standing by. Welcome, and thank you for joining the SAP Q4 Earnings Conference Call. Throughout todayâs recorded presentation, all participants will be in a listen-only mode. The presentation will be followed by a question-and-answer session. [Operator Instructions] Good morning, everyone, and thanks for joining us today. With me on the call are CEO, Christian Klein; CFO, Luka Mucic; and Scott Russell, Head of Customer Success. On this call, we will discuss SAP's fourth quarter and full year results for 2022. You can find the deck supplementing today's call, as well as our quarterly statement on our Investor Relations website. During this call, we'll make forward-looking statements which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties that could cause actual results and outcomes to materially differ. Additional information regarding these risks and uncertainties may be found in our filings with the Securities and Exchange Commission, including but not limited to the risk factors section of SAP's annual report on Form 20-F for 2021. Unless otherwise stated, all numbers on this call are non-IFRS and growth rates and percentage point changes are non-IFRS year-on-year at constant currencies. The non-IFRS financial measures we provide should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with IFRS. As you know, this is Luca's final earnings call with SAP. So before we start, I would like to take a moment to express my personal gratitude to you, Luka, for the close collaboration over the years, for the great partnership and for the strong engagement with our investors. Congratulations on 27 years at SAP and a fantastic ride. So it has been a distinct honor to work with you, with lots of great memories. So I wish you nothing but the best of success. On behalf of the SAP family and the broader community, many thanks, Luka. Yes. Thank you, Anthony, and really well said, and thanks to all of you for joining us today, and welcome to 2023. This has been a good Q4 and a very important year for SAP, bringing to a close a year of great momentum. Our results in Q4 show once again a strong demand for our products and services, reflecting the confidence and trust companies have in working with SAP. Let me call out some key highlights for Q4. Current cloud backlog exceeded â¬12 billion, up 24% this quarter against a strong compare last year. Cloud revenue grew 22%, and cloud revenue for S/4HANA further accelerated once again, growing at 90%. We reached a tipping point in our transformation, as we returned to positive operating profit growth of 2%, with a recurring revenue share of 76%, which is up 6 percentage points compared to Q4 2021. For 2023, this is setting us up to deliver expected accelerated total revenue and our promise of double-digit operating profit growth. For full year 2022, we delivered upon all our top and bottom line guidance, with cloud revenue growing 24%, up five percentage points from 19% in 2021. S/4HANA cloud revenue grew 79% for the full year. This is compared with 47% full year growth in 2021 and putting our S/4HANA cloud revenue to over â¬2 billion for the first time ever. Our cloud transformation is in full swing, and we have also built a highly resilient business with recurring revenue up from 75% in 2021 to 79% in 2022. I believe we will look back at 2022 as one of the most important years in our history. It is now over two years since we launched our strategy for transformation. We kept our promise and delivered despite the combined impact of three factors; our exit from Russia; our divestiture of Litmos; and the macroeconomic volatility facing the world. Why is our position so much stronger and SAP more relevant than ever? Because our RISE with SAP offering is much more than only a shift of our technology to the cloud. It is a true business transformation offering and we are focused on helping our customers solve their biggest challenges. First, we enable companies to transform their existing business models and drive simplification and automation of their core business processes to offset inflation pressure. Second, SAP enables supply chain resilience. Supply chains are disrupted and need to be diversified as a result of the pandemic, geopolitic tensions and shifting business dynamics. We are helping our customers to build more resilient supply chains by connecting the suppliers and providers from the raw material provider to the manufacturer. SAP's business network facilitated over $4.9 trillion of global commerce and â¬730 million of B2B transactions in Q4 alone. Third, we are delivering the green letter [ph] for every industry and every customer to measure ESG based on actual instead of average data, data that is fully orderable and based on industry specific standards. With Scope 3 emission tracking across value chains via our network, and we will give our customers the ability to act by embedding sustainability into every business process and every company decision. RISE with SAP is at the heart of our strategy and is one of our most successful offerings ever. As stated, it is much more than a technical lift and shift to the cloud for our installed base. It is a true business transformation offering and around 50% of our customers are net new customers to SAP. I'd like to walk you through some of our RISE with SAP Q4 wins. As part of Merck's long-term collaboration with SAP, they will be using SAP S/4HANA cloud to help further digitize their business processes and make them more efficient, agile and adaptable. This will enable them to act to disruptions and capitalize on business opportunities more quickly. Porsche, the German sports car manufacturer has selected RISE with SAP to support their move to the cloud and maximize value through innovation and speed. PwC, one of the largest professional services networks in the world, significantly increased their user base for SAP S/4HANA public cloud. To support Lenovo's Group Everything as a Service transformation strategy, a fundamental change of their business model will â they will be moving their digital core to S/4HANA cloud. Earlier this month, I had the pleasure of meeting with the leadership team of Al-Futtaim Group from the United Arab Emirates. They operate across a number of sectors and will be embarking on a full digital transformation powered by Wise with SAP. We also announced a joint collaboration with ExxonMobil to establish and adopt industry best practices and help them with their sustainability efforts. Finally, we are very proud to announce that we signed a long-term strategic deal with BMW this week based on Wise with SAP. We have been partners for more than 30 years and their cloud strategy is based on SAP across all dimensions on all key end-to-end business processes. The SAP business technology platform is the foundation behind Wise and our portfolio momentum. Already today, more than 80% of Wise with SAP deals include the business technology platform as the foundation for integration and extensibility. This is powered by thousands of APIs, integration flows and low-code, no-code content packages. Lockheed Martin of the US is an example of this. Lockheed's collaboration with SAP began in 1998. They will be now leveraging Wise with SAP to move their core business processes to a secure, managed fab ramp compliant cloud. They will be using the SAP business technology platform for emerging technology and the SAP Analytics Cloud to enhance their strategic data management. With S/ 4HANA and BTP at the core, our line of business applications also benefit from a flywheel effect as it is twice as likely that these ERP customers buy another SAP line of business application. More than 30% of SAP's current customers use two or more SAP solutions, and we see this increasing through this flywheel effect created by the business technology platform. At the same time, coming out of a strong year, we will not rest as we continue to focus on our cost trends to increase both win rates and productivity. In previous quarters, we spoke with you about our continued focus to simplify and consolidate our portfolio with S/4HANA and BTP at the core. Our divestiture of Litmos in Q4 is an example of this. In 2023, we intend to sharpen this portfolio focus further. As we continue to build on our core strengths, we will be pivoting our CX and industry areas to be more focused on specific industries, complemented by a strong ecosystem. This focus on our core, together with our ongoing optimization of SAP's structure for cloud success are behind the announcement we made today. The intent to carry out a targeted restructuring in select areas of the company. This will impact up to 3,000 positions and will include a headcount reduction amounting to about 2.5% of our workforce. While we know these changes are necessary, it is never easy to make decisions that affect our colleagues in this way. In the same context, SAP has determined to explore a sale of its stake in Qualtrics. This would be a continuation of the strategy we set at the time of the Qualtrics IPO in 2021. SAP believes that this potential transaction could unlock significant value for both companies. For SAP, to focus more on its core business and profitability; and for Qualtrics, to extend its leadership in the XM category that it pioneered. Since the acquisition, Qualtrics has increased revenue by 3.5x to US$1.5 billion, while delivering profitability, and has significantly expanded its offerings and enterprise customer adoption. In the event of a successful transaction, SAP intends to remain a close partner. A final decision is subject to market conditions, agreement on acceptable terms, regulatory approvals and the approval of the SAP SE Supervisory Board. SAP has retained Morgan Stanley as financial adviser to assist in the exploration of the sale of its stake in Qualtrics. I'd like to close by taking a look at our outlook and ambitions. As these results have shown, the power of SAP solutions in an increasingly uncertain world is clear. We are providing strong guidance for 2023 despite the continued macroeconomic pressures. The strategic transformation we announced over two years ago is in full swing and has reached a significant inflection point. The strength of our recurring revenue base is the foundation, which will power our next 50 years at the forefront of business and technology. We will already see a positive impact in 2023, including the promise we made to return to double-digit operating profit growth as well as accelerated cloud and total revenue growth. For our 2025 ambitions, we are ahead of plan and expect to provide an update to these ambitions later in the first half after the arrival of Dominik Asam, our new CFO. In closing, I can sense both, the possibilities as well as the caution that will be required to navigate today's uncertain world. And lastly, on a more personal note, you all know that our CFO, Luka Mucic, is passing the torch to Dominik Asam on March 7. Luka, as Anthony said, you have enjoyed an impressive career at SAP. And of course, the whole SAP family will be always grateful for your commitment and your contributions to our success. I guess today also marks the 37th earnings in your CFO career. And personally, I would like to say you not only many, many thanks, especially over the last two years as the CFO and supporting this significant transformation, but as well for your partner and even more important, your personal mentorship. So many thanks to you, Luka, and all the best. Yes. Thank you very much, Christian. It's a bit hard to follow with business as usual. Thank you so much for your kind words. But also from my side, a happy and healthy 2023 to everyone. Let me start by saying that I'm extremely proud of SAP's solid finish to 2022, demonstrating great resilience in the year that saw certainly many challenges. But despite the extremely volatile business environment, we delivered on our financial commitments for 2022. And we are likewise on track to deliver our growth and profitability commitments for 2023. Our financial performance shows that we kept our promise and thoroughly executed on our plan by being laser-focused on building cloud momentum through agility and great cost discipline. This resulted in a successful finish to the year, and I am personally extremely confident that we will carry this strong momentum into the new year. Customers around the globe continue to choose RISE with SAP to drive their end-to-end business transformations. Large cloud transactions with a volume greater than â¬5 million contributed 48% to our cloud order entry for the full year and an impressive 50% in Q4, the highest number on record. Now, let me dive into more details around our financial highlights. Current cloud backlog now exceeds â¬12 billion, continuing its growth at scale to 24%, despite being negatively impacted by approximately 1.5 percentage points from the divestiture of our Litmos business and the wind down of our business operations in Russia and Belarus. S/4HANA current cloud backlog growth accelerated to 82%, driven by the strong adoption of RISE with SAP. In Q4 alone, we added more than â¬500 million to our S/4HANA current cloud backlog, leading to a total of â¬3.17 billion. Cloud revenue this year surpassed support revenue and became the largest single revenue stream for SAP. Our combined SaaS and PaaS portfolio for 2022 continued to grow an impressive 27%, with SaaS cloud revenue up 25% and PaaS cloud revenue up 45%. This strong cloud growth was primarily the result of an outstanding contribution of S/4HANA cloud and the business technology platform. Driven by this strong double-digit cloud growth and an outstanding performance in services, total revenue was up 5% year-over-year, showing great traction compared to the year ago period. Now, let's take a brief look at our regional performance, where in the fourth quarter, all regions delivered a strong double-digit cloud performance with Brazil, Germany, and Japan being standouts. For the full year, the Americas increased by 22%, EMEA by 26%, and APJ likewise by 26%. Germany, the United States, and Japan had outstanding performances, while Brazil, Chile, China, Italy, Saudi Arabia, South Korea, and Switzerland were all particularly strong. Now, moving on to the bottom-line, where our cloud gross margin for the full year continued its upward trend from last year and expanded 2.1 percentage points to 71.3%. This increase was driven by expanding gross margins across all cloud business models, with efficiency gains overcompensating increased investments into the next-generation cloud delivery program. The improvement of the cloud gross margin contributed nicely to our cloud gross profit growth of 28%. In the fourth quarter, non-IFRS operating profit grew by 2%, reaching an inflection point in our cloud transformation towards double-digit growth in 2023. Full year 2022 non-IFRS operating profit came in at â¬8.03 billion, a 7% decline, mainly impacted by the decision to wind down business operations in Russia and Belarus, a reduced contribution from software licenses revenue, as well as accelerated investments into R&D and sales and marketing to capture current and future growth opportunities. Earnings per share decreased 39% to â¬4.08. The year-over-year decline reflects the contribution to financial income by Sapphire Ventures, that due to market conditions faced throughout the year was significantly lower than in the same period last year. The IFRS effective tax rate for the full year was 44.6% and the non-IFRS tax rate was 29.5%. This year-over-year increase mainly also resulted from changes in tax exempt income related to Sapphire Ventures. Free cash flow for the full year came in at â¬4.35 billion, in line with the revised outlook of approximately â¬4.5 billion. This is predominantly due to lower profitability and adverse working capital impacts in other assets. While tax payments developed positively, smaller negative impacts came from share-based payments as well as capital expenditures and leasing. In addition, the increased volume of trade receivables sold in 2022 amounting to â¬800 million versus â¬500 million in 2021 had a positive impact on free cash flow. As you already heard from Christian, we will be initiating a targeted restructuring program this year with two main objectives. First, to focus our portfolio on our key strategic growth areas; and second, to improve overall process efficiency as we continue to accelerate our cloud transformation. We are highly confident in our short and mid-term prospects. We see 2023 as another pivotal year that will help deliver on the accelerating top line and double-digit operating profit growth that is reflected in our outlook. Finally, let's discuss our non-financial targets. Our greenhouse gas emissions were 95 kilotons within our adjusted target range. We remain on track to be net neutral in our own operations this year and we are continuing on the path to achieve net zero across the entire value chain by 2030. Employee Engagement Index was down three percentage points. This decrease is in line with global industry trends and related to external factors, such as the lasting impact of the pandemic and macroeconomic conditions. We achieved 35% of women in the overall workforce and 29.4% women in management. In November, we brought the latest release of SAP Sustainability Control Tower to market, which effectively shares and organizes ESG data so companies can more accurately and readily report their performance to various reporting requirements and frameworks. This enables companies to set targets in actionable insights into core processes and create role specific actions to improve sustainability performance. As many of you may know, I not only have a passion for the financials, but also for sustainability and non-financial metrics. It has been an honor to drive this topic together with my colleagues during my tenure. We have been a pioneer in integrated reporting, and it has been a privilege to have a role in shaping this area. So to summarize, 2022 was another strong year for SAP, highlighted by our cloud performance across all regions despite the macroeconomic environment. This demonstrates our continued progress with customers who want to transform their businesses into more intelligent enterprises. Even with the challenges that we are seeing in the world today, we are confident in the opportunity ahead. Our 2023 outlook best illustrates that we are now entering the next phase with a pivotal year characterized by business momentum acceleration. And finally, on a personal note, again, as you all know, this is my 37th and final earnings call with SAP. And I'm proud to have been part of such a great company. As I'm about to pass the torch, it is exciting to see that SAP is in such a position of strength and moving along on its growth trajectory. Let me also take the opportunity to share my own personal appreciation to all of you and to the broader financial market community. Providing transparency in an open and constructive dialogue has always been my goal. I hope that I was able to live up to this goal, despite the often volatile times and the unprecedented transformation of our company in the last nine years. It has always been a privilege. All right. Thank you, Luka. And I would like to remind you to limit yourself to one question only, please. So, Natalie, please open the line. Ladies and gentlemen, at this time we will begin the question-and-answer session. [Operator Instructions] And our first question is from the line of Adam Wood from Morgan Stanley. Please, go ahead. Hi. Good afternoon, Christian. Good afternoon, Luka. And also, Luka, best wishes from my side for the future. So the question was just around the fourth quarter cloud growth. We went into the quarter with the 26% cloud backlog growth and ended Q4 with 24%. And yet the cloud growth was 22%. Could you just help us understand why that anomaly is there? And also help us understand how that accelerates into a higher level 22% to 25% in 2023? Specifically, is there any issue with rational revenue growth in that side of the business that you're seeing in the fourth quarter that would have explained that, please. Thanks so much. Yes. Thanks for the question, Adam. And let me get started and then in the overarching momentum. Perhaps Christian, you might want to add some comments or also, Scott, on what you see in the market. So, essentially, in the fourth quarter, I think, you have to remember a couple of effects. One, and that is something that I flagged on the CCB growth to be expected, we had the divestiture of Litmos, which obviously affected CCB negatively, and together with the continued effect from the Russia exit that resulted in the 24% CCB growth versus the 26% that we had. Actually, it is also sometimes a matter of rounding where you exactly end up on that. But we are actually very happy with the 24% that we reached. And I can also spend a few words on how we expect this to unfold in 2023. But just to round this up, on the revenue front, you need to take into account that next to all of those impacts, of course, the divestiture of Litmos also meant that we lost some revenue due to the closure up to early December. We had also the anniversary of the Clarabridge acquisition that Qualtrics had done in the fourth quarter a year prior. And that obviously then brought the year-over-year growth rates down a bit, together with all of the other effects. Transactional revenues were actually quite resilient in particular in Concur. I have to say that business is back. And I was surprised actually a bit that in Q4, they were already back in volumes to the pre-pandemic levels. So they grew actually in the 20s, which is a very decent performance. So it's really mainly down to those divestiture impacts and the anniversary of Clarabridge. When we think about 2023, I would expect general re-acceleration throughout the year already starting in Q1 because of the strong backlog that we have been building that always comes into the revenue lines with one to two quarters of delay. And so you should see already a reacceleration in Q1 that would then further build up during the year. I'm sure there will be more questions around seasonality, but I'll leave it on that comment for cloud revenues. And then in terms of the forward-looking momentum, I think Christian has already talked about the great success that we had with BMW, the signing yesterday. But perhaps you want to add some more comments around what you see in the market. Yeah. Luka, and also adding from my side, I guess we also provided for the first time today also the total cloud backlog, including not only the annual contract value, but the total value over the lifetime of the contracts. And there you're also going to see that we are also, in the meantime, have that â¬34 billion in the books. And this has increased by 35% versus the 27% we saw a normal growth in Q4. And so this is also a signal that deals like BMW, I mentioned Porsche, I mentioned Merck, there are a lot of large enterprises now following our move. And, of course, they have a certain ramp in their contract. So we're actually super confident that we already have the backlog to deliver on our ambition for 2023. And even beyond, together with the recurring revenue share, I mean, the business is super resilient. And I mean, for the year to come, I mean, Scott, we look into Q1 already. Luka already mentioned, there will be a reacceleration in the cloud, no matter if it's now on customers like BMW, where we are driving automation in manufacturing, in finance where we are working on analytics, or if we're working on the supply chains of this world to make them more resilient, or last but not least, if we are helping customers like Exxon and others to measure ESG in a standardized way and act on circular and other sustainability capabilities. The pipeline is actually very strong, and we are as confident as we have been last quarter. And Luka mentioned the one-timers we had in Q4, especially in the cloud revenue. Scott? Yeah. Look, I'll probably only add two comments to add to what you and Luka mentioned, Christian. So Adam, the first is, you would see in Q4 that we not only continued to grow and RISE is the enabler in the flywheel that Christian mentioned at the beginning in the total cloud backlog. The proportion of large customers continues to expand. That gives health to our broader portfolio. So we mentioned many of them today, but you think about Fujitsu, Natuzzi, Tech Mahindra, Sumitomo, Renault, the list goes on. So large organizations, which will have that ramp that Christian mentioned. And the reason why they're choosing SAP and RISE with SAP is because the market today needs companies they trust. More than ever, trust in the technology, trust in the partnership, trust in the capability that delivers scale, resilience, outstanding capabilities that helps them navigate whether it be supply chain or sustainability or other aspects. And the other thing that we saw in Q4 was consistent performance across the world. We're a business that we see momentum in all of the regions. We -- obviously, Luka mentioned some of the countries, but that gives a level of confidence but also strengthen as we move forward. We have a consistent portfolio. We have a consistent business. And no matter where a customer is based and they're headquartered, they're trusting SAP to move forward. So, I guess, we look ahead with relative confidence not despite the factors that are outside of our control. Thank you. Hello, everyone. Amit Harchandani from Citi. And before I ask my questions, thank you, Luka, for the partnership over the years, it's been a pleasure over the past decade. Moving on to my question, my question is really with respect to the free cash flow trajectory in 2023 and if you look at it relative to what played out in 2022, quite a few moving parts, right? You had the sale of receivables, there's the dynamic around pre-payments to hyperscalers, potentially deferred revenue. There's obviously restructuring next year. So if you could kindly help us build a bridge towards how we arrive at the free cash flow for 2023? And more importantly, how should we get confident that you're on track to get to â¬8 billion or potentially higher by 2025? Thank you. Yeah. Thanks for the question. That's a detailed one that, I guess goes to me. So first of all, when you take a look at where we ended with the â¬4.35 billion and then you build up, there are a couple of elements here. First, on the negative front, yes you're right. We have a restructuring that will result also in cash outflows of roughly â¬300 million. So you need to subtract that, so to say, back. On the sale of receivables, actually, SAP has a long history of engaging in customer financing. In 2022, the â¬800 million was actually a step-up over the roughly â¬500 million that we had in the year before. But you need to understand, the prior year was in the long-term average, actually quite a low figure. So the long-term average is more around â¬700 million. So we, yes, would expect that also in the future in 2023 and in the years beyond, we will have customer financing-related cash inflows at the same levels as what we have seen in 2022. So that is actually more or less a wash in terms of how you build the bridge for 2023 and beyond. When you then think about the progression, well, first of all, of course we expect that we will have a significantly higher profitability in 2023 compared to 2022 that will result also in a higher cash flow performance. You pointed to the fact that, we had, in 2022, significant prepaid expenses from some strategic transactions that we did with hyperscalers that were kind of a working capital headwind for us, but made sense for us in the long run, because we were able to capitalize on better conditions as a part of that. So that is something that we don't expect to the same extent to see in 2023 for the further years. Then you need to keep in mind that, we have started in 2022 to move our share-based compensation plans to equity-settled plans. And under the old plans, we had actually a one-year vesting period and then essentially payouts on a rolling basis. That is now changing. And the majority of our awards that now start to vest actually already after six months will then be paid out in equity. And so, we will see starting this year and then with further increases of tailwinds in the following years as the old programs, the large cash settled anniversary and therefore, don't affect the cash flow anymore a reduction, to the point that we would expect in 2025 to end up only with roughly a bit more than â¬500 million of cash-settled cash flow headwind, so to say, in the results. And so it's basically mainly the combination the increase in profitability, as well as the positive impact from the move to equity-settled programs that will define the trajectory. The receivables financing should be neutral for the performance in the future years as we would expect to finance similar volumes as we have done in the past. On the working capital impacts that were particularly pronounced in 2022, I would expect a slight moderation of those and then it's at the end of the day, the growing profitability in the business. Obviously, we don't intend to rest with the growth that we have guided for in 2023, but actually see a strong prospect to further increase the growth rates on the profitability side in 2024 and beyond. I hope that's helpful, at least at the level that we can cover in such a call. Yes, good afternoon. Thank you very much and Luka, all the best for the next chapter. My question is on the Qualtrics announcement, if I could ask you to elaborate perhaps a bit further there on the rationale. Why now when if you say the business has matured so much since the original acquisition and has worked very hard around the integration with certain other assets in the portfolio on the cross-selling opportunities as well? I mean you talked about a strong ongoing relationship with Qualtrics, clearly. But any detail there would be helpful, including no circumstances under which you would or wouldn't sell it, given what's happened to valuations in the space and whether they're specific use of the proceeds? Thank you. Yes, I'm happy to answer that question. And look, when we did the first step with the IPO in 2021, we already, of course, have thought and planned what could be actually the end goal and what could be our journey together. So, you are right. We invested heavily in the last years into the integration and embedding XM into our solutions. And we have seen great sales success and go-to-market success, tripled sales. But then also, I would say, around Q3, Q4, we were sitting together with the Qualtrics management team, we've [indiscernible] and said, hey, actually, what we are doing, we can continue to do also in the future by embedding Qualtrics and our products go-to-market together, while we can also consider a sale which allows SAP on the one hand side, to free up investments and efforts to double down on our growth in the core, which is super strong. You have seen the S/4HANA cloud numbers. The platform is booming. While Qualtrics can also, of course, go even more out and close another great partnerships with other partners in the market. And last but not least, we were jointly also of the opinion that we can significantly enhance also the value for the Qualtrics and the SAP shareholders. And that actually what made us came out of -- why we came to this decision to consider the potential sale. And it's a great asset. It's by far the best product in the XM category. So we're actually also seeing a lot of interest and, yes, we are very positive about the ongoing process. The process should also be straightforward, because Qualtrics is really set up independently already since some time. They have a dedicated leadership team. They have a strong culture across the organization. So it's really straightforward, does not require any carve-out efforts or anything like. But perhaps to just add to the rationale, I think, one financial reason that we are also taking seriously, because we want to make sure we maximize value, as Christian has said. And to the shareholders of both Qualtrics as well as SAP, is that we have seen in the -- in particular, in the last year, that while I think both Qualtrics and SAP make progress in the partnership and we drive good results. Also Qualtrics, I think, had not only a decent performance in 2022, but is also now guiding to stronger profitability while continuing on its march to gain share in the experience management space. There is a certain level of overhang of the SAP majority share. I believe that Qualtrics and SAP are not at the moment set up to optimally crystallize the value that is behind the company. And therefore, exploring that sale could be a way to unlock more of this value the benefit of the Qualtrics shareholders and SAP at the same time. But it means at the same time, that we absolutely expect this value to crystallize in order to ultimately then consider to consummate a transaction. So we will absolutely prioritize getting optimal value for a premier pristine cloud company that Qualtrics is. And we will prioritize this over timing and will certainly also be prepared to ultimately not consummate a transaction in the unlikely event that we would not generate the value that is fair for all stakeholders of Qualtrics, including also the SAP shareholders. And that's why we cannot, at this point in time, tell you with precision when this process would be over. We wanted to give you early insights and transparency around it. But that, of course, remains to be seen. And that means, at the same time, that also the use of proceeds is a question that is understandable, but perhaps a little bit premature. But to say, generally, of course, assuming that we are able to strike a deal at a strong valuation, we would have a range of options with any proceeds, which could range all the way from reinvestment in some interesting assets around our core that are closely associated with our strengths, all the way to enhance capital returns to shareholders. We will determine this when we have greater visibility in the process, but it gives us great optionality, of course, to crystallize more value also for the SAP shareholders. Yes. Thank you. Good afternoon. Luka, I can't let you get away without a question on cloud margins. Could you say a little bit about the convergence costs for 2022 and 2023? And how much of those went into the cost of sales rather than R&D? And then obviously, you've now got several thousand customers on RISE, do you have a better view on where cloud margins are going to mature to in the next few years or certainly the end of this year as well, given that those investments will fade in the second half? Thank you. Yeah. And you're always very welcome to post your cloud margin questions. That allows me to be the only one in the room who can answer them and that always makes the feel â kind of seriously speaking. In terms of the convergence costs, it was significant in 2022 as we accelerated in order to be ready in time to finalize the program. So we had around about â¬450 million in total costs associated with the harmonized cloud delivery program. That's significantly more double, more than double, actually more than what we had in 2021. And approximately â¬200 million of those with roughly â¬50 million per quarter were actually spent on the cost of cloud line. This cost will, as I said, for a couple of quarters, fade away in 2023. There will still be a portion around in the first half of 2023, but substantially smaller already than the run rate that we have seen in 2022, can think roughly half of that run rate. And then as we have now a full visibility into the completion of the program, there's essentially only one line of business left with some data center migrations and then the final asset retirement, but that is absolutely certain now to happen on time. The second half year will be completely free of these cloud delivery harmonization related expenses. And therefore, in terms of the progression on the cloud margin front, you have seen that we had a decent progress already in 2022, more than two percentage points against this headwind is actually already a very good progress. I would not have entirely expected this to be quite honest, to be the case already this year, for the first half year. I'm also confident that, despite the remaining headwinds from the program, you will already see some further acceleration in the cloud margin in the first half year. And then obviously, a more pronounced one in the second half year. I would not be surprised, if we had an exit rate ultimately at the end of the year in the neighborhood of what we always soft guided for, for 2023, even a few years ago without the S/4HANA private cloud search of around about 75% plus and minus. And again, the plus and minus is really the success in sales of S/4 in the private cloud deployment option in the first half year. Because especially as you start the build of those landscapes, of course, you have a small ramp. Yet, you have already a relatively high level of cost and set of cost for those landscapes. So that's the remaining uncertainty here. But certainly, the exit rate will be significantly ahead of where we are currently. And then for 2025, it's basically unchanged from what I said at our Capital Markets Day, assuming that RISE with SAP and S/4 private cloud remain as successful as they are today, and we have more and more customers of the likes of BMW moving their entire landscape in massive contracts to the cloud with us. There is going to be an increasing headwind against the continued progress in the public cloud that we expect now where, I would say, that all of our main assets will end up come 2025 above the 80% mark. But then again, with the dampening impact of the private cloud, we could end up a couple of percentage points below the 80% mark. But if that was the case, then we would actually have, at the same time, a massive search in cloud gross profit, which would be actually more than an offsetting help to guide us towards our profit ambition for 2025. So, that's a nice problem to have. And rest assured that we will stay focused as we have been in the last two years of pulling all of the available levers in order to further improve our performance. To a certain extent, the development of prepaid expenses that you saw in the free cash flow side and that we discussed are also a means to set us up for more efficient consumption of cloud infrastructure entitlements that will further help with the margin. And maybe just to prove, Luka, that also the CEO has some expertise in that subject. Michael, I mean, you should not expect -- I mean, now the infrastructure is clean. It's a clear set of -- on the one hand side, we have our own infrastructure, which is now completely harmonized. Yes, we have to do some work on the decommissioning. We have our hyperscaler-s strategy clear set and done with a lot of fail over and backup scenario. So, that's super modern and super resilient. But what we still do as part of our continuous efforts is we are working on further scale-out capabilities of our database, which has significant impact on the TCO. Scott did some great work on putting higher incentives on price versus volume, and that led to also a very, very good trend on keeping also our prices up and running. We are infusing the CPI clauses. We announced in a very successful way, both from an engineering perspective as well as from a pricing perspective, I'm actually very confident that we're also going to see some good levels also in the years ahead. And now where we are also after. Luka is not here anymore. There will be someone looking at this KPI very closely. Yes, thanks for taking my question and also Luka, thank you very much for the great collaboration over the last years. I may have missed that, but did you provide the cloud extension multiplier for the quarter? So, that's just a housekeeping item. And then I think it's very useful that you give the total cloud backlog number now. How should we think about the kind of average duration or average contract lifetime of that number maybe? And then just on S/4HANA cloud, I mean that continues to grow really impressively despite -- from a mathematical perspective, comps getting much tougher. So, how should we think about that over the course of 2023 from a revenue and CCP perspective? Will that at one point normalize, or should we really be thinking about these great growth rates continuing? Thank you. Yes. Let me start with the more technical aspects here, in particular, around the cloud extension policy. So when you look at the full year, actually, the multipliers continue to hover rather around the 3x than the 2x factor. However, you will always have a seasonality in Q4 because you sign up the largest transactions that you have a slightly higher exposure. So for Q4, we had an extension factor of roughly 2.6 now, which still made it in total for the full year, a 2.9 factor. So you see that this is substantially ahead. And I would also expect as we go into the next year, that in the first half, we will rather have higher multipliers. And then, as we sign up the very large deals, then it might moderate a bit. But this continues to show the same behavior as we have seen actually since we launched RISE. And you can see it also in the resilience of our support revenues. I mean, with those heavy software license declines having actually only a flat support revenue development for the year is actually very resilient. In absolute numbers, we had roughly â¬200 million of support revenues that changed sites to the cloud line, so to say, over the entire business year. So this is very resilient. In terms of the total cloud backlog, I'm happy that you find it useful. And indeed, I think it follows the kind of verbal comments that we had already on the past earnings calls, that we have seen the total order entry actually moving with even greater speed and pace in terms of growth than the annualized performance or the current cloud backlog, for that matter. It's a figure that we are currently prepared to produce on an annual basis. So we'll provide an update at the end of next business year as well. And in the meantime, we'll also provide color commentary on what we are seeing. But I would expect this trend to continue for a while, in particular as long as our upgrade cycle of customers to S/4 and in the cloud is in full swing, which certainly will be the case for the next three, four years. And because there, you have then those large contracts with more significant ramps. Perhaps as a last case in point that we did not discuss yet also, the average contract duration at SAP in the cloud is up. It's by now almost reaching four years, and that is another function of those large multi-year deals that we are signing up. And so therefore, the TCB is actually a helpful measure even though, of course, as it's not broken down to individual business, yes, we'd rather give you a measure of the underlying orders that we have already under the belt for our midterm ambition than a really good predictor of in-year revenues for the years beyond 2023. Perhaps on the S/4 cloud revenue, number you might have a view, Christian, but I think it will certainly remain a high growth... Look, this morning, I got also the question in the press conference, what about the end of maintenance for our ECC and older ERP version? And do we go to expand and extend this time line again? No, we are not going to extend that, because we're actually giving customers already a lot of choice to move with us to S/4HANA. We still have on-prem and guaranteed until 2040. But we, of course, see now in the meantime, big success with our move to the cloud with RISE. And we're seeing that a lot of customers are now left who are now starting with us in this journey. You have seen all the large logos. But also important to mention, while there is a lot of business left in our installed base and we give customers choice, but the predominant share will move with us to the cloud, especially that the time line is coming closer with 2027. But of course, we also have seen 50% net new customer share, and we are putting a lot of work currently into our volume business. So let's not forget with Julia, Scott and Thomas, we are working now on we have customers like Doctolib unicorns who actually celebrate go-lives in weeks. And we want to activate this channel even more because the product is really designed also for the small and the midsized customers. So while we are moving the large ones and the installed base, we're definitely also not going to rest on the small and midsized segment, and we see good business coming in there. We want to activate the channels here much stronger across the world. And last, but not least, I mean, what we are doing also with the restructuring. Look, this is â has a moderate impact on 2023, but we're already doing this now and also for the years to come, to also have their strong results, especially also both top and bottom line. But also even more important we also, with this strategy activate our cross-sell potentially, because the BTP is now de facto standard. S/4HANA is booming. And then we can also increase the win rates of our applications, who are circumventing the core, as we have shown on this one slide. That is working, and this is what we are doubling down on. So, you can definitely expect a further acceleration. But at a certain point, we should really look at the absolute terms because, of course, mathematically, the percentage growth rates, this is just mathematically then at a certain point of time, a question mark. Yes. Hi. Thanks for taking my question. And Luka, all the best as well in your next endeavor, I enjoyed working with you over these past few years. So I just wanted to follow-up, I guess, two quick points. Just on the hyperscaler relationships. Obviously, they're seeing a bit of pressure in terms of consumption. Does that give you an opportunity to negotiate some better bulk transactions? And is that maybe what we saw there in Q4? And can that also be a tailwind to margin? And then just a second one on the backlog, you just talked about the multipliers, the visibility there. How confident are you about getting to double-digit revenue growth? Could that happen as early as 2024, or would that require sort of a much better macro environment in 2024? Thank you. On the hyperscaler engagements, I would definitely say, yes, the environment is good. We, of course, in constant talks around our partnership, both technical as well as commercially. And second, about double-digit total revenue growth, 2024, it's â yeah, absolutely. It's possible. And as you're going to see the recurring revenue shares growing and growing, we are talking about 83% already in 2023. It's absolutely feasible to come to double-digit total revenue in 2024. Yes, hi. Thanks for taking the question and Luka, all the best for the future. Just thinking about the EBIT growth trajectory that we're on, clearly, minus 8% in Q3, plus 2% in Q4. How should we think about this phasing as we move through 2023? If I look back through 2022, it looks as though the easiest comps are in Q1 and Q2, but also mindful there are now cost savings in the mix here as well. And there's a phasing element to that. So, could you just help us understand the exact phasing or the trajectory of the EBIT growth through 2023? Thank you. Yes, absolutely. Thanks for the question. I have actually expected it and waited for it as it's a very good one. So, we actually believe that our easiest compares and therefore, the best performance will be in Q2 and Q3. In Q2 for the obvious reason that last year, we had the significant impact of the exit of Russia. Most of it was realized in Q2. And why Q3? Well, because it will be the first quarter where we will be entirely free of the cloud delivery harmonization expenses, and that will be a significant help to the P&L then. The difficult, the toughest compares are actually Q1 and Q4 for different reasons. In Q4, it's because last year, we had the Litmos divestiture, which broad one-time gain of â¬109 million in non-IFRS results. And that is not something that at the moment we have in our planning for Q4 of this year. And Q1, because it was still relatively unaffected by the Russia exit. And you cannot -- you must not forget that we had still in the first quarter some revenues in Russia, mainly in support revenues and also in cloud revenues. And for 2023, we essentially, we plan with zero revenues in Russia. Nevertheless, I would say already in we should be pretty close to, if not already achieving a double-digit growth than we would have in Q2, the highest growth of the year followed by another a very decent performance in Q3. And then in Q4, the growth should moderate again. And for the future years, again, we are expecting an accelerating trajectory because then in 2024, the entirety of the cloud delivery harmonization program will be behind us. And that will, of course, provide next to additional efficiency gains that we expect across our business and further progress on the cloud margin, will provide some significant further relief. I hope that's helpful from a planning perspective.
|
EarningCall_1161
|
Ladies and gentlemen, thank you for standing by. Welcome to the Cohen & Steers Fourth Quarter and Full Year 2022 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded, Thursday, January 26, 2023. I would now like to turn the conference over to Brian Heller, Senior Vice President and Corporate Counsel of Cohen & Steers. Please go ahead. Thank you. And welcome to the Cohen & Steers fourth quarter and full year 2022 earnings conference call. Joining me are our Chief Executive Officer, Joe Harvey; our Chief Financial Officer, Matt Stadler; and our Chief Investment Officer, Jon Cheigh. I want to remind you that some of our comments and answers to your questions may include forward-looking statements. We believe these statements are reasonable based on information currently available to us, but actual outcomes could differ materially due to a number of factors, including those described in our accompanying fourth quarter and full year earnings release and presentation, our most recent annual report on Form 10-K and our other SEC filings. We assume no duty to update any forward-looking statements. Further, none of our statements constitute an offer to sell or the solicitation of an offer to buy the securities of any fund or other investment vehicle. Our presentation also contains non-GAAP financial measures referred to as, as adjusted financial measures that we believe are meaningful in evaluating our performance. These non-GAAP financial measures should be read in conjunction with our GAAP results. A reconciliation of these non-GAAP financial measures is included in the earnings release and presentation to the extent reasonably available. The earnings release and presentation, as well as links to our SEC filings are available in the Investor Relations section of our website at www.cohenandsteers.com. Thank you, Brian. Good morning, everyone. Consistent with previous quarters, my remarks this morning will focus on our as adjusted results. A reconciliation of GAAP to as adjusted results can be found on pages 18 and 19 of the earnings release and on slides 16 through 19 of the earnings presentation. Yesterday, we reported earnings of $0.79 per share, compared with $1.24 in the prior yearâs quarter and $0.96 sequentially. Revenue was $125.5 million for the quarter, compared with $159.7 million in the prior yearâs quarter and $140.2 million sequentially. The decrease in revenue from the third quarter was primarily attributable to lower average assets under management across all three types of investment vehicles. Our effective fee rate was 57.8 basis points in the fourth quarter, compared with 58 basis points in the third quarter. Operating income was $50.9 million in the quarter, compared with $8.6 million in the prior yearâs quarter and $60.1 million sequentially. And our operating margin decreased to 40.5% from 42.8% last quarter. Expenses decreased 6.8% when compared with the third quarter, primarily due to lower compensation and benefits expenses, and lower distribution and service fees. Compensation and benefits expenses were lower in the fourth quarter when compared with the third quarter, primarily due to a reduction in incentive compensation to reflect the actual amount expected to be paid. This reduction was more than offset by the sequential decline in revenue, and as a result, the compensation to revenue ratio was 36.4% for the fourth quarter. For the year, the compensation to revenue ratio was 34.9%, an increase of 40 basis points from last quarterâs guidance of 34.5%. And the decrease in distribution and service fees was primarily due to lower average assets under management in U.S. open-end funds. Our effective tax rate, which was 25.95% for the quarter included a cumulative adjustment to bring the rate to 25.4% for the year, an increase of 15 basis points from last quarterâs guidance of 25.25%. The higher effective tax rate was primarily due to the effect of the non-deductible portion of executive compensation on lower than forecasted pretax income. Page 15 of the earnings presentation sets forth our cash, cash equivalents, corporate investments in U.S. treasury securities and liquid seed investments for the current and trailing four quarters. Our full liquidity totaled $316.1 million at quarter end, compared with $269.9 million last quarter. As mentioned on previous calls, our business has become more capital intensive, potential uses of capital range from funding the upfront costs associated with closed-end fund launches and rights offerings, seeding new strategies and vehicles, co-investing in private real estate vehicles and making various one-time investments to grow our firm infrastructure as our business scales. Our new corporate headquarters in New York City and the associated build-out and related technology infrastructure is an example of that. In order to provide us with the financial flexibility to pursue these opportunities, earlier this week, we announced that we arranged for $100 million three-year senior unsecured revolving credit asset. As you know, we have historically been debt-free, meeting our capital needs and commitments organically. Consistent with that long-term philosophy, it would be our intent to repay any amounts for under the credit facility with cash from operations as soon as practical. Assets under management were $80.4 billion at December 31st, up slightly from $79.2 billion at September 30th. The increase was due to market appreciation of $3.5 billion, partially offset by net outflows of $1.1 billion and distributions of $1.2 billion. Assets under management declined to $26 -- declined $26.2 billion from December 31, 2021. The decrease was due to market depreciation of $20.9 million, net outflows of $1.6 billion and distributions of $3.6 billion. Joe Harvey will be providing an update on our flows and institutional pipeline of awarded unfunded mandates. Let me briefly discuss a few items to consider for 2023. First, regarding our expected compensation to revenue ratio, we intend to balance the anticipated revenue decline that will occur from our year-end assets under management being about 12% below 2022âs average assets under management with a disciplined approach towards human capital. In addition to the increase in compensation expense from higher stock amortization, salary increases and the full year impact of our 2022 new buyers. We plan on making controlled investments in our business in order to broaden our product programs, expand our public and private distribution efforts, and most importantly, to maintain our strong investment performance. As a result, we expect our compensation-to-revenue ratio to increase to 38.5% from the 34.9% reported in 2022. Next, we expect G&A to increase 12% to 14% from the $52.6 million reported in 2022. The majority of this increase relates to costs associated with our new corporate headquarters at 1166 Avenue of the Americas. Excluding these lease costs, we would expect G&A to increase 4% to 6%. By relocating to 1166, we are able to expand our footprint in creating a next-generation state-of-the-art working environment at more favorable economic terms. In addition, we intend to make incremental investments during 2023 in our existing technology, including the implementation of new systems that will add efficiencies and expand our capabilities, cloud migration and upgrades to our infrastructure and security. And we expect that sponsored conferences in travel and entertainment costs will increase in 2023 as business travel resumes to more normal levels. Finally, we expect that our effective tax rate will increase to 25.5%. Now Iâd like to turn it over to our Chief Financial -- Chief Investment Officer, Jon Cheigh, to discuss our investment performance. Thank you, Matt, and good morning. Today, Iâd like to briefly cover three areas; first, our performance scorecard; second, how our major asset classes performed in the quarter; and finally, our 2023 investment outlook. In particular, I want to focus on real estate and topics such as how we expect public and private real estate to perform, our view on recent non-traded REIT redemptions and our initiative to be a market leader providing research and advice to clients across both public and private real estate. Turning to performance. In the fourth quarter, four of nine core strategies outperformed their benchmarks. Over the past 12 months, eight of nine strategies outperformed. While our batting average in the quarter was lower than normal, the magnitude of underperformance by strategy was generally modest and all related to strategies that ultimately outperformed in the year. Measured by AUM, 74% of our portfolios are outperforming their bank on a one-year basis, a decline from 81% last quarter. The biggest driver of the decline was the performance of our U.S. real estate focused strategy, which is more concentrated and has had greater weightings in small top real estate stocks, which lagged during the year and the fourth quarter bounce back. This strategy had a 25-plus year track record, a 400-plus basis points of annual alpha. And while underperformance has occasionally happens, rectifying our track record here is a key investment priority. On a three-year and five-year basis, 99% of our AUM is outperforming, which is slightly down from 100% last quarter. From a competitive perspective, 98% of our open-end fund AUM is rated four or five stars by Morningstar, up from 97% last quarter. For the quarter, risk assets broadly recovered with global equities up 9.9% and the Barclays Global Aggregate up 4.6%. Our asset classes were led by natural resource up 17.1%, international real estate up 10.3% and global listed infrastructure up 9%. Then by U.S. REITs up 4.1% and core preferred interest, excuse me, core preferred securities up 3.4%. Digging into the details, infrastructure continued to perform well, beating U.S. equities but modestly under deploying global revenues. This performance narrowed year-to-date performance to only down 4.9% in the year, handily beating very negative performing broader equity and fixed income indices. Subsector level performance started during the quarter was high, with cyclical subsectors such as railways and reopening plays such as airports and toll roads outperforming. Midstream energy or pipelines reversed its earlier trend, underperforming in the fourth quarter but still ending the year as the best performing subsector. For preferreds, the November CPI report and subsequent inflation readings supported the Central Bank Hike Deceleration occurred in December. Central Banks remain pause when markets priced in volume inflation. They likely also began to price in a better growth outlook based on falling energy prices, warm winter weather and the China reopening the COIVD policy change. Overall, the risk reward profile in fixed income markets included. For real estate, international REITs led the way of 10.3%, benefiting from their same dynamics, including a weakening U.S. dollar, while U.S. REITs were up only 4.1%. The U.S. saw significant sector dispersion with retail real estate up 17% to 33%, while sectors such as self-storage and residential were down 7% to 10% in the quarter. Global markets saw similar levels of performance dispersion with markets in Europe of 20% to 25% and Hong Kong and Australia up 12% and 18%, respectively. Phase COVID re-openings, combined with more divergent economic trajectories has strengthened the investment case for global real estate and the diversification it can provide. If we see this shift continue, I would expect investors to be can allocate more to global real estate, either incrementally or at the expense of U.S.-only REIT. So while the quarter was generally positive, where does that position us for 2023? At a high level, we believe inflation will continue to come down, but that it will stabilize at around the 3% level by year-end, which will prove to be the new rule. In order to get there, we think we will likely experience an average recession. Last, we think that over time, long-term interest rates should be a bit higher than where they are today. With that as our backdrop, we see the economy transitioning to early cycle by the end of the year and positive returns for all of our asset classes in 2023. For preferreds, we see very good asset value, coupled with the fundamentals of our issuers remain very strong, particularly balance sheets. Bankâs non-performing loans are moving up, but very gradually and from very low levels. Meanwhile, net interest margins have expanded into the higher rate environment. So from preferreds, we would expect potentially double-digit total returns in 2025. For infrastructure, we continue to expect the asset class to perform well, but in the early cycle phase it typically performs more in line with global equities. Despite that, we donât count the table on infrastructure because of just 2023, our conviction in the asset class is in its long-term strategic role in the new regime where the criticality of infrastructure businesses means demand is less economically sensible, plus its pricing mechanisms tied to inflation will help even in a new normal inflationary environment. Those are multiyear benefits rather than for a single phase. In terms of how we see our biggest asset class real estate, in 2022, U.S. REITs were down roughly 25% as the listed asset class re-priced quickly to the chain macro environment. In contrast, reported private real estate values generally increased as they tend to be historically lagged as deal volume declines. For example, the NCREIF Odyssey Index [ph], a measure of private real estate had a positive total return of 7.5% versus listed REITs of minus 25%. In 2023, we expect this trend to reverse with listed outperforming private real estate, consistent with what we normally see in a transition to early cycle. This forward shift of listed outperforming private has already started. In Q4, NCREIF was actually down 5%, while listed REITs were up 4%. Historically, listed REITs have performed remarkably well after recessions. Since 1990, REITs have returned on average 10.8% 12 months after a recession and a notable 20.4% on average 12 months after early cycle recovery periods. Because of these lags, private real estate specifically declined on average, 11.8% in the 12 months following a recession. By understanding the leading and lagging behaviors of listed and private markets, real estate investors can assemble a much more efficient portfolio and tactically allocate at different times across the two asset classes. We have always been the REIT experts, but we believe investors need integrated advice and research around both listed and private. And this is why we have committed over the last two years to build out our solutions and advice business. We strongly believe that our vantage point at this intersection of public and private real estate positions us to provide frameworks, models and guidance for investors to help them be better real estate allocators. As an example, we have recently been sharing our thoughts and views on the non-traded REIT redemptions, which have been in the news recently. First, these redemptions do not reflect broad economic or systemic risk. The redemption limits are designed to protect the funds from having to liquidate significant real estate holdings and discounted prices or materially boosting leverage in response to elevated redemption requests. We do not see a disorderly unwind or panic selling scenario for real estate funds to meet retentions. MTRs also only represent 1% of the $21 trillion commercial real estate market. The non-traded REIT story is not one of systemic risk or commercial real estate crashing. It is simply that the investors are rebalancing away from prices they believe are expensive and are seeking higher returns in other asset classes, including listed real estate. We believe the redemption activity underscores the potential rebalancing opportunity that exists for investors to pivot out of private and into listed real estate. Thank you, Jon, and good morning. I will first discuss our fourth quarter business fundamentals and then follow with a review of our 2023 corporate priorities. The fourth quarter was weak, measured by the fundamentals that we focus on, yet hopefully represents the climax of what I have characterized as the greatest macro regime change in my career. If the fourth quarter has mostly reflected investor reactions to regime change, then hopefully, the first half of 2023 will be the start of the transition to the next phase where after the resetting of financial asset prices, a new return cycle can follow. Our investment performance continues to be strong overall. One quarter does not change our strong long-term record and we remain well positioned to win investor allocations. Notably, our market share, as measured by active open-end funds continues to expand in U.S. real estate, global real estate and global listed infrastructure, with U.S. real estate most notable at 37%. Our market share in preferreds has declined to 43%, which reflects more asset managers offering the strategy in response to investor views of preferreds as an attractive source of alternative income. We remain very competitive, thanks to our performance and what arguably is the broadest range of preferred strategies and vehicles in the market. Firm-wide outflows in the fourth quarter were $1.1 billion, led primarily by preferreds at $873 million, but notably, and for the first time ever, all of our core strategies experienced net outflows. Even though markets rallied in the quarter and all of our asset classes had positive returns, the outflows in the quarter had already been prompted by broader dynamics such as year-end tax loss selling and reallocations to cash and treasuries. Open-end funds dominated outflows with $1 billion out. Both our core preferred mutual fund, Cohen & Steers Preferred Securities and Income Fund and our low-duration preferred mutual fund had outflows totaling $819 million. And U.S. REIT fund, our flagship Cohen & Steers Realty Shares had outflows of $276 million, which included the completion of the redemption by a large allocator that we mentioned last quarter. Our real estate fund, Cohen & Steers Real Estate Securities Fund, which has a broader opportunistic mandate had $210 million of inflows. Flows and other segments of our open-end fund category were small by comparison, but we had inflows for the 10th straight quarter into our offshore SICAV vehicles and outflows from our UMA and SMA vehicles in the U.S. Institutional advisory had outflows of $392 million. While redemptions from COVID-driven opportunistic investments has subsided, asset owners have been trimming portfolios for various funding needs such as benefits, private investment commitments and overall rebalancing and light of market movements. Outflows from existing clients totaled $573 million. In the quarter, we had four new mandates fund a total of $242 million across four strategies, the largest being a global real estate mandate for $182 million from a European corporate pension fund. Sub-advisory ex-Japan was slightly positive at $27 million. Japan sub-advisory continues its trend of inflows with $281 million, which netted to $44 million after distributions. The rotation out of technology and growth and the strength in the U.S. dollar contributed to Japan sub-advisory inflows. We expect to see increased marketing activity with our partners in Japan in 2023 as the country continues to reopen for business and we look forward to celebrating our 20-year anniversary with our key distribution partner, Daiwa Asset Management. Our one unfunded pipeline was $885 million at year-end, compared with $1.1 billion at the end of the third quarter and the three-year average of $1.3 billion. 72% of our pipeline AUM is in global real estate strategies, led by a recently won completion portfolio, which is a customized strategy designed to complement existing private holdings by expressing allocations in the listed market that are cheaper or cannot be expressed in the private market. 50% of our pipeline is in Asia-Pacific, which is consistent with our recent commentary about emerging demand in the region for listed real assets. To set the table for our 2023 priorities, we are expecting that the macro environment over the next 12 months to 18 months will include the following elements. The Fed will over tighten and will endure an average recession as foreshadowed by the seemingly daily pace of corporate layout announcements. The futures markets indicate that we should see the peak of monetary tightening at some point this year. So sometime in 2023 and itâs unknowable exactly when we should see the emergence of a new return cycle as financial assets have already re-priced and markets anticipate Fed easing as the economy stagnates. Inflation is expected to remain a wildcard with root causes embedded in the system itself. In terms of investment strategy priorities, we believe that global listed infrastructure and multi-strategy real asset strategies are generally underrepresented in portfolios and will continue to gain share. Although infrastructure has been defending very well in the current volatile environment, institutional allocations have averaged only 4.6%, compared with our targets of 6.6%. Our research has demonstrated how listed infrastructure can complement private infrastructure allocations through similar to slightly better returns and low correlations. We will continue to educate while broadening our investment offerings and universe to include energy transition and other secular opportunities. With respect to multi-strategy real assets, even though we expect inflation to come down, we believe investors are under-allocated to inflation solutions. We, therefore, expect demand to grow as the continuing risk of inflation states the case for insurance. We are expanding our educational outreach through our real asset institute and our focus on customization, which includes plans to launch a solution using CIT vehicles to customize allocations for retirement plans. In terms of REITs and preferreds, we believe these asset classes are poised to benefit from the next return cycle and we expect to see attractive entry points over the next year. As Jon mentioned, listed real estate return cycles historically proceed private, so investors who utilize both markets and more and more are should be focused on allocated to the listed market now. We expect private real estate prices to correct and that listed REITs will see acquisition opportunities at values 10% to 20% lower than the peak in 2022 due to higher debt costs and slower growth. Our firm is now organized with deep expertise and resources to help advise investors on allocations between listed and private real estate and implement customer solutions. With respect to preferreds, Jon characterized our favorable outlook and accordingly, we are looking for ways to invest in the business. By example, we have seen in a new preferred strategy that is more global in composition with a focus on the large universe of foreign currency-denominated preferreds outside of the U.S. Our other strategic priority is private real estate. With our expectation that prices should correct between 10% and 20%, we believe that sometime in 2023, we will see emerging opportunities to deploy capital. After several confidential filings on Wednesday, we publicly filed the registration statement for our non-traded REIT, Cohen & Steers Income Opportunities REIT. Because we are in registration, that is all I can say at this time. In addition, we continue to focus on other private real estate investment strategies for institutional investors. Finally, we have integrated our private and listed real estate capabilities with our real estate strategy group led by Rich Hill. They will help identify the best property sectors, geographies and themes, while identifying where real estate is the cheapest. Looking at distribution priorities, we recently built a key position by hiring Kimberly LaPointe as Head of Wealth. Our core institutional and wealth teams are now fully staffed. Incrementally, we are adding resources to focus on distributing the non-traded REIT and providing advice for optimizing real estate portfolios in the wealth channel, specifically, how much real estate to have in the portfolio and how to divide that between listed and private. And consistent with emerging demand for real assets in Asia, we are expanding our sales capabilities there. In closing, we are highly focused on our priorities and I believe well organized to pursue them. This year will be key in helping clients adapt to regime change in the next phase, which will include shifts in allocations between asset classes, including listed versus private. In each case, calibrating for how the return and risk profile has changed and anticipating the new return cycles. Our strategy with respect to resourcing is to ensure we have the talent to run the business, navigate regulation and execute the new initiatives right in front of us, such as private real estate, but we have set a higher bar with success based triggers for any other roles. While some of our peers are announcing layoffs, we are in a phase of potential growth that requires resources, and we are committed to helping our clients achieve their objectives. Change creates opportunity and we are committed to capitalizing on this for our clients and for our shareholders. Thank you. [Operator Instructions] Our first question comes from John Dunn from Evercore ISI. Please go ahead. Your line is open. Thank you very much. Maybe just to start off with -- on the micro side, fund wise, you talked about Realty Shares outflow and real estate securities inflow. What do you think in 2023 in the wealth management channel, what do you think is going to be inflowing versus outflow? Well, as I mentioned, John, toward the end of last year, we -- with recent down mid-20% as you normally would expect, we saw a tax loss selling. And I believe, as you have identified, looking at the mutual fund flow data, we have started to see improved flows this year, which kind of validates the shift from tax law selling back to investors capitalizing on the decline in prices and the potential positive entry point that I described. But I think both Jon and I complemented it a little bit, identified that we think that there are going to be really good entry points for -- both for REIT investors in 2023 and so we would expect flows to improve for our open-end mutual funds. Yeah. The first two we definitely show that. And then on preferreds, what do you think like the next okay demand rate environment is, not necessarily the, like when you -- itâs a leader, but less of the drag? Well, again, Jon laid this out the -- was laying out a case for double-digit returns from preferreds. And one of the things that we have always experienced with preferreds and considering that they have some of the highest income levels of -- in the fixed income world as investors are very attractive to them, particularly when you consider the tax benefits on top of that. So one of the things thatâs the change at the margin is with fixed income yields up across the yield curve and across different sub-segment types, thereâs more competition for income. But again, preferreds still have some of the highest income rates out there. So we are thinking that between that and what the capital appreciation opportunity, as Jon mentioned, a double-digit return opportunity. I think once investors see kind of an all clear signal from the Fed that we will see inflows into our preferred vehicles. Got you. So you talked a little bit about the private real estate effort. Can you give a little more kind of like say the union of not just NAV, but over the next few years, what do you think itâs going to develop into? Sure. So really for the past two years, we have been building a private real estate team better and consistent with our philosophy, we didnât try to go out and acquire something that was up and running and so we build it piece-by-piece. And Iâd say we are gaining momentum on all fronts, including the capital raising front and I have outlined kind of two vehicles that we are working on, but most importantly, we -- with commercial -- our expectations that commercial real estate prices will correct 10% to 20% this year. I think thereâs going to be a really great entry point for us to commence our track record. And thatâs the thing that we are obsessed about, is making sure we get that timing right and considering the prior real estate business is a new business, so we started with a really great track record and so we are more focused on that than raising assets as fast as we can. So the next phase will be to get the non-traded REIT up and running. And as I said, because we are in registration, we are not going to get into some of the things that are happening there. But our overall effort in private real estate is gaining momentum. Got you. So this is a question I get. What do you think it takes to get U.S. infrastructure flows really going and kind of the potential timeframe? Is it in 2023 or is it more in the out years? Well, I would say for infrastructure overall on the institutional side, itâs probably one of the most active areas that we have. Our pipelines and we characterize it in terms of things that are specific active searches and then behind that, thereâs shadow pipelines with investors that are thinking about it. Iâd say itâs one of the most active areas that we have. Thatâs been enhanced recently by how infrastructure has performed in this environment. On the wealth side, we have gotten a little bit of a pickup from all of the current administration focus on infrastructure spending. Itâs been a great advertisement for infrastructure. So our flows into our open-end fund have improved. But I think itâs still early days in terms of a broader adoption of infrastructure in the wealth channel. John, I would only add. So we are seeing certainly more interest in the wealth channel for infrastructure. And our fund there, CSU was upgraded to five stars a few months ago. And so we have seen with all of our other funds, obviously, when you go from four to five stars, we can see a pretty meaningful share in investor interest were optimism. Got you. So you guys have a lot of growth engines which ever been recognizing. But maybe to distill it down a little bit. If you think about your regions as being U.S., Asia, Europe and now like sovereign wealth funds in the Middle East. Whatâs like -- whatâs the number one thing in each of those regions that you think is going to do best in 2023? Well, let me start with the U.S. Our wealth business is one of our larger businesses and so when the conditions are right for wealth that can really have the biggest impact on the business. I would say with some of the private real estate things that we are doing and Jon mentioned it, I mentioned it, in terms of our vision of being able to help the wealth channel with real estate allocations considering all of the mandates by the largest firms to increase alternatives, weightings and portfolios. I think thatâs something that in time can really help our market share in the wealth channel. Just sticking with the U.S., there are -- when you look at our shadow pipeline, thereâs some very large pension plans that are conducting searches for strategies like U.S. real estate, global infrastructure and our multi-strategy real assets portfolio, which is consistent with the comments around investors. Looking backwards, not needing inflation protection. That obviously has changed. So the U.S. is one of the biggest markets and considering our presence in both wealth and the institutional channel, I think, it have the biggest overall impact on the business. In Europe, we have talked about whatâs going on in the Middle East and thatâs most active in real estate and in infrastructure. Elsewhere in Europe, itâs one of the interesting things is that they have been allocating to our -- also to our multi-strategy real assets portfolio. Asia is, as we have talked about in the past couple of calls, say on emerging demand front for listed real assets and thatâs going to focus on mostly on real estate, but infrastructure to a lesser extent. And because of some of the mandates that we have won and the mandates that are and competition still were -- we want to boost our sales presence in Asia, because if they now begun to adopt, we want to make sure we establish our market position. These are mandates coming from sovereign well type funds from Thailand, Malaysia and Korea. But overall, just again, based on size and based on our presence, our rent order is U.S. The U.S. is the largest and most influential on the overall business. But the Middle East and Asia are kind of emerging areas of demand. Right. Yeah. On that last one, can you frame for us the -- what inning maybe we are in, in the shift from private real estate to public? And do you think, is that just a rebalancing thing or a couple of quarter thing or a multiyear thing? Hey, John. Well, as we mentioned earlier, so again, last year, U.S. REITs were down 25%. Private, I think, was up 7% or 8%. So thereâs been a 30%-plus gap from a performance standpoint. Of course, no one exactly knows how much of that gap from a performance standpoint we expect to close out. But we could see in relative terms, probably, 10% to 20% outperformance over the next 12 months to 18 months between, again, how the private market has been valued and how the public market has been valued. So itâs pretty significant. Of course, for different kinds of investors their ability to take advantage of that from a tactical standpoint for some of the large sovereigns and other institutional investors they are an inflow mode. They have capital put to work. So I think for institutions like that, they are able to rebalance where they are investing incremental capital and we are certainly seeing that. A lot of these conversations with institutions that have been going on for 12 months, 24 months and this is similar to what we saw in 2020. You have those conversations, people feel like they miss something and then they get the opportunity. Sometimes they are a little bit nervous because things are going down. But then as things start to stabilize, they get in a position to take advantage of opportunities. So we think we are transitioning from this. Everything is volatile. Everything are correct. If people donât want to buy a falling knife to people are in a better position to take advantage of where they see relative value. So I think for institutions like that, they can certainly take advantage of it. And look, I talked about whatâs happening on the non-traded REIT side. I think that the redemptions are a symptom of investors recognizing that most things in their portfolio, including listed REITs, went down 10%, 20%, 30% last year and something didnât and that creates a really good rebalancing opportunity. So I think the redemption activity is an outcome of the relative value thatâs been created and so I definitely think we are going to see some shifts at the margin in the wealth side, which we are already seeing. Right. Yeah. Yeah. And on that last point, beyond the right now, how would you kind of categorize the close-end fund window and do you have a target for the number of launches per year? We donât have a target for the launches for year. We have ideas that we think are great ideas for the close-end fund market. As you know, right now, it is closed. Itâs been closed for well over a year and the market volatility and interest rate cycle had the most effect on that. But one of the things that that has been happening as we get further along in the interest rate cycle is that the discounts on some of our closed-end funds have been narrowing. Just by example, our listed infrastructure fund has been trading pretty close to NAV and I expect that once we get to the end of the tightened cycle and closer to the easing cycle, these -- some of these discounts will go close fully and perhaps go into premiums and then the conditions will set up for the new issue market to open up. So right now, itâs not factored into our planning other than we have investment ideas that we think are good, but itâs going to take a while before the new issue market opens up. Got you. And then maybe turning to the institutional side, like 10 years ago, your guysâ pipeline was on average about $500 million and then it kind of leveled up to $1.5 billion often plus that. Do you think over the next maybe few years, is there ability to level up again at some point to get consistently above maybe $2 billion and is that even an aspiration? Thatâs not something that we can predict. Iâd say, in my comments that itâs averaged $1.1 billion for the last three years, which includes a favorable environment for investing in our asset classes. So I would expect this adoption of real assets to continue and as the environment gets better that we should revert back to that level. And when you think about what we have invested in our distribution capabilities, and the fact that we have expanded those markets, I would expect something to a multiple to be added on to that. So I donât know what that number ends up being, but I would be disappointed if we didnât get into the $1.5 billion to plus $1 billion range as we get back in the normal environment. Makes sense. Okay. I get this question recently. Whatâs kind of like the profile of your REIT competitors? Are people exiting the space? Are they shrinking? Are the larger players getting larger? Whatâs going on with reinvesting competition? Well, the first thing is, as Joe mentioned, how much our market share in active peers grown. The first thing is, I am not going to say all of our competitors have shrunk significantly. But over the last two years, there has been some comparatives that have gone away and there are some that have shrunk in considerably. And over the last 10 years or so, there have certainly been other competitors or players in the space that have been in favor. And then I would say, to be honest, because they had good performance and then there have been -- and then sometimes they have gone out of favor. I think we have been consistently in the mix because we have been consistently top quartile, even though who has been in that top quartile has lacked some wins over time. So we continue to take market share because we are putting up consistent performance, we have a consistent team and our platform is very healthy. So we are able to continue to invest in our people, invest in the resources that we need and the resources we needed 20 years ago, they were very different today. And thatâs -- I think our clients and prospective clients see that we are investing on the macro side, on the risk side, on the data side, on the quantitative side, and all those things have allowed us to evolve and keep getting better. I would just add a perspective on that, John, from the wealth channel, which is that with the adoption of private strategies in the wealth channel, we have a new competitor. So while we have done extraordinarily well versus our active peers and open-end funds in the wealth channel. And we have also had to compete against passive strategies, which are gaining share versus active, as you know. We are now competing with the private equity firms who are offering private or semi-private real estate solutions and wealth channels. So that is a big part of our impetus for us to create a vehicle in private real estate for the wealth channel and a vehicle that is a little differentiated, but itâs to help take advantage of the opportunity that we see to help advisors optimize their portfolios. And the private equity firms arenât going to do that, right? They are going to try to optimize their private allocations. They are not going to help advisors add listed allocations to that. So for us, itâs, on one hand, a competitive challenge, on the other hand, itâs a great business opportunity, investment opportunity for the wealth channel. Okay. So just last one, maybe more big picture. When I think about companies over the last phase, I think of you guys broadening in the strategy you want to be in, getting deeper in the wealth management channel, revamping U.S. advisory and adding private real estate. Now that you are driving, Joe, whatâs your vision for the next few years? Starts with creating investment performance and then maximizing all of the investments that we have made in distribution and capitalizing on just the overall position of us as a real asset provider and looking backward, we have mentioned our multi-strategy real assets portfolio a couple of times, because inflation hasnât been a thing, that hadnât met its full potential. But when I look at how we are positioned today, we have invested in distribution, in vehicles and I think thatâs our time to maximize our market share of the potential real assets in the investor portfolio as well adding private real estate in that. We have no further questions in queue. I would like to turn the call over to Joe Harvey, Chief Executive Officer of Cohen & Steers for closing remarks. Great. Well, thank you, everyone, for your time this morning. We look forward to speaking with you next in April when we release our first quarter results. Have a great day.
|
EarningCall_1162
|
As always, we will reference our financial highlights presentation, which can be found on the Investor Relations page of our website at bnymellon.com. I'm joined by Robin Vince, President and Chief Executive Officer; and Emily Portney, our Chief Financial Officer. Robin will start with introductory remarks, and Emily will then take you through the earnings presentation. Following their remarks, there will be a Q&A session. Before we begin, please note that our remarks include forward-looking statements and non-GAAP measures. Information about these statements and non-GAAP measures are available in the earnings press release, financial supplement and financial highlights presentation, all available on the Investor Relations page of our website. Forward-looking statements made on this call speak only as of today, January 13, 2023, and will not be updated. Thank you, Marius. Good morning, everyone, and thank you for joining us. Before Emily takes you through our quarterly results, I'd like to make a few broader comments on our performance in 2022 and on some areas of focus for 2023. As you can see on Page 2 of our financial highlights presentation, we reported earnings per share for the full year of $2.90, down 30% compared to the prior year, and a return on tangible common equity of 13%. Excluding the impact of notable items, we reported earnings per share of $4.59, which was up 8% year-over-year, and a return on tangible common equity of 21%, reflecting our solid underlying performance against the backdrop of a complex operating environment in 2022. Our results this year included several notable items; for example, those related to Russia in the first quarter and the goodwill impairment related to investment management in the third quarter. And our fourth quarter results reflect the impact of a number of decisions that we made to improve our revenue growth and efficiency trajectory moving forward. Excluding notable items, revenues grew a little faster than expenses as we continued to see strength in client activity and volumes, while continuously positioning ourselves to derive meaningful benefit from the upward move in interest rates. Together, these factors more than offset the stiff headwinds from lower market levels. On the back of organic growth in AUC/A, we're continuing our role as the world's largest custodian, and we saw cumulative net inflows in assets under management. Beyond the numbers, I'd like to highlight a couple of areas where I'm particularly encouraged by our performance in 2022. First, our sales momentum, which speaks to the strength of our client franchise and our capabilities. In Asset Servicing, we continued to elevate our client dialogue, while maintaining a strong focus on service quality to support our clients through a difficult environment. Sales wins increased off a strong 2021, and we're winning larger and higher value deals, which is where the elevation of client dialogue matters. In ETFs, AUC/A reached $1.4 trillion, as we saw strong net inflows throughout the year and the total number of funds serviced rose by 12%. And in Alts, we grew AUC/A by 14% and fund launches were up by over 25%. Treasury Services delivered strong broad-based growth throughout 2022. In the fourth quarter, we announced a collaboration with Conduent to be their trusted payments infrastructure provider as they launch a digital integrated payments hub for businesses and the public sector. This hub will enable access to more secure, faster and cost-effective options to send, request and receive payments and refunds in a matter of minutes using real time payments and other proven payment technologies. And we also onboarded several new clients during the quarter as we continued to build our digital payments and related FX businesses. And finally, while 2022 was no doubt a difficult environment for the wealth market, our Wealth Management business acquired more clients with particular strength in the ultra-high net worth and family office segments, and we continued to deepen existing relationships through our expanded banking offering where the percentage of advisory clients who also bank with us rose by about 5 percentage points. Notwithstanding the tough backdrop, Pershing, which is, in fact, our largest play as a company in the wealth space, brought in net new assets of over $120 billion, representing 5% growth. In the fourth quarter, we announced two very exciting wins, demonstrating the broad-based capabilities that Pershing is uniquely positioned to offer. The first was State Farm, which is an exciting relationship given State Farmâs size and reach with its thousands of agents across the country serving tens of millions of households. And we also onboarded Arta Finance, which was founded by a team of former Google executives, who are now leading a global digital family office that uses advanced technologies to empower investors with tools to invest intelligently. This win is an important proof point of our proven set of APIs and digital capabilities and demonstrates our ability to win with tech forward clients. The second area of performance I'll call out is that we continue to forge ahead with our longer-term growth initiatives, such as Pershing X, real-time payments, the reimagining of custody and collateral, and digital assets. These initiatives will help position the company for the next leg of growth beyond the medium term. We went live with our digital asset custody platform in the U.S. in October. And as I highlighted in my op-ed in the Financial Times a month ago, this will continue to be a focus for us, not so much for crypto, but really the broader opportunity that exists across digital assets and distributed ledger technology. If anything, the recent events in the crypto market only further highlight the need for trusted regulated providers in the digital asset space. We are also now live with our first release at Pershing X, just one year after launching the initiative. This release to a small number of select clients includes three core products: Portfolio Solutions, including direct indexing; Client Servicing; and Data and Reporting tools. But equally importantly, this release is about our ability to set a goal on a tight timeline and execute. Finally, the third and probably most important highlight of the year for me is our people and our systems, once again, demonstrated remarkable resilience. Across the war in Ukraine, the extraordinary moves we saw in several government debt markets and volume surges, the operational readiness of our people and our systems consistently enabled successful outcomes for our clients. I cannot thank our people enough for their hard work and dedication to serving our clients. While we're proud of these accomplishments, it's also important to humbly recognize an area where we fell short this past year, acknowledging the inflationary headwinds, expense growth for a second straight year was around 5% ex notables. We consider that number too high, especially considering the expense growth benefited from a stronger U.S. dollar throughout the year. On a constant currency basis, expense growth ex notables was approximately 8%. While I'm encouraged by the renewed sense of urgency across the organization over the last few months to better manage our expenses, we still have ways to go on this journey, which brings me to our key focus areas for 2023. First, expenses. My leadership team and I are fully committed to bending the cost curve this year. That will come from instilling further expense discipline across the firm and from focusing more on profitable new business growth, saying no to more things when the economics aren't what they should be. Efficiencies are also going to come from implementing ideas that will make BNY Mellon a simpler, more efficient place to do business with. And so here, we've embarked on an enterprise-wide initiative, led by senior leaders and high-performing employees from around the world focused on driving greater efficiency and enabling sustainable growth. No one knows the ins and outs of our products, services and processes better than our people. And so, all of our staff have had the opportunity to take an active role in this initiative by submitting ideas for how we can run the company in a better way for all our stakeholders. To date, we've approved about 1,500 high quality ideas, of which about 200 are already completed and another 500 are on track to be implemented this year with a meaningful amount of these ideas requiring little upfront investment. Emily will cover this in more detail, but as a result of these initiatives and our renewed determination, we expect to achieve nearly double the amount of efficiency savings this year compared to what we achieved in any of the recent years. But our priorities are, of course, not just about managing expenses. We are also focused on reinvigorating profitable growth. Our project commits to achieving positive underlying growth this year across almost all of our businesses, with particularly healthy growth coming from Asset Servicing, Pershing and Treasury Services. We will continue full speed ahead with our critical long-term growth investments that I mentioned earlier with clear and specific targets that we expect the teams to hit over the course of the year. Lastly, on the top-line, our priorities include goals for our ONE BNY Mellon program, which incentivizes cross business referrals and development of innovative, multi-business solutions that only BNY Mellon's unique collection of businesses is equipped to provide. In 2022, we saw good initial momentum and we surpassed our initial goal for the year, and we intend to deliver a further pickup in 2023 as we increasingly sell our platform and better connect the dots for our clients. Finally, on capital management, I'll highlight that our Board of Directors has authorized a new $5 billion share repurchase program, which provides us ample flexibility, and having ended the year comfortably above our capital management targets, we're now resuming buybacks. And so, in summary, while none of us can predict exactly what the operating environment will look like in 2023, we are laser focused on growing the franchise and executing against our efficiency plans with discipline and urgency to drive some positive operating leverage in 2023, while returning a healthy amount of capital to our shareholders this year. As I walk you through the details of our results for the quarter, all comparisons will be on a year-over-year basis, unless I specify otherwise. Starting on Page 3 of our financial highlights presentation. Total revenue of $3.9 billion in the fourth quarter was down 2% on a reported basis and up 9% excluding notable items. As Robin mentioned earlier and as you can see at the bottom of the page, our reported results in the fourth quarter included a few notable items resulting from actions to improve our revenue and expense trajectory. Reported revenues included approximately $450 million of net securities losses recorded in investments and other revenue, resulting from a previously disclosed repositioning of our securities portfolio, which I will expand upon later. Fee revenue was flat, as the benefit of lower money market fee waivers and healthy organic growth across our Security Services and Market and Wealth Services segments was offset by the impact of lower market values from both equity and fixed income markets and the unfavorable impact of a stronger U.S. dollar. Firm-wide assets under custody and/or administration of $44.3 trillion declined by 5%. The headwind of lower market values and currency translation was tempered by continued growth from both new and existing clients, and assets under management of $1.8 trillion decreased by 25%. This also reflects lower market values and the unfavorable impact of the stronger U.S. dollar, and again, this headwind was partially offset by cumulative net inflows. Investment and other revenue was negative $360 million in the quarter on a reported basis. Excluding notable items, investment and other revenue was a positive $100 million, a good result reflecting another quarter of strong fixed income trading performance. And net interest revenue increased by 56%, primarily reflecting higher interest rates. Expenses were up 8%, or 2% excluding notable items. Notable items amounted to approximately $200 million in the quarter, primarily severance expenses. And provision for credit losses was $20 million, primarily reflecting changes in the macroeconomic forecast. On a reported basis, EPS was $0.62; pre-tax margin was 17%; and return on tangible common equity was 12%. Excluding the impact of notable items, EPS was $1.30, up 25% year-over-year; pre-tax margin was 31%; and return on tangible common equity was 24%. Touching on the full year on Page 4. Total revenue grew by 3% on a reported basis and by 6% excluding notable items. Fee revenue was flat. Investment and other revenue was negative $82 million, or positive $340 million excluding notable items. And net interest revenue was up 34%. Expenses were up 13% on a reported basis and up 5% excluding notable items, consistent with our goal to drive 2022 expense growth towards the bottom half of the 5% to 5.5% range that we guided to throughout the year. Excluding the benefit from the stronger U.S. dollar, expenses ex notables for the year were up 8%. On a reported basis, EPS was $2.90; pre-tax margin was 20%; and return on tangible common equity was 13%. Excluding the impact of notable items, EPS was $4.59, up 8% year-over-year; pre-tax margin was 29%; and return on tangible common equity was 21%. On to capital and liquidity on Page 5. Our consolidated Tier 1 leverage ratio was 5.8%, up approximately 35 basis points sequentially, primarily reflecting capital generated through earnings, the sale of Alcentra and an improvement in accumulated other comprehensive income, partially offset by capital returned through dividends. Our CET1 ratio was 11.2%, up approximately 120 basis points, driven by the increase in capital and lower risk weighted assets. And finally, our LCR was 118%, up 2 percentage points sequentially. Turning to our net interest revenue and balance sheet trends on Page 6, which I will also talk about in sequential terms. Net interest revenue of $1.1 billion was up 14% sequentially. This increase primarily reflects higher yields on interest-earning assets, partially offset by higher funding costs. Once again, NIR in the quarter exceeded our expectations as noninterest-bearing deposits remain elevated. Average deposit balances decreased by 2%. Within this, interest-bearing deposits increased by 2% and noninterest-bearing deposits declined by 11%. Despite this decline in the quarter, the share of noninterest-bearing deposits as a percentage of total deposits has held up better than expected at 27%, which is higher than historical averages. And we continue to actively manage our deposit footprint to optimize across NIR, liquidity value and return on capital. Average interest-earning assets remained flat. Underneath that, cash and reverse repo increased by 4%, loan balances were down 1%, and our investment securities portfolio was down 3%. As I mentioned, in the fourth quarter, we took actions to reposition the securities portfolio to improve our NIR trajectory for the coming years. We sold roughly $3 billion of longer-dated lower-yielding municipal and corporate bonds, which we've been replacing with significantly higher-yielding securities earning roughly 5% or 250 basis points to 300 basis points more than what we were earning on the securities that we sold. While we realized an approximately $450 million pre-tax loss with this sale, this transaction was virtually capital neutral because the unrealized loss was already recognized in AOCI. In fact, we freed up roughly $150 million of CET1 capital as a higher credit quality replacement portfolio consumes significantly lower RWA. Moving on to expenses on Page 7. Expenses for the quarter were $3.2 billion, up 8% year-over-year. Excluding notable items, expenses were up 2% year-over-year. This year-over-year increase reflects investments, net of efficiency savings, higher revenue related expenses, including distribution expenses, as well as the impact of inflation, partially offset by the benefit of the stronger U.S. dollar. Security Services reported total revenue of $2.2 billion, up 18% compared to the prior year. Fee revenue increased 2% and net interest revenue was up 79%, driven by higher interest rates, partially offset by lower balances. As I discuss the performance of our Security Services and Market and Wealth Services segment, I will focus my comments on investment services fees for each line of business, which you can find in our financial supplement. In Asset Servicing, investment services fees were down 1% as the impact of lower market values and a stronger U.S. dollar were mostly offset by the abatement of money market fee waivers, higher client activity and net new business. In Issuer Services, investment services fees were up 7%, driven by the reduction of money market fee waivers and higher depositary receipt issuance and cancellation fees. Next, Market and Wealth Services on Page 9. Market and Wealth Services reported total revenue of $1.4 billion, up 19%. Fee revenue was up 14% and net interest revenue increased by 33%. In Pershing, investment services fees were up 22%. This increase reflects lower money market fee waivers, higher fees on sweep balances and higher client activity, partially offset by the impact of lost business in the prior year and lower market levels. Net new assets were $42 billion, reflecting a very healthy level of growth from existing clients, while flows related to dividends and year end capital gain distributions were naturally more muted than in the prior year quarter. And average active clearing accounts were up 4% year-on-year. In Treasury Services, investment services fees were flat. The benefit of lower money market fee waivers and net new business was offset by the negative impact to fees from higher earnings credit on the back of higher interest rates. And in Clearance and Collateral Management, investment services fees were up 6%, primarily reflecting higher US government clearance volumes driven by continued demand for U.S. treasury securities due to elevated volatility and an evolving monetary policy. Now, turning to Investment and Wealth Management on Page 10. Investment and Wealth Management reported total revenue of $825 million, down 19%. Fee revenue was down 18% and net interest revenue was up 2%. Assets under management of $1.8 trillion declined by 25% year-over-year. This decrease largely reflects lower market values and the unfavorable impact of the stronger U.S. dollar partially offset by cumulative net inflows. As it relates to flows in the quarter, we saw $6 billion of net outflows from long-term products and $27 billion of net inflows into cash. Among our long-term active strategy, liability-driven investments continued to be a bright spot with $19 billion of net inflows in the quarter, a real testament to our market-leading capabilities and resilient performance during the recent market dislocation. A very healthy net inflows into our cash strategies come on the back of strong investment performance, most notably in our Dreyfus money market funds. In Investment Management, revenue was down 22% due to lower market value and mix of cumulative net inflows, a stronger U.S. dollar and the sale of Alcentra partially offset by lower money market fee waivers. And finally, in Wealth Management, revenue was down 12%, primarily reflecting lower market values. Client assets of $269 billion were down 16% year-over-year, primarily driven by lower market value. Page 11 shows the results of the Other segment, where investment and other revenue includes the net loss and the repositioning of the securities portfolio and expenses include severance. With regards to NIR, we have positioned ourselves for another year of healthy growth. And so, we currently project an approximately 20% year-over-year increase for the full year and that assumes current market-implied interest rates. Having said that, the range of potential outcomes remains relatively wide and the quarterly trajectory of NIR will be dependent on various factors, including the path of deposit levels and mix, as well as interest rates. As it relates to fees, as you know, market-driven factors like equity and fixed income market levels, currency and interest rates dominated fee dynamics in 2022, while underlying growth across Security Services and Market and Wealth Services was offset by headwinds in Investment and Wealth Management. For 2023, we expect to return to some underlying fee growth for the firm. Now, Robin talked about the work we've been doing over the last few months to bend the cost curve, while making sure we're continuing to invest. For 2023, this translates into expenses, excluding notable items, increasing by approximately 4%, assuming exchange rates remain flat to where they ended 2022 or by approximately 4.5% on a constant currency basis. This compares to 8% in 2022. And then, on taxes, we expect our effective tax rate for the year to be in the 21% to 22% range, primarily due to an increase of the corporation tax rate in the UK this year. And finally, I want to close with a few remarks on capital management. As you saw, we ended 2022 comfortably above our management target. And our Board of Directors has authorized a new $5 billion share repurchase program, which provides us ample flexibility. As always, the timing and the amount of repurchases is subject to various factors, including our capital position and prevailing market conditions, among others. Based on our current expectation for continued earnings growth in combination with our estimated trajectory of AOCI pulling to par, we're now resuming buybacks and weâd expect to return north of 100% of earnings through dividends and buybacks in 2023. I'm sure you won't miss our earnings quarterly, but it was a real pleasure to work with you here these past few years. So, I'd love to drill down on the NII expectations. You indicated that it assumes current market rates, but maybe you could please walk us through some of the more specific drivers, primary assumptions and moving pieces that underlie that 20% growth assumption. Good morning, Brennan. And it's been great to work with all of you as well. So, if you think about the NIR outlook, the first thing I would just mention is that we use the forward curves to as a basis of our projection. So, we don't try to get cute. And as all of you know, for the Fed that assumes another 50 basis points of hikes in the first quarter, probably followed by a pause until the end of the year. The curves outside the US assume about 125 basis points to 150 basis points worth of hikes by both the BOE and the ECB. So, as a result of these curves and rising rates as well as, I would say, all of the actions that we've taken in the securities portfolio, and by that, I don't just mean the rebalancing that we did in December, but we, obviously, positioned the portfolio throughout the year, meaningfully shortening duration, adding floaters, et cetera, so with all of that, we do continue to expect to benefit from significantly higher reinvestment yields. Now tempering that a bit, we do expect deposits to decline modestly, call it, low to mid single digit from fourth quarter average. And finally, as it relates to marginal betas, we would expect them to continue to increase, but of course, more so for non-dollar balances. So that's really what's behind the 20% guide year-on-year. But I would also say there's a lot of uncertainty in the market and certainly, we're prepared for many different outcomes. It will be highly dependent upon deposit levels and there's some upside there if we retain more NIBs. Great. That's very helpful. Thank you, Emily. Capital accretion was really encouraging this quarter. You guys have the rather large buyback announced and you made some positive comments on it in your prepared remarks, Emily. So, how should we -- AOCI was really, I think, the source of the big surprise from my perspective. How should we be thinking about AOCI accretion if yields remain stable from here? What does that timeline look like? Sure. So, assuming the portfolio doesn't change and forward rates are realized. The latest -- our latest forecast would expect to recover probably close to 50% of the $2.5 billion of unrealized loss in the AFS portfolio over the course of, call it, 15 to 18 months. Hey, good morning, everybody, and Emily, congrats again. I was hoping we could start with a question around fixed income markets. There's generally a broad set of bullishness on the outlook for fixed income flows, particularly with respect to ETFs. I'm curious, as a very large servicer of fixed income assets, and you guys just kind of touched that whole ecosystem in multiple different ways, can you help us frame how BK's fees overall and servicing fees specifically could benefit from an improved outlook for our -- from fixed income flows, both mutual funds and ETFs? Is there a particular difference, when it's like inflows versus outflows? Just hoping to get a little more granularity as we think about the fee outlook for '23. Sure. So, just as we think about the fee outlook, what I would say is just our base case assumption is that there's a relatively soft landing in the U.S., so that would be average equity markets as well as fixed income markets are not that far off from what we've seen averages in 2022. You are correct that our money market platform does benefit that to a degree. Having said that, we do expect some modest runoff in balances as well in money market funds. And what I would also just highlight is that any strength in the fixed income market really does play to the strengths of our investment management business. Yes, Alex, I -- it's Robin. I would just add a couple of things to that. Just as you think across the breadth of our franchise, and Emily mentioned a couple of them, we have a lot of oars in the water on fixed income generally. So, our asset servicing business is fixed income heavy, that gives rise to a fixed income heavy, security lending business. We have a $1.3 trillion worth of cash on our investment platform. So that plays in the short end of the market, which obviously has an overlap with fixed income as well. We have our Dreyfus money market fund, which has done -- which has performed really quite well over the course of the year in terms of performance and asset gathering. We have our treasury business in terms of our clearance business. We have our treasury market repo business. So, we've got a lot of different opportunities that come from all of this, and we're obviously paying attention to all of them. Got you. Great. Thanks. And then maybe just my follow-up on operating leverage in the business broadly, and you mentioned, Robin, a number of different efficiency programs that you have in place that sound like they're ramping nicely and just kind of incorporated in your expense guidance for this year. But when you sort of take a step back and assuming that short-term interest rates remain sort of range-bound or whatever the forward curve is forecasting, how are you thinking about the pre-tax margin for the firm as a whole over time? I'm not sure if you're ready to talk about those targets yet, but in the past, you guys were north of 30%. Is that ultimately the goalpost as you think about the ins and outs of your programs, but also what's going on in the top-line? So, you're right in that we're still working on it. I'm four-and-a-half months into my tenure. We've talked about the strategy reviews. They are ongoing. We've made some good progress. It's true on the business side. It's also true on the function and the support side as well, but we are focused. To your question on margin, we are focused on driving profitable growth which is top line, but with an eye to the bottom line and also just exuding expense discipline through doing the work. We think we've got a high-performing culture, but we continue to drive on things that relate to that. And I think when you look across revenue growth, pre-tax margins and ROTCE, you have the key metrics that we're really using. Now, we are considering a variety of different KPIs, and we look forward to giving you all more transparency on some of those KPIs as the year progresses. And so as we do the work, we're going to come talk to you about it. Great. Thanks. Good morning. [Technical Difficulty] great working with you over the years. Maybe you could talk a little bit shift gears a bit to a scenario in which we don't have a soft landing, let's say we do have a recession and a lot of pressure on markets. In that scenario, if we assume that there still is actually pretty good allocation to fixed income, which of course, you would benefit from, can you just talk about throughout your platform, to what extent you would expect to be resilient against that? And some of the areas I'm thinking of or even in deposits where deposit growth could outperform the expectations that you described, Emily? And then, if you could also just remind us on the fee revenue sensitivity to equity market declines? I think, it's 1% plus through every 10%, I think. Sure. So, a couple of comments there, and I think Robin will add on probably. So, just in terms of our sensitivity overall, our fee sensitivity to fixed income market. Just remember for every 5% or so gradual change in fixed income markets that impacts annual fee revenue to the tune of south $40 million. So that gives you some idea on how to size that. And then, certainly, as Robin pointed out earlier, we have many different businesses that ultimately would benefit from also strength in fixed income markets. But Brian, let me just add something else. One of the things that -- we're a trust bank, we often get obviously compared to trust banks, and I understand why. But we have a broader portfolio that I think is quite relevant in answer to your question, particularly, and they happen to be higher growth, higher margin businesses for us. So, things like Pershing, things like Treasury Services, our Clearance business, our Collateral Management business, and those really do contribute to the underlying diversification that we have as a firm. And that portfolio helps us with the stability of underlying revenues through different market conditions because they're essentially driven by different things, and so we get a balance for that. Now, on top of that, we're, of course, thinking about how to make sure that we are increasing the mix of the types of revenues that we have as well. So, yes, we have fees. Yes, we have net -- NIR, but we're also powered by transaction volumes, and we're also powered by subscription fees. And so, the combination of these diversification of the businesses and the diversification of the types of revenue streams, we think helps us quite a bit in these different market conditions, and that's why you've seen us, in fact, perform in an effective and relatively stable way through some pretty significant gyrations. That's great color. And then, maybe, Robin, if you just want to continue on the growth initiatives that you've outlined, Pershing X, the payments venture with digital payments, especially in terms of -- these are definitely long-term investments and trajectories. But maybe if you can sort of think -- or sort of telegraph what you think might be the contribution this year or just outline what you think might be a reasonable organic growth rate -- revenue growth rate for this year? So, look, we've talked about the fact that these are medium-term initiatives, and they are. The contribution to revenues today from real-time payments is really small. But we do see this as rails of the future, and we see it as creating an opportunity for a connected set of services; think of fraud prevention and account validation and bill pay-related things. So, there's an ecosystem that builds around the actual capability. And we think that that's a significant opportunity for us. You've seen some announcements that we've made. But if I tick through very briefly, and I will try to be quick about it, but through each of our businesses. Look, in Pershing, we've had a strong year of net new asset growth. We talked about it in my prepared remarks. And we think that we'll have growth in the near-term through onboarding the pipeline, and then we've got the medium play of Pershing X. In Asset Servicing, we've been growing sales. And at the same time, we're leaning into the future with things like digital assets, and we're focusing on the expense base as well. So, again, it's something for the near term and for the medium term. In Markets, we're driving with foreign exchange and liquidity and securities lending, and then for the medium term, execution services and new products. In CCM, we expect the evolution that will come from the gradual decant of repo into tri-party, which we think we're well positioned for. In Treasury Services, we're picking up cross-border activity in terms of U.S. dollar clearing and we're playing for the longer term that I talked about with real-time payments. And so, across so many of our businesses, we've got opportunities in the near term, we're focused on executing them, and we're investing for later. Good morning, guys. I appreciate the color on deposits for 2023. I wanted to ask a little bit more about what you saw in the quarter. Interest-bearing deposits flipped to growth. Wondering what the drivers are there. And on the noninterest-bearing side, that outflow accelerated quarter-over-quarter. So, any more color on either of those would be great. Thanks. So, deposit balances overall for the quarter were down very modestly as you can see. And most of that was a runoff in non-operational, but NIBs did and still are remaining at elevated levels. So just for what it's worth when we're talking about the trajectory for deposits in 2023, as I said before, we would expect average deposits to decline very modestly, call it, low single digit from fourth quarter averages. And you should expect and we are expecting the large majority of that to be from NIBs because they will probably revert back to about 20%, 25% of our total deposit balances as we've really seen in historical average. Okay, thanks. And then, Robin, you highlighted healthy growth in Asset Servicing as a priority for this year. That's a business that's well established, sometimes can be more difficult to differentiate. So, what are the kinds of things you can do and you want to do to accelerate growth there? Well, I'm going to start off on this one, but then I'm going to give it over to Emily because she is going in to run that business and knows it pretty well already from her prior time. But I think there are a variety of different opportunities for us. I mentioned in my prepared remarks that we're really elevating the conversation more into the C-suite of some of these firms, because gone really are the days where we're selling a small component of a service on an isolated basis, we see more opportunities to sell bundled deals with data and digital capabilities, all wrapped up in it. And that we see -- we are getting traction from that. We had a very significant new client that we announced earlier on in the year -- or last year, that is a good example of that type of package sale. So that's one thing. We also have the bottom-line focus. I want to continue to point you at the comments that we've made before that the margin in that business is not acceptable and that we will continue to invest both in the top-line, we'll benefit some from rates, and investing in making the cost of execution cheaper and more efficient in that business. So, it's really a package of all of the things. Yes, just a few things to add. So, as Robin alluded to in his prepared remarks, I mean, we are winning larger and higher-value deals, but we're also very focused on the profitability of the mandate and the relationship overall. And so that also means we're being more selective even in the RFPs that we participate in. Likewise, we're leaning into higher-growth areas like Alts and ETFs. 20% of the wins that we have seen or -- had a data component, and data is very critical, especially, in the forward trajectory to our clients. And I would say our pipeline is very strong. And the other thing, of course, as Robin mentioned, is we are very, very focused on driving the cost down across the Securities Services segment, inclusive of Asset Servicing for those businesses, which remain pretty manually intensive, so think Transfer Agency, think Fund Accounting. So, there's opportunity there for sure. So, Emily, I'm going to ask the question I had asked you 12 months ago, roughly, on the earnings call about Basel IV. We still don't have a proposal, but we know something is coming in early '23. And given his speech had hinted at capital requirements moving higher for the G-SIB cohort, recognizing there is still no proposal, but I was hoping you could just speak to how you're scenario planning for the finalization of Basel III? Whether that has any influence on the potential cadence of future buybacks or just capital management, more broadly? How you see that potentially evolving? Sure. So, look, we're obviously very involved with regulators in the industry around the conversations around Basel IV. It's true, of course, the introduction of operating or operational risk RWA into the standardized approach would, by itself, drive an increase in our standardized RWAs. When we crunch the numbers, our calcs suggest something a bit less than probably what you've seen for the GSIBs aggregate in the QIS. And there are also -- we do also expect there are going to be some offset for us. So, lower credit risk RWAs and also, we'll probably benefit modestly from the more risk-sensitive market -- the market -- the more risk-sensitive, excuse me, market framework. So, they'll be puts and takes. We'll have to wait, really, until the regulators release their proposed version. And we already -- and we do obviously -- for us, we're always looking at RWA optimization. You can actually see that RWAs came down in the quarter, again from optimization that we have been ongoing, that's ongoing and we've been doing. And I would just remind you, too, that the industry will have time to leg into whatever the results end up being. Fair enough. And just for my follow-up on expenses. I was hoping you can help us reconcile what the expense guidance for '23 implies for both the op margin and dollars of expense as it relates to the Securities Services segment specifically? It feels like that's the area where there's still some of the most low-hanging fruit, if you will, to drive efficiency gains. And just given the planned efficiency actions, how should we think about that second derivative for expense growth? Should we expect that to steadily improve over the course of the year, where you implement the plan, you start to realize some of the benefits, and the exit rate on expenses, therefore, in '23 should reflect a lower level of expense growth relative to the other quarters? So, I'll kind of answer that more focused on margin for Securities Services because that's really what we've been talking about and a very critical KPI for us. So -- and I think Robin already said, we are very committed to a 30%-plus margin over the medium term. You'll see we printed in the fourth quarter, margin of about 27%, for the full year that was closer to 21%. In 2023, we will benefit somewhat from NIR. So, higher rates will be partially offset perhaps by a modest decline in NIBs. Also, we are absolutely extraordinarily focused on executing against the revenue growth as well as the efficiency initiatives that we have been talking about. When you think about Securities Services though, I'd also just mention, there's going to be some nonrecurring activity that we enjoyed in 2022 that we won't have in 2023 in Issuer Services in particular. So, kind of net-net, putting it all together, when you look at the margins for Securities Services overall, they're going to be lower than what we printed in Q4, but certainly higher than the full year level. So, we're making progress. And just the expense growth, on a firm wide basis, whether the exit rate for '23 should reflect some of those additional efficiency benefits that you had cited? I'm just trying to think about the cadence for how we should think about the expense trajectory over the course of the year. Yes. So, I'm not going to kind of give too much detail on what we expect quarter-on-quarter. I mean, the only thing I would say just and all of you guys know this is that for the first quarter, staff expenses are typically a bit higher due to long-term incentive comp associated with retirement-eligible employees. And of course, the actions we're taking, they're front-loaded, but you'll see that over the course of the year. So, I think, I would just go back to, we are absolutely bending the cost curve. We are expecting to deliver and are very committed to deliver year-on-year growth of about 4%, 4.5% constant currency, and again, that compares to 8% in 2022. Good. Robin, I think you inherited a tough hand here. So, I mean, BNY Mellon historically has had periods when they do a better job controlling expenses, but that typically coincides with periods of slower top-line growth, but you're starting off here, fees were down 3% last year. Looks like your guide for NII implies that's flat with the fourth quarter. So, it's not so much, okay, revenues are slow, you can control expenses so much they've already slowed or they're about to. So, it just seems like your efficiency savings are going to be tougher. And as part of that, this predates you, Robin, but when it comes to notable items or one-time items, you had some this quarter, but if you look over a decade, your notable items add up to $3.5 billion. That's almost a year's worth of earnings. So, the real question here is how can you improve your profit margin and your efficiency ratio and squeeze more out of BNY Mellon when the revenue environment has been tough and you have inflationary pressures? I guess, how confident are you to turn this around in terms of the positive operating leverage on a core basis? So, Mike, without reflecting on the past in terms of what people have done and how they've done it, I'll just say that we acknowledge that the past decade has been disappointing in terms of our company's broad financial performance. You can look at some spots on the top-line, the bottom-line, expenses, we pick your spot, but we're not comfortable with the broad performance of the company over the past decade. And that's how we've talked to our Board about it, that's how we talk to our employees about it, and we're determined to change that. And so, you're hearing from us, I think, I hope, a determination around changing that outcome. Now to your question, let me take the two parts of the things that you've really talked about. So, first of all, the notable items. And so, we are very, very clear, and we do this in our earnings release and we do it in our prepared remarks, we talk GAAP first. So, you can see the reported numbers and it's very clear and you can judge us on that. But we also want to give you the transparency, and frankly, the insight into the way that we're running the company under the hood. And we think that's why that additional element of disclosure is helpful, but you'll make your judgment based on that transparency and the insights that we're trying to provide. Now, I own that 4% to 4.5% number, 4%, if use the exit rate of currency, 4.5% on a constant currency basis, and that's essentially half of what it was in 2022. And the environment, from an inflation point of view, isn't expected to get any better. We had inflation over the course of the past few months, CPI between 6%-and-change and 9%-and-change, we've still got that environment. But we've been very deliberate in terms of staffing, choices of things that we're going to do, choices of how we're going to do it. I talked in my prepared remarks about a variety of -- involving our employees in bending the cost curve, because I think it's a cultural thing for us as well. We're attacking it on all of those fronts. Now, once we've done all of those things to the implied question of what do we think the future holds, well, we don't want to stop there. We don't have line of sight to all of the things that we're going to do in the future, but we see opportunities. For instance, I'm just going to pick one and then I'll finish, which is on technology. We've invested a ton rightly so in resiliency as a company. Resiliency is incredibly important to our products and services. It's wrapped up in our brand, and we wanted to make sure that we really took ourselves to a better place than where we were five years ago. But now we've largely done that. It's a continuous journey. We always have to do stuff. But the next leg for us is investing in things like the applications, the digitization of our footprint. We're the world's largest custodian, but we've got more than one custody system. We've got multiple loan systems. We've got five different call centers, and so we're going in and seeing all of these opportunities. And then, over time, we'll do the work to resolve the issues. But we can't do it all at once, because otherwise, we'd spike on the expense base in order to solve the problems, and we only have finite bandwidth. So, we're working through it and we'll continue to work through it. Yes, that would be great if you can share more of those metrics over time and how -- what your targets are. The other part of that is your -- you said you have four growth initiatives. You did mention digital assets and -- post the recent debacle. Can you put any concrete metrics or put more meat on the bones as far as where you'd like to eventually get to, or revenues, or what's the endgame, just something more on this whole? It's one of your four key growth initiatives. Just a little bit more color? Sure. So, I just want to make one comment about the four things that I mentioned and that you're quoting. Those aren't the only growth initiatives in the company. I pick them out because I think they're good and representative examples, but -- and they're different things, and they have different timelines associated with them as well. But there are other things that I haven't mentioned, at least haven't given great as much prominence to, but that could be very interesting to us over time. But specifically for digital assets, it's the longest-term play out of any of the things that we talked about. I expect it to be negligible from a revenue point of view over the course of the next couple of years, it might be negligible for the next five years. But as the world's largest custodian, we are in the business of looking after stuff. We look after $44 trillion worth of stuff. And if there's going to be new stuff to look after, we should be in the business of looking after it. If the way in which we look after stuff, which is the point about the technology changes, we have to adapt to that. And so, we're investing for a future that probably will come to be, but it may not. But if it does come to be, we have to be there. It would be like being the custodian of 50 years ago and sticking with paper and not adopting a computer. That's not going to be us. So, we're investing. We're being cautious. We're being deliberate. And we've got R&D in different parts of the company, and it's measured. But we do think it's important for us to participate in the broader digital asset space. Hi, Emily. Hi, Robin. Emily, on the noninterest-bearing deposits, you mentioned how they are a little higher than normal. I think you said 27% of total deposits, but you do expect them -- I think you said to drop to more normal levels, 20% to 25%. What's keeping them up so high? And second, could they remain maybe higher for longer this year? Or do you see some real trends that, no, they're definitely going to get back to normal? Great question. And frankly, there is a lot of uncertainty around that. So, look, more generally, as it relates to NIBs, I think -- we think it's -- they're high. They're probably elevated because of certainly some risk-off behavior. The other thing though that I'd really mention is that we've gotten a lot more sophisticated too in just how we manage our deposits and the tools with which we manage our deposits. So, I think there's something to that also as well. We do expect the NIBs to revert to about 20% to 25%, but you're right, I mean, to the extent they remain elevated, that is going to be very helpful and we will have upside to our NIR projection. And look, the only other thing I'd mention is that we've seen significant growth in, for example, Asset Servicing, Corporate Trust, et cetera, which actually those businesses attract NIBs. Very good. We all know that, obviously, your bank is a fee-based bank, it is not a bank that any of us are concerned about credit quality, but I would just like to get your guys' thoughts. And you had a small provision increase, again, nothing material. And again, I emphasize nobody is really concerned about Bank of New York's credit quality. But with the expectation of a soft recession or a slowdown, whatever you want to call it, are you guys seeing any trends in the loan book that you're just watching maybe a little more closely today than 12 months ago? So, just as a reminder, and I think you've already alluded to it, the quality of our portfolio remains very high. So, weighted average rating is AA minus. Investment grade is over 90%. NPLs and delinquencies are stable. The only area that, of course, we're monitoring very closely is the CRE portion of the portfolio and the office segment, in particular. At the moment, occupancy and rent collections remain high, but it is an area that we're paying closer attention to. Hi. Thanks. Good morning. Robin, I know you talked earlier just about the general view for fees to increase and some thoughts on Asset Servicing. Just wondering if you have a view on just what you think organic growth can look like? And also, it's nice to also see some of the movement in the fourth quarter in specifically in Pershing and Collateral Management. Just wondering if you have a thumb nail on what the outlook for those two areas is as well. Thank you. Sure. So, from an overall fees point of view, we are focused on this internal growth. Forgetting about M&A or any of those other ways to grow, just the blocking and tackling and execution of what we think we can do in the company over the course of the year. We haven't given fee guidance because of the reasons that Emily alluded to, which is there are just so many things going on in the market. There are just too many puts and takes for that to be credible for us so that we are -- but we, of course, have our internal budget, and that's what we've been working through over the course of time. Look, you called out two businesses and those are businesses where we both -- where we think those are bright spots for growth. And so, we expect those to be above the average growth of the company. They're not the only ones that would be above the average, but they are two that would be, and we feel quite good about the prospects for a variety of the different underlying reasons that we've talked about already. Okay. Very good. And then, just one quick one in terms of that follow-up on the balance sheet mix. Emily, is there anything changing with regards to how you think about the mix of securities that you add from here in terms of as we get towards the peak of the rate cycle, whether you start thinking about putting on more fixed rate versus the floating type, and what that means for the types of yields that you're able to get on your kind of front book investments? Sure. So, there's a lot in there. So, look, we've been very nimble and continue to be very nimble in terms of managing our portfolio. Bottom-line right now, we're positioned to benefit from higher rates, but I just call everyone's attention to the fact that the duration of our portfolio is the shortest it's been in recent memory, and more than 60% of the portfolio is in available-for-sale. So, we've really retained a lot of flexibility, and we can act very swiftly should the environment ultimately change. And as it relates to reinvestment yields, I guess it was in the second quarter, I believe, in 2022 that reinvestment rates began to exceed roll-off rates. The difference between the two has steadily expanded to about 250 basis points in the second quarter. And when you just think about how much of the portfolio resets at any moment in time, about 40%, as I said, of the securities, or you can see it, 40% of the securities portfolio is floating rate assets. And the duration of the fixed asset securities is about three years. So, you can kind of do the math there. Yes, hi, Robin. Hi, Emily. I guess, my question was kind of as we think about further out into 2023, and so, the market is assuming some rate cuts could occur before year-end. As we get -- if we get to that point, what is your view on how deposit pricing performs there, right? Because if your deposit betas were generally higher than the broader banking system on the way up, how do we think about it to the point where we start to see some early rate cuts? Because I guess in that backdrop, it's not an expectation that we're heading back to where we were, just some modest rate cuts. So, how do you think about the deposit pricing in that environment? Sure. I'll take that. So, we do expect deposit pricing to perform similarly on the way down as it did on the way up. So, we'll get the benefit, of course, because our -- we will get the benefit should rates suddenly start to come down of deposit costs also coming down very quickly. And likewise, I'll just remind you that to the extent that rates start to come down, then AOCI will pull to par faster. Okay. Great. Thank you for that. And then, just one more on NII. Appreciate the full year annual guidance. As you look at the fourth quarter, it was up about 14% sequentially. Within the annual guidance, any view on how we should think about the first quarter? I know it's a moving target, but any range here just to help us think about the trajectory. Yes. As I mentioned, the range of outcomes is very wide. So, it's really hard to predict the trajectory in any given quarter. It really is very dependent, probably most specifically on the deposit trajectory. And like I said, if NIBs remain elevated, there's upside there. And with that, that does conclude our question-and-answer session for today. I would like to hand the call back over to Robin for any additional or closing remarks. I'd like to close today's call by thanking Emily for her time as our CFO and to congratulate her on taking up her new role, starting February 1 as the CEO of Asset Servicing, which as you know, is our largest business. Emily brings a set of experiences and relationships to this role that are going to be invaluable in driving profitable growth of our client franchise. And finally, I'd like to welcome Dermot McDonough, our next CFO, to the BNY Mellon team. He joined us in November, and he's hit the ground running. I know that you are all looking forward to his first earnings call with him in April. So, with that, I'd like to thank you for your interest in BNY Mellon. And if you have any follow-up questions, please reach out to Marius and the IR team. Be well. Thank you. This does conclude today's conference and webcast. A replay of this conference call and webcast will be available on the BNY Mellon Investor Relations website at 02:00 p.m. Eastern Standard Time today. Have a great day.
|
EarningCall_1163
|
Thank you, Catherine, and thank you, everyone, for joining us today. After a positive investor feedback from our Q4 FY 2022 public earnings call, we have decided to reinstate quarterly public earnings calls, and we'll continue them as long as they continue to be useful to investor understanding of our financial and operating performance. With us today are Robert Keane, our Founder, Chairman and Chief Executive Officer; and Sean Quinn, EVP and Chief Financial Officer. I hope you've all had a chance to read our earnings document. We really do appreciate the time that you've dedicated to understanding our results, commentary and outlook. This live Q&A session will last 45 minutes to an hour, and questions â you can submit questions via the question-and-answer box on the bottom left of the screen. Before we start, I'll note that in this session, we're likely to make statements about the future. Our actual results may differ materially from these statements due to risk factors that are outlined in detail in our SEC filings and the documents that we published yesterday on our website. We invite you to read them. Great. Thanks a lot, Meredith, and thanks everyone for joining us today. I'm just going to start by highlighting a few key points from the results that we published yesterday, along with our outlook. As we outlined back in our September Investor Day, the fiscal year results for this year, we're going to be characterized by margin compression in the first half of the year as we annualized the impact of cost inflation that accelerated in the second half of last year also as we annualized the impact of last year's investments in Vista and we experienced some unfavorable shifts in our product mix from a margin perspective. And we said that as we exit this fiscal year, we expect to be on a path to expanding our EBITDA, both through margin expansion and through revenue growth. All of this remains the case and our second quarter results reflect this. Our total revenue grew in constant currencies across all segments, including growth in revenue from new customers in the Vista businesses last quarter. However, constant currency revenue growth slowed from the first quarter. Revenue from consumer products was down slightly and has more weight this quarter, particularly in the months of November and December. That being said, in January month to date, as mix shifts back, our organic constant currency revenue growth has accelerated back above the 9% consolidated growth rate that we reported for the six months ended December. And over the remainder of the fiscal year, we're going to be comping last year's Vista site migrations to our new tech platform in large markets like the U.S., like in France and Germany that we expect to support higher year-over-year growth as well. From a cost perspective across Cimpress, we see signs that our year-over-year pressure of many input costs is stabilizing and in some cases costs are starting to decrease. That said, gross profit did weigh on our year-over-year results and it's still impacted by both increased input costs net of the pricing increases that we've taken as we're still lapping cost increases that accelerated in the second half of last year. But also product mix shifts, particularly in the Vista business, also had an unfavorable impact. If you look at it in total, consolidated gross profit declined year-over-year by $36 million. About $22 million of that decline was from unfavorable currency fluctuations on our gross profit that are offset throughout the rest of the P&L, including from our hedging gains. Of that remaining $14 million of operational decline in gross profit, that was really from our Vista business. All of our other businesses had constant currency growth in gross profit. So for Vista, in addition to increased input costs year-over-year, as I mentioned before, gross margins were impacted by product mix as we had constant currency decreases in consumer and in digital product bookings, which represented a combined $7 million decline. Those are categories that have high variable gross margins. While we had very strong constant currency bookings growth of over $16 million in our promotional products, apparel and gifts category and that has very strong customer economics, but it has lower variable gross margins. Sticking with Vista, our full funnel advertising test that we outlined back in September generated differential performance. New customer count and new customer bookings both grew this quarter overall for Vista and that was helped by markets where we had been testing mid and upper funnel advertising spend and new customer growth was one of the specific outcomes we were looking to deliver. As previously disclosed, it was always our plan that the spend behind that testing will be front-loaded in the first half of the year, that remains the case, and we'll now use the learnings from this testing to continue to evolve and test our channel mix going forward. In the quarter, we actually decreased our performance advertising spend year-over-year in Vista, and that includes during the consumer-driven holiday peak. Following actions that we took to reduce operating costs as we enter the fiscal year, we took some further actions this quarter to contain our operating cost. Operating expenses, excluding restructuring charges, were up only modestly year-over-year in constant currencies despite the significant investments we made in Vista throughout last year that we're still lapping and despite continued growth in our businesses. On the net income and EPS side, we had sizable losses there due mainly to non-cash drivers, including the establishment of $116 million valuation allowance that drove tax expense in our P&L, but doesn't have an impact on our cash taxes. That was a reversal of a tax benefit that we reported back in fiscal 2020 for net operating losses that aren't available to use until 2025 to 2030. We still expect to use a large portion of those NOLs, but we aren't able to support maintaining that deferred tax asset based on the U.S. GAAP rules. Additionally, given the weakening of the U.S. dollar against our largest currency since last quarter, we had unrealized losses from currency hedges that flow through our P&L and affect net income. Moving on to cash flow, last quarter, we told you we increased our safety stock of certain raw materials to mitigate supply chain disruption, especially related to risk related to energy disruption in Europe. We started to work this inventory down in Q2, and actually we had cash inflows from inventory as a result when we would typically see cash outflows in our December quarter. We expect to continue to work that inventory down in the back half of FY2023 as well. That said, from a working capital perspective, we didn't see as large of an overall benefit as we have in recent years due to the lower, sequential increases in our cost base given some of the actions that we've taken. And therefore, we also should not experience a significant of an outflow as we go into the third quarter. During Q2, we did pay $95.6 million to acquire noncontrolling interest in our businesses, $91 million of that was for the settlement of a put option for over 90% of the noncontrolling interest in the businesses in our PrintBrothers segment, which has been our fastest-growing segment. Last quarter, we told you that we were preparing for that likelihood so that actually happened and those payments reduced our liquidity, which was down sequentially, although still sufficient at $213 million. Net leverage increased this quarter, we did expect an increase given the lower year-over-year EBITDA. The settlement of the put options and the noncontrolling interest payments overall, of course, had an impact on our net leverage. That alone drove about half of the increase in that leverage from last quarter. At the end of December, our net leverage was 5.52 times, and our first lien net leverage was 3.34 times. Finally, let me just say a few words about the guidance that we provided in last night's release. As I said earlier in our past commentary we described an expectation for margin compression in the first half of the year, for all the reasons I outlined and profitability expansion as we were exiting the fiscal year, with growth in the years ahead. We are committed to expanding profitability, we're committed to delevering the balance sheet. I previously mentioned that revenue growth in January has accelerated, but we will not rely on revenue growth alone to drive those profit improvements. We've taken multiple steps over the last year to contain or reduce cost, but over the remainder of the fiscal year, we plan to take further steps to significantly reduce our cost base in support of expanding profitability as we exit the fiscal year. As I noted or we noted in our release last night, in light of anticipated cost reduction measures, we expect that we'll be able to return to our prior fiscal year high adjusted EBITDA of $400 million in fiscal 2024. That's next year. This higher adjusted EBITDA, combined with the expected free cash flow generation, would bring net leverage levels to approximately 3.5 times or below. We have a midyear strategy update plan for investors on March 21, and there, we'll share more details on the steps that we're going to take to drive that profitability expansion, including cost reductions and the associated net leverage improvement. Now I will hand things over to Robert to say a few words about the Vista CEO transition that was referenced in the document last night. Thanks, Sean. Good morning to everyone who is calling in today. Given the guidance, as Sean just outlined, I also wanted to [indiscernible] importance to Cimpress overall. When I returned to Vista four years ago, there was straight but also areas that needed really significant attention in order to transform the business for the coming decades. In January 2019, I expected that would take a couple of years to establish strong foundations for Vista's future, and then pass the baton to Vista's next CEO. The pandemic slowed down our progress for a time, and we have been focused on multiple major multiyear investments. These included replatforming the Vista technology â positioning that had been highly dependent on deep discounts, better serving higher-value customers, and adding the groundwork, upon which we can revitalize Vista's traditional strength in design and service. Thanks to the â and thanks to the great talent that Vista already had, to new talent that we attracted over the last four years and to the contribution from people [Audio Dip]. I told you at the Investor Day in September that Vista was ready to run, and that certainly remains true today. Notwithstanding the fact that macro conditions are causing us to look at significant cost reductions for the coming months. Vista will be able to improve how it serves customers, thanks to the strong foundations we've built across technology, data and analytics, market, product ranges and the beginnings of a full spectrum of design capabilities and certainly the talent pool at Vista capabilities. That's why at this juncture, it's the right time for me to now pass the baton to Vista's new Chief Executive Officer; Florian Baumgartner. Under Florian's leadership and his strong executive team, I expect this soon will progress steadily towards its North Star to be the design and marketing partner for small businesses while delivering the financial results necessary to support what Sean has just outlined, and the continued growth beyond that. In my role as CEO, I look forward to spending my time supporting all of our business abilities to drive both higher level â and higher financial returns for our investors as we focus on delivering the guidance outlined in yesterday's release, and on growing the per share value of Cimpress. Great. Thanks, Robert. So as a reminder you can submit questions during this webcast via the questions and answers box at the bottom left of the screen. Some of you have already found that. Thank you very much. We received a significant number of pre-submitted questions as well. Also thank you so much. We really do appreciate that. There are in some overlapping areas, which is good. So there's going to be a couple of cases where I will ask a representative question that we have got from multiple people, and then our answers will do our best to cover everybody's questions. We'll get to as many as we can, and we'll make sure that we get to a variety of topics that are on people's minds. So let's take our first question, which was a pre-submitted one, which is this: In the last earnings document published in October, you wrote, âas we publish this, our customer demand picture remains strong across Cimpress.â However, organic constant currency growth has slowed materially from the mid to high teens to the mid-single digits. What happened in November and December that changed things for the worst? Yes, I'll take that. That's right. A lot of that impact is from Vista. And so in October, October was a stronger month for Vista than November and December. One of the big drivers there is mix and in particular, the mix of consumer. Just to put that in perspective, consumer in our October bookings was about 13% of our overall bookings. In November, it was 31% and December is 38%. So you can see the weight really ramps up throughout the quarter. And that really does have an impact on overall growth kind of month by month, especially given the fact that the consumer category declined slightly year-over-year. So that's the big driver. I think it is also worth noting that just from an advertising perspective in Vista and this is in our results from last night, but our performance advertising was 13% of revenue this quarter. It was 15% last year. And we had made some choices, including through the high volume weeks to operate with tighter payback thresholds and stick to that. In October, we were also at the full pace of our full funnel testing and in particular, kind of the full rate of spend in our mid and upper funnel categories where we were testing in certain markets. So ad spend did have some impact on that month-by-month profile as well, but product mix is the big driver. Outside of Vista, there really was not one trend. In some of our businesses there was acceleration in growth throughout the quarter, and some others there was deceleration. Great, thank you, Sean. So I'm going to stick with you for the next question which was on revenue growth. So was there a slowdown in growth in the Vista segment revenue ex consumer products? And another person asked a similar question, what was the constant currency growth rate for the business, not marketing products in the quarter. Yes, it did slow slightly. Constant currency growth rate for â just for the small business products was a little bit lower than Q1. That number was a little bit over 7% growth in those categories, so ex consumer in the December quarter. And then just to kind of bring that all the way forward to today, as I mentioned in the upfront remarks, our constant currency growth in January overall on a consolidated basis, accelerated above the 9% year-to-date growth that we reported for the six months of December. Vista's bookings growth did accelerate in January as well. That's actually one of the biggest components of that acceleration and that's also helped by less consumer in the mix as well. Great. Okay. So sticking with consumer, this maybe one that you both went away in on, but we'll start with Robert. So this is the second year in a row where we have had poor performance in consumer products, which has historically been an important profit driver for the business. Two questions. Does Vista's consumer products offerings still resonate with the consumer? If yes, what gives you confidence and what steps are being taken today to avoid another poor seasonal period next year? And if consumer products aren't as important to Cimpress moving forward due to changes in what the consumer wants and/or our inability or unwillingness to meet those changes, what structural changes need to happen to make the Q1, Q3 and Q4 relatively more profitable quarters? So thank you. Frankly, this is a topic we discuss internally. You're right, the consumer is an important part of Vista's profitability, and it's been traditionally that remains the case. To put numbers on it, on an annual basis, it's roughly 20% or so of revenues, although, of course, it's higher in Q2. One thing, Sean, and you can jump in and correct me if I'm wrong, but I think there was a thing I mean you just mentioned a moment ago that performance advertising, we've limited â pulled back last quarter, it was 13% in the quarter versus 16% the year before. So we have made some cap rate with tighter paybacks. But if you go beyond that, I think, the core is we are focusing so much on small customers where we have our biggest opportunity. A consumer has had less focus. And we had to be clear in our small business to move that, and that certainly has impacted things like our brand messaging, our go-to-market and resource allocation generally. Again, the business â like all of this is traditional business was very discount driven. And as â away from discounts for consumers, but there has been a shift there. That said, we have created a dedicated consumer team that look â added resources so they can be focused on consumer around the year rather than just seeing it as a holiday. And that team has improved the product and service offering already this year. We had planned for a flat year overall in â $4 million, although we did that with less advertising spend, as I just mentioned above. So the consumer category should also benefit from the improvements that we have been making and will be making â so it could be getting to the ease of getting new products launched, improved experiences on the site for conversion â integration of design services and many other things. Now another thing that should over time help â weâre introducing for business, for example, promotional products have interesting use cases for consumers where drinkware and apparel are good examples. And consumer-focused promotional products â and have been performing well during holiday. That being said, we do recognize that consumer is a far -- is a base, and we see the competitive set there when holiday season comes around really spiking up â the advertising goes up. And we did not -- we intentionally did not chase bookings. We really try to be disciplined to stick to our set thresholds. A couple of more comments. Iâd say we do have some key products like holiday cards and invitations and announcements and we are seeing changes in behavior over time that are likely leading to overall market declines. But if you look at consumer â category, we still feel thereâs a great opportunity there. Again, itâs important to us, itâs second â of our business that comes through small business. But going forward, weâll keep pushing and having consumer benefit, we front doing across the site. Yes, I think that covers. Just to touch on I think there was part of the question, which was the things that we can do in other quarters to change if we are going to not focus on consumer, which is, as you heard from Robert, not the case, itâs still as important. It just has been secondary. And the answer there is basically everything that weâre doing across Vista to support small businesses, how we serve them, how we partner with them and how we can serve them across their entire lifestyle -- sorry, life cycle and in turn, increased volume across the year in serving small business customers in addition to improvements that we can continue to make in consumer as well. Okay. Iâm going to move into a couple of questions that we received on both pricing and inflation. So weâll start on the pricing front. Sean, how much pricing has been taken in Vista and in other businesses? Also how much was overall inflationary pressure? How much more pricing is there to take over the course of the next 12 months to 18 months? Yes. This is an important question, and frankly, itâs one that is difficult to answer with precision because there are a lot of nuances here, business by business, market by market. And thereâs all sorts of impacts of changes in volume and discount rate and mix and so on. So let me -- Iâll do the best to answer here. Weâll also think about how we could package this up as well in our March session at a little meat to this. But all of our businesses have seen increased input cost. Weâve been talking about that for the last four quarters in particular, five quarters. Some have been impacted more than others. So just as an example of that, things like energy costs. In Italy, theyâve increased a lot. In France, they have it, right? So thereâs things like that that will have an impact business by business. Thereâs also, obviously, depending on the raw material profile for our businesses that has a big driver. Some impacted more than others, some are more directly tied to commodity prices, including paper. And in other businesses, including, for example, for National Pen, they do a lot of sourcing from China. There weâve actually seen, and this is an overall market thing, weâve seen meaningful decreases in things like inbound freight costs, which are more material for that business. So thereâs a lot of nuance here. In our Upload and Print businesses, in National Pen and to some extent in BuildASign, weâve been able to largely offset those cost increases with price increases, and that remained the case through Q2. Again, differences business by business. Theyâre not fully offset, but weâve been able to largely offset those cost increases. In Vista, of course, our largest business, thatâs where weâve seen the most net impact, the timing of the ramp-up in those cost increases we talked about last year coincided with our technology migration that weâre doing, some of our largest markets that delayed when we could start to put those pricing benefits in market. We implemented broad-based price increases back in June and then we continued from there. We talked last quarter about some of the benefits we are seeing. Those benefits were higher in the September quarter than they were in December because of the mix of consumer and the level â also the level of discounting for holiday promotions. And in consumer, just given the price sensitivity there and the fact that we had brought down our discount levels over the last two, three years, there, itâs a more price-conscious customer. There is more price sensitivity on the consumer side. And so weâve done less in terms of the pricing benefits there. And that has an impact given the mix in the December quarter. We had said back in our September Investor Day that for Vista, we expected to deliver at least $20 million through pricing changes in FY2023. Thereâs, again, a lot of nuance to that, but weâre definitely. Weâre on track to that for that. Weâre on track to achieve more than that. But the relative benefit in the December quarter was less than it was in the September quarter. I think as we get to the March quarter and that mix shifts back again more towards the small business products, weâll see more benefit in Q3. There is still room for improvement, especially on the Vista side. We continue to optimize. We have specific plans for that. We have teams that are focused on that every day. But I do think that the pace of that especially after this fiscal year is likely to slow. So to the question of kind of whatâs left to go get, I think the opportunity set is lower than it was over the last year, just given the steps that weâve already taken. But there still is opportunity, and we monitor that very closely. Great, and then this one can be, I think, a quick follow-up because youâve already talked a bit about what weâre seeing in terms of the cost inputs lately. But inflation peaked in the late summer and has been gradually coming down, but the gross margin pressure this past quarter was more pronounced than two quarters ago, 400 basis points of compression this quarter versus 200 two quarters ago. Why is that? Yes, just like anything, we will experience the market over time. And when it comes to how we buy, we always seek to be below the market, but we have to move with the market over time because a lot of that is underpinned by things like commodity pricing and so on. But we donât move exactly with the market. So we do see stabilization, I mentioned that, but we donât see cost overall coming down yet at least in most of our main input costs. Although as I just mentioned, things like inbound freight or down quite a bit, and weâre seeing stabilization elsewhere. So cost did still have an impact over the last six months, because I think the question is referring to gross margins in the December quarter versus the June quarter. So costs still did have an impact, although the shape of that is definitely improving. Product mix, again, here is a big driver. So in some of our businesses, gross margins did â sorry, did increase in the December quarter versus June. And in some cases, they were lower. But again, Vista has the biggest impact here. In Vista, our gross margins were down about 400 basis points in the December quarter versus June, if you compare them back to June. Thereâs really three drivers to that. One is that, like I said before, consumers where weâve done less on a net pricing basis given the competitiveness there and the price sensitivity and consumers much higher in the mix in the December quarter. Two, business cards and stationery that category is amongst our highest variable gross margins, and that has a higher concentration in the June quarter. Thereâs a little bit of seasonality there. But that was 32% of our bookings in the June quarter, it was 25% of our bookings in the December quarter. So again, mix. And then the other thing is that we did have a â we mentioned this in the release, we had a $3.1 million charge in Q2 that comes through gross profit. And so thatâs about 70 basis points alone of that overall 400 basis points delta. So consumer, some of the business card mix and then that charge has an impact as well. Great, thanks. Okay. Robert, we continue to grow headcount at a time when results are weak and other businesses are entering cost-saving mode given the macro uncertainty. Why does it make sense to continue to add where we are adding? Well, first of all â cost savings makes sense given the macro uncertainty. We certainly talked about that in our prepared comments that we released last night. So some of the growth in headcount comes because we are growing in our Upload and Print businesses, but if I focus on Vista, there are roles that impact our operating expenses and our fixed costs. So in the plants, in customer care â strictly year-over-year in the quarter. We also have significantly curtailed hiring across the different roles and in the Cimpress central teams as well and actually reduced those back in June. Now the data that we provide is still related to Vista, our headcount is up, but that is really because of the staffing for a seasonal peak at largest production facility in Canada, where these roles are classified as permanent. But you can see in our normal pattern that in the March quarter. Great. Okay, so Iâm going to ask one or two more questions on the quarterly results, and then weâre going to shift to a couple other topics. But this one is on geographic growth in Vista. I get the economy isnât what we thought it would be, though I have been hearing Europe is worse than the U.S. And here, your European business continues to look great, while the predominantly U.S. focused Vista continues to lag, especially in gross profit. More context on any call out drivers on whatâs good in Europe or bad in the U.S. would be helpful. Sure. Good question. I start out by saying our upload and print businesses, call four plus years ago, we really pushed to more autonomy and more decentralization. The entire teams in both of those businesses are just doing a great job. Theyâre firing on all cylinders and weâre just really proud of what theyâre doing and having a positive impact. We do believe this market overall has room for consolidation and that we can leave that. And I think competitive market like the uploaded print market in Europe, the fact theyâre doing well demonstrates that belief. Now at Vista, we are actually seeing higher constant currency growth outside of U.S. compared to what we are doing in the U.S. Thatâs true in Canada, itâs true in Europe, and itâs true in Australia. Now consumer revenue â up year-over-year, down slightly overall, but there are a few markets where it grew stronger outside of the U.S. I think the main issues that we really have to understand our customer sentiment, they do drop in some business oriented products, but again, that changes market by market. If I look at the ability to â that changes market to market, and again, I realize Iâm in this comment, Iâm mixing upload and print in Vista. But weâve been able to map or get quite a bit of pricing changes in upload and print earlier. We will be lapping some of those and you may face some great moderating there. Sean, you may add a few more comments. I guess the last thing is, in the U.S. a supermarket is tough and competitive. As I mentioned, we didnât chase revenues with advertising. And in this quarter that has been a big impact, especially in the U.S. Do you have any other thoughts on the difference between Europe and⦠Yes, I think you covered most of it. Weâve seen â I think the as you indicated, a lot of the sort of differential growth in our upload and print businesses versus, letâs say, Vista in North America is not necessarily market specific. Thereâs other dynamics at play there, including the speed at which theyâve been able to operate, crack into new product categories, acquire new customers especially over the last two years, take share. And so thereâs market specific but also kind of business specific factors there. I think just in Vista, our absolute growth in revenue was basically this roughly the same between Europe and North America in Q2, just to kind of give you a sense of that weight. And I think â thereâs all sorts of dynamics here. A lot of it does come down to also product mix. You see that as a kind of a theme throughout this call where the performance of consumer had a little bit more weight on the U.S. in particular than it did in Europe in terms of overall growth. That said, PPAG growth is stronger in North America as well in absolute dollars. So all those things are at play, all these markets are in focus. The only other thing Iâd say is there are a couple European markets that have been very strong, especially France. France is also where we have been doing some of our full funnel testing and that had differential performance this quarter as I referred to earlier. So I think thatâs it. Great. Okay. Iâm going to shift gears to some questions on liquidity and capital allocation. So first one, Sean is on the minority interest purchase this quarter. What was the EBITDA multiple of that acquisition and what will that do to our core cash flow going forward, if anything? Iâll stop there and please jump in. Yes, sure. So the way that this arrangement worked, we had a â so there was a reciprocal put and call and the valuation for that was â it was a formulaic valuation that had two main inputs to it. One was revenue growth, and the other one was â revenue growth in order to determine the multiple and then cash flow before tax to determine the actual value. So thatâs kind of â thatâs how that worked. These businesses had revenue growth last year, which was over 30%. And actually 30% was the kind of the cap in terms of how that multiple table worked. But they also have really high free cash flow conversion there. We had some caps in terms of how that valuation was calculated in terms of contribution of certain elements of cash flow. The way I would think about this is that in terms of a multiple we paid between 8x and 9x the unlevered free cash flow before tax on these businesses for that purchase of the non-controlling interest. These are businesses that continue to grow at rates that are amongst the highest across Cimpress as a segment they are the highest over 20% year-to-date. And going forward in terms of the impact on our future cash flow, what that purchase means is that we will maintain almost all of the cash flow generated from those businesses, whereas before we only retained about 90%, the other amount of roughly 11%, we were paying out as effectively a dividend to those minority holders in the past. So, weâll retain more of the cash that they generate. Great. And just a quick follow-up that we had as a live question. What other non-controlling interests are left to be put to us is there, whatâs the materiality of whatâs left essentially? Yes, itâs pretty small now. So the, you have a little over 1% of these PrintBrothers businesses that remains. Otherwise we in addition to the PrintBrothers put option that we settled there was also the purchase of non-controlling interest in build assigned. So thatâs now cleared out. All of this has disclosed in our 10-Q. We have the table that kind of walks through that in the footnotes, so you can refer there, but the short story is that this is the vast majority of it. Great. Okay. Any updated thoughts on the liquidity threshold? At which point the company would be willing to deploy capital for bond repurchases? We had multiple questions on bond repurchases. Yes. Thereâs no specific number that weâve given. Weâll continue to not give a specific number. Weâve said consistently over the last couple quarters that our focus and our priority has been on liquidity that remains the case. That was especially in focus because we viewed and we had previously disclosed that there was a high likelihood that we would be settling that put option that I just went through. And so therefore necessitated a focus on liquidity versus taking advantage of things like the way that our bonds were trading. We donât have any active plans to repurchase our bonds. Liquidity remains the focus. I think that as we execute on the things that we outlined in our guidance and we execute on our delivering over the quarters ahead and throughout FY 2024 then capital allocation opportunities start to open up. But there are no plans to â no active plans to buy our bonds. Great. So a couple people noticed obviously that our first-lien leverage was above the leverage test if we were to have any amounts drawn at the end of a quarter. So thereâs been some questions on our revolver. So would we think about extending the maturity of the revolver in the near term, what we think about amending the credit facility in order to get a waiver? Multiple questions on that front, Sean. Yes. No, so the short answer to all that is, no. The revolver matures in 2026. We arenât actively looking to extend that. Of course, as we get closer to that maturity, we will. But thatâs in the sort of 12 months to 18 months timeframe, not in the next kind of three months timeframe. And then as it relates to the first-lien leverage, so just to be sure itâs clear as you referenced in the question, Meredith that only applies, that test only applies to the extent that we have a drawn balance at the end of a quarter. We have not had that. We donât plan to have that. We are just slightly above that first-lien test, which is at 3.25 times our first-lien leverage. However, if you think about the guidance that we provided last night, as we â again, as we start to march up that EBITDA expansion curve, and also delever then we would quickly be below that that first-lien test. So thereâs no active plans to either you seek an amendment there or anything like that nor look to extend the maturity. We donât need to do that now. Great. Okay. Robert, Iâm going to ask you a question. Given increased leverage, will you consider issuing equity? Or monetizing one or more divisions to reduce debt? Well, first of all, I want to repeat what we said in our [Audio Dip] say, our plan is to reduce leverage, net leverage through adjusted EBITDA expansion and returning to our high adjusted EBITDA levels and the cash flow that comes with it, kind of full stop. Now in the past businesses, so divestiture is certainly something we understand. It would consider if the right conditions are there, and if we believe weâre better off for couple of other things. But this is not something we would do without a lot of thought about the long-term capabilities of Cimpress. And certainly in the near-term, the environment right now is not really favorable to divestitures. Great, thank you. So, Iâm going to hit one question. This is more of a strategic question before I move to the outlook section. But thought worth asking, how has the development of the mass customization platform changed your acquisition strategy? For example, it seems your recent tuck-in acquisitions are able to quickly implement several MCP products, if itâs easier and the technology gains are relatively larger for smaller firms, in the future could you see Cimpress pursue several tuck-in acquisitions annually compared to one large acquisition every few years, as was the case from 2016 to 2018? Well, itâs a good question. Let me start out by saying we do not anticipate material M&A in the near term because of [Audio Dip] EBITDA expansion bringing net leverage down. But if you look at from a longer-term perspective, yes, we do think there are a lot of advantages that could derive value. And they are certainly in tuck-in acquisitions as well as in larger acquisitions â it may not be so obvious, but we have made, I donât know if Sean, you can tell me over the last five years, six, eight â that are or investments that are relatively â really relatively small, often well under that have gone very well. Is that rough number correct before I go on? Okay, great. Going back to MCP, at this time, our focus is very much on internal leveraging it in the businesses we have â in January, Pixartprinting, which is the largest part of print group and print group is doing very well, including Pixart doing very well. Pixartprinting migrated Italy and Italy is their largest revenue country. And the last country that migrated to MCPs e-commerce tools. Theyâve migrated France and Spain and the UK and others previously and that migration. So again, weâre really leveraging MCP on the assets we have today. As the future M&A [Audio Dip] right now. The size really depends on vertical integration into a supplier. And theyâre relatively easy, nothingâs easy, but relatively easy to extract value from those long term. Yes, we havenât provided a specific number of kind of minimum cash. So letâs say, we have â at the end of December, itâs $230 [ph] million of liquidity that is sufficient including any kind of working capital outflows that we normally â seasonally have in Q3. So that remains sufficient. That revolver is there too if we need it during the quarter in terms of just movement of cash around the business and kind of timing there. But that liquidity is sufficient and then we expect that to build over time given the guidance that we released. So no specific number there. But liquidity that we have is sufficient, again, including any outflows from working capital in Q3. Great. Okay. So letâs get into the outlook. So first on revenue, you called out that overall trends have improved in January. Anything more to call out there? Can you give us a sense of how much constant currency revenue growth has accelerated relative to the first half of the year? Yes, the â so we didnât give a specific number, but we said it was higher than 9%. We were at 5% consolidated organic constant currency in Q2. So thatâs the acceleration. And itâs above 9%. Yes, I think the thing that I would call out is really Vista in those numbers. There was improvement elsewhere too relative to Q2, but Vista was really the one to call out. And I do think as we track through the March quarter, thereâs a few things at play there. One is last January and February, there was quite a bit of COVID impact on demand, especially in Europe. So thatâll have some impact just in terms of the comps. And then as I mentioned before too, we had the site launch of our U.S. market in the â roughly the third week of February last year. And as we talked about throughout last year, when we did those migrations, they would have an initial impact on revenue, and then we would grow from there. So weâll be lapping all that, which will help to support higher growth rates as well. And then, the last thing is just again, from a mixed perspective that Vista acceleration in growth in January is helped by the fact that the mix shifts back to small business products and theyâve been growing more strongly. Great. So you all but answered this next question with that one. But I just want to be very clear for everybody. Does the previously provided guidance for Vista revenue growth to accelerate in FY 2023 versus FY 2022âs FX neutral rate of 5% still stand? Great. Great. Okay. Now, weâve had many, many, many pre-submitted questions about the guidance that we gave yesterday from an EBITDA perspective. Everybody wants details. How do we get there? What is that going to look like in FY 2023? What is that going to look like in FY 2024? Where are the costs going to come out? Are they going to come out of advertising? Are they going to come out of operational expenses? Where are these things coming from and what is the map to get there? Robert, do you want to take this one? Sure, Iâll jump in. And Sean, feel free to jump in obviously if you have [Audio Dip] that we have in March Investor Day, which we have said, we want to give you a lot more details, and thatâs â asking, we can talk to. Although certainly we have begun our scenario developments and planning before. We have not completed that work. And so itâd be premature to give you a lot of detailed answers. We certainly believe there's an opportunity here, and we're going to work through those different scenarios. It should depend on how much revenue growth we're seeing. We do expect, as Sean just said, to have revenue growth â to that EBITDA bogey of $400 million in Fiscal 2024 will require substantial cost reductions in addition to that revenue growth. So I think the framework to thinking about this is internally we're saying we are not simply cutting costs of getting the goal of getting to $400 million alone. We believe that we can â do more with less. We can drive efficiency, performance, simplification and that tightening down if it's done right, can really lead to some significant acceleration beyond that. No one likes to know in any business. Certainly, we don't like to do this at Cimpress, and actually a Vista. We have done this in the past for those long-term shareholders who benefit â when these are done the best. We had very much achieved the dual objectives of saving costs â in the velocity of the business. So again, we certainly look forward to giving you more details in our midyear strategy update on March 21st. Yes, maybe just to add two things. I think the meta point here is there's a lot more that we'll share in March. But yes, I think some of the thread of questions and if I were an investor too, why now? And Robert alluded to this to some extent; but I think our view is like our profitability has been impacted by external factors over the last year, two years. And we just feel, because of our commitment to expanding EBITDA in the ways that we talked about and also delevering that we need to do this through things that we can control, really drive us through things that we control, and yes, we also expect revenue growth as well to contribute to that, but we really need to drive this through things we control. And as Robert said, we think that there's opportunities to do that and do that in ways that are supportive of, of course, not just getting the $400 million, but growth beyond that. There was â and one of the questions that was referenced to like how should 1 think about this. Should we look back to what we did back in the pandemic as the guide to the actions that we might take? And I would say there, of course, what we had â what we went through during the pandemic is informative. But I think this playbook is quite different in its context. There we were trying to very quickly reduce cost wherever we could with the primary motive being make sure we protect liquidity. This is a very different context. We've been investing a lot, we've made significant improvements, including in our largest business in Vista and also with the replatforming, which has a really, really significant impact on that business and how we can operate. And so now we need to take a step back, look at both the investments that we've made, some of those that are longer duration and make some assessment about should we bring some of those in, make some choices there, but also how can we operate in different ways and how can we â and where can we operate more efficiently. And so from that perspective, I think it's a different playbook than what we went through in 2020. But of course, that's always informative in terms of what's possible. Yes, Sean, I 1,000% agree with that. Just for my part is back to almost 2018 or so, we â and certainly, the financial crisis, the global financial crisis in 2007, 2008, we've done similar things. Thank you. Okay. A quick one, Sean; does getting down to 3.5 times net leverage involved actively paying down debt or mostly driven by EBITDA expansion and cash generation? It evolves â well, first of all, we â I mean, this is all on a net leverage basis. So in terms of paying down debt, that doesn't necessarily factor into the math because cash generation, including just increase in liquidity on the balance sheet, funded liquidity does have an impact on net leverage as well. So there's not an assumption of will we pay down debt or not. That's stuff that we will consider going back to a prior question of would you repurchase your bonds, for example. So therefore, most of this is driven through EBITDA expansion and then the resulting cash generation. Great. Okay. So I've had a couple of follow-up questions, and we had a pre-submitted question really around what should people take from the fact that we have decided to pull back on costs? So this one particular person, I read the comments on cost cuts driving profit improvement as a view that revenue growth is likely to be less than previously modeled. And as such, cost controls will be needed to meet the $400 million bogey. Can you confirm on that front, just to be very clear? Well, I think in terms of this year, and there was a prior question about being above 5% constant currency growth in Vista this quarter, which is our prior guidance, and I said that was still the case. So I don't think from a near-term perspective, that there's necessarily that type of a correlation between cost reductions and growth. Over time, that might be the case, including, as I mentioned before, looking at where we have sort of longer-term investments that have longer-term paybacks than where we might look to make some different choices. So, those things can impact growth in the years ahead. But I wouldnât see them as directly connected. And also I think in terms of the why I go back to what I said in reference to a one of the recent questions, like I think the why here really is that weâre committed to EBITDA expansion, weâre committed to delivering, and we canât just rely on revenue growth, which is subject to factors that some of which are outside of our control. And so we really feel like, we need to do this even more so, kind of boosted through things that are in our control. And thatâs really the main thrust of the, the why. Thanks, Sean. Okay. Iâm going to try to sneak in two more questions before we end this call. So first oneâs for Robert. Given the mix shift in Vista, will Vista margins go back to where they were, will mar or will margins be lower than previous years even after recouping higher input costs currency headwinds, et cetera, due to the mix shift? Yes, I think it depends. Iâm talking about, and the margins weâre talking about, but if I think of segment EBITDA, we certainly believe that Vista can achieve e those in 20 milligrams get over time. Gross margins have shifted and we think that those are more permanent but they often come with lower gross margins, often come with higher lifetime value customers. So we think itâs a factor that we can manage. Great. Okay. And then Sean Iâm going to go back to the liquidity topic here from an outlook perspective and from a very near term perspective. So short-term liquidity looks tight without access to the revolver, especially in that there are likely to be restructuring costs around the announced cost controls coupled with this seasonally weak working capital period. And this person says, I think 3Q normally sees something like $60 million in working capital burn in addition to normal expenses. It feels like liquidity could get very tight next quarter. Can you comment on how the company thinks about that? How we think about it? Yep. Yes, sure. So the you know, if, just kind of going back to that picture of what FY 2023 was planned to look like in terms of first half of the year margin impression, second half of the year as we exit, EBITDA expansion if you think about that and would apply it to our liquidity also to our leverage, like he was always our expectation that weâd have increasing leverage in the first and second quarter and then we would start to march down that curve. We had prior commentary that we expected to do lever from last yearâs levels. That was before the non-controlling interest payment. So relative to Q3, as I said before, we have sufficient liquidity, $213 million at the end of December. We do seasonally have working capital outflows in Q3. Weâve planned for that. And the plan had been and continues to be that Q3 would be the, the low point, and then weâd be marching up from there as it relates to the impact of restructuring costs. Typically those are paid over time. And so the way to think about that is as we experience EBITDA savings, the cash flow savings attached to that will be on a delay because weâll still be paying out those restructuring costs for a number of months while we are starting to experience the, the EBITDA benefits. So thatâs how I think about that. So that, that doesnât for the most part doesnât lead to some like one, one time large cash outflow, but rather, the sustained kind of cash outflows that we already have in our run rate for longer than we will have those things in our EBITDA. So hopefully that sets the picture for everyone. Well, first of all, thank you everyone for the time. Youâve all invested â published quarterly results the questions that youâve all asked and the time youâve put into this call. As we said, we are optimistic about the future of Cimpress of Vista, specifically within Cimpress and about the opportunity for us to demonstrate â availability to come out of this sustained period of investment and return to our traditional early â of adjusted EBITDA beyond. So we look forward to you all joining us on March 21 â for the year. And until then have a great day and a great month and a half. Operator?
|
EarningCall_1164
|
Good morning. Thank you for joining OFG Bancorp Conference Call. My name is Shelby. I will be your operator today. Our speakers are Jose Fernandez, Chief Executive Officer and Vice Chair of the Board of Directors and Maritza Arizmendi, Chief Financial Officer. A presentation accompanies today's remarks. It can be found on our Investor Relations website on the homepage in the What's New box, or on the quarterly results page. This call may feature certain forward looking statements about management's goals, plans and expectations. These statements are subject to risks and uncertainties outlined in the risk factors section of OFG's SEC filings. Actual results may differ materially from those currently anticipated. We disclaim any obligation to update information disclosed in this call as a result of developments that occur afterwards. [Operator Instructions] Good morning and thank you for joining us. We are pleased to report our fourth quarter and fiscal year 2022 results. We are extremely proud of the work we did last year and our performance reflects that. We achieved great progress executing our strategies for the benefit of our customers, deploying technology, expanding and improving our network and investing in people and talent. We took major steps forward in our digital first business transformation, solidifying our position as a challenger bank, differentiating us from our competitors. In addition to ATMs, we now have seven self service banking kiosks and 23 interactive teller machines as part of our enhanced sales and service banking network. All this has contributed to our strong financial results. Our performance metrics are at the highest they've ever been to-date. The Puerto Rico economy is also doing well. Businesses and consumers remain in good financial shape. We look forward to another good year with a cautious eye as always on economic and financial uncertainties. Now please turn to page 3 of our conference call presentation. This was our strongest quarter this year. It was driven by total core revenue growth of more than 7% quarter-over-quarter and more than 19% year-over-year. Looking at the income statement, earnings per share diluted was $0.97. Core revenues totaled $168.3 million. Net interest margin was 5.69%. Provision was $8.8 million. Non-interest expenses was $91.6 million and pre-provision net revenues totaled $76.9 million. When we look at our balance sheet, customer deposits were $8.6 billion. Loans held for investment totaled $6.8 billion and new loan origination remains strong at $616.4 million. Investments totaled $2 billion and cash was $550 million. Capital remain strong with CET1 ratio at 13.64%. Please turn to page 4. When we look at our results for the year, earnings per share was $3.44 up 22%. This was driven primarily by total core revenue of $607.8 million. Net interest margin of 5.05%. Provision of $24.1 million and net interest expenses of $345.5 million. We ended the year with total assets of $9.8 billion. As a result, we remain under the Durbin threshold. As part of our ongoing strategic reviews at the end of the year, we decided to take advantage of an opportunity to sell our retirement plan administration business. The rationale behind this decision is to focus our efforts on 401K business development while leveraging the service and scale of a larger U.S. player in this segment. There was minimal financial impact from this transaction. And, as we've previously reported other capital actions in 2022 included completing $64.1 million of our $100 million buyback authorization plan, and increasing our common stock dividend to $0.20 per share from $0.12 an increase of 66.7%. Then yesterday, we increased the quarterly dividend 10% to $0.22 per share. Thank you Jose. Please turn to page 5 to review our financial highlights. Let me start with total core revenues, they increased $11 million quarter-over-quarter and $27 million year-over-year. Looking at the key components of that interest income was $11 million higher than the third quarter. That reflects the benefit of higher yields on increased average balances of loans and of investment securities. Net interest income for the quarter was $9 million higher compared to the third quarter and $31 million higher compared to the year ago quarter. Of the $9 million, about $11 million came from higher rates on interest earning assets, partially offset by $2.5 million in higher costs of funds. Looking at banking and wealth management revenues. They increased $3 million from the third quarter. This reflected higher electronic banking activity and gain on sale of mortgages compared to the third quarter when Hurricane Fiona interrupted business. The annual recommendation of insurance commission was $1 million. This was $1.2 million lower than a year ago due to financial aided claims. Year-over-year banking and wealth management revenue declined $4 million. This reflected lower wealth management revenues due to lower equity market valuation. It also reflected the lower annual insurance commissions. Looking at the efficiency ratio. It was 54.45% in the fourth quarter. That's another nice improvement from the third and year ago quarters. Similar to the last few periods, it reflects our positive operating leverage. As per net interest expenses totaled $92 million, that's $4 million higher than in the third quarter. That reflects higher compensation expenses due to hourly salary increases implemented in the third quarter increases in yearend performance bonuses, and other technology staffing. It also reflects increased amortization related to new digital projects and the [views] Hurricane Fiona related expenses. Non-interest expense should average about $90 million to $92 million per quarter in 2023. As we previously mentioned, our efficiency ratio target range is in the mid 50s. As Jose mentioned we sold our retirement and plan administration business in the fourth quarter. This will reduce our wealth management revenues by about $2 million, which will be fully offset by an equal amount of savings in non-interest expenses. Looking at our performance metrics. They improved nicely quarter-over-quarter and year-over-year. They also continue to exceed our target ranges. Return on average assets was 1.86% that is up 21 basis points from the third quarter. Return on tangible common equity was 20.36%. This is up 231 basis points from the third quarter. Looking at tangible book value per share. That was $19.56, an increase of $1.10 compared to the third quarter. This reflects increase retained earnings and other comprehensive income. Please turn to page 6 to review our operational highlights. Looking at average loan balances. They increased $72 million from the third quarter. End of period loans held for investment increased $150 million. Compared to the third quarter 2022 loan growth reflected increased balances of commercial, auto and consumer loans. End of period loans increased 2.3% from the previous quarter and 6.8% year-over-year. We're extremely pleased with our performance this year. Looking at loan yield. It was 7.32%. That is 43 basis points increase from the third quarter. That's largely the effect of Fed rate increases on new and variable rate loans in our commercial loan portfolio. It is also due to a higher proportion of auto, consumer and commercial loans versus residential mortgages. Looking at average core deposits. They decreased $165 million from the third quarter. End of period deposits declined $287 million. That reflects commercial withdrawals of $172 million which included $59 million in government funds. It also reflects retail withdrawal of $150 million which included $37 million transferred to Oriental wealth management operation. Looking at core deposit costs. It was 39 basis points. That is an increase of 11 basis points from the third quarter. That was mainly due to government accounts with a specified deal parameters and migration from savings accounts into time deposits. Of the 11 basis point increase, 6 basis points came from government deposits. So far in this rate cycle, our deposit [data] has been 7%. We expect deposits cost to increase given the magnitude and the speed of Fed from the recent and expected increases. But we believe that through this interest cycle, they will continue to be below mainland level. Looking at new loan origination. They totaled $660 million compared to $511 million in the third quarter. This reflected the strong production of commercial loans in Puerto Rico and the mainland. It also reflected continued high levels of auto loans at a record of $221 million. Looking at net interest margin. That was 5.69% an increase of 46 basis points from the last quarter and 151 basis points year-over-year. This higher net interest margin reflected growth of the loan portfolio at the higher yield, growth of the investment portfolio also at a higher yield and higher yield on cash. This was partially offset by the increasing cost of funds. Please turn to page 7 to review our credit quality and capital strength. Looking at net charges off. They totaled $11 million in the fourth quarter. That's reflected $5 million for auto loans, $4 million for consumer loans, and $3 million for a commercial loan previously we served. Looking at provision for credit losses. So that provision was $8.8 million that reflected $9.2 million in higher provision due to the increased loan volume. It also includes a net release of $400,000 mainly related to reduction in the qualitative adjustments due to improved macroeconomic environment in Puerto Rico, as well as a stable delinquency trends. Fourth quarter allowance coverage ex-PPP was 2.24%. That's down 9 basis points from the third quarter. Looking at non-performing loans. The total non-performing loan rate was 1.61%. That's down 10 basis points from the third quarter and 37 basis points from a year ago. Overall, credit was a stable without rebound from the last quarter effects of Fiona. Looking at some of our other metrics. The CET1 ratio was 13.64%. That's up 13.38% in the third quarter. Total stockholdersâ equity was $1 billion up $49 million from the third quarter. The tangible common equity ratio increased to 9.59%. Now here is Jose. Thank you, Maritza. Please turn to page 8 for our outlook. When we entered 2023, we entered 2023 with strong momentum in loan growth, customer acquisition and market penetration; all of which are helping to transform our company. While we need to keep a watchful eye towards uncertainties from Fed rate hikes, inflation, and a possible mainland recession we should benefit from a full year of higher loan balances and rates combined with a relatively low deposit data as compared to our mainland peers. We should also start to benefit from a full year of the investments in technology and people that we made in 2022. On a macro basis, the Puerto Rico economy should continue to grow, perhaps at a slower pace, but better than the mainland, given the level of continued federal spending here. All this should enable us to continue to invest in people and technology as part of our digital first strategy. Good. Thanks. I just wanted to start off. I know you guys mentioned that you expect the deposit rate to be lower than the last year cycle. But given the rising deposit costs, do you see increased pressure in any specific segment of deposits in the island. So when we look at betas, we kind of look at the past to use it as a reference. And when we look at our origins, deposit betas in the last cycle, it was somewhere around 16%. So we expect given the speed and the size of the increases that we've seen in 2022 we see our betas to be higher than that 16% that we had in the last rate cycle hikes. Now, where do we see that? We definitely have an adjustment with a lag from the Puerto Rico government. We have very little but whatever it is, is going to have some impact on that. And then when we look at the core, I think the ones that will have a higher beta will be in commercial deposits across the board, but in particularly the higher balances accounts. Got it. Thanks. And I know you guys had another great quarter of asset yield growth. I'm just curious to know what rates are coming on the books from new loan production right now or moving forward? So on the commercial book, we're seeing rates on the 6% handle, more or less, north of 6.5, I'm talking about larger type of loans. And then on the small commercial closer more to the 7%, 7.25. Okay, and lastly, I know you've had your efficiency ratio target around 54%. Also curious to know where you see going moving forward throughout the year. Yes. We are targeting mid 50s. So you should expect our efficiency ratio around those levels. And this is the way we think about this and take this opportunity to give you a little bit of our thought process here for 2023. We see loan growth around 3% to 4% for the year as interest rates start to slow down loan growth in the island. I mentioned the beta is slightly higher than what we had in the last cycle of 16%. So given the current yield curve, our net interest margin should start to stabilize at these levels. There's a slight positive trend during 2023. Remember that in 2023 we also, we will realize the full effect of higher loan balances and interest rates, as Maritzamentioned. So net interest expenses are $90 million to $92 million per quarter. We keep on investing on our network optimization, self service and process improvement technology, and people on talent and recruitment of additional team members. So that puts it around the mid 50s range for the efficiency ratio. Hi, good morning. Maybe circling up on the loan commentary and the expectation for 3% to 4% growth next year. I mean, you've been calling for slowing loan growth here now for a couple of quarters, especially on the auto side and trends seem to be going in the opposite direction. How much of that 3% to 4% is more wishful thinking versus what you're currently seeing? And then specifically on auto, are we close to an equilibrium there? Or is there still a big delta between supply and the increased demand? So you bring a very good point. And you're correct also. We've been kind of guiding towards a slowdown in loan originations, particularly on the auto side and hasn't played out. But we continue to feel that the level of cars inventories in the island, the level of new auto sales are starting to stabilize. And I think the fact that interest rates are going up and the effect that might have on slowing down the economy during 2023, we should see a slowdown. We've been wrong for a couple of quarters. But we want to not be wrong on the wrong side of the equation here. So we'll be also prudent on the auto lending side. On the other buckets, on the commercial side, interest rates also play a game here in terms of the demand for commercial loans. So we're also seeing good pipelines but not as strong as they were last year. So we were confident that we will continue to have good strong generation of origination of loans on the commercial and auto but none of the same levels of 2022. Okay, and your competitor reported yesterday, their auto balance, actually I think shrunk a little bit. I'm just wondering, is there kind of a changing of the guard in the auto market on the island? Or I guess what are you seeing from a competitive standpoint in that asset class? I can't speak for our competitors. But I can tell you that is a very competitive market. And I do not see any change of guard happening in the near term. We see very strong competition and certainly the largest competitor is a formidable competitor. Got it. And then as you think about funding that loan growth, is the expectation that we should continue to see the bond book being used as a source of funds for both loan growth and then I guess maybe looking at the deposit base, I would love to hear your thoughts on what you think deposit balances do if we're in a higher for longer type Fed environment? I could not hear well, the first part of your question. But the second part of your question in terms of deposit balances, first I think we will see a transition of some of those deposits either to wealth management, which we have seen so far. I think for 2022, the full year deposits transferred to our wealth management unit was around 100 million bucks. So that's one thing that we're seeing already clients with high deposit balances, putting money in the investment treasuries or whatnot. That's one shift that we saw. I think we also seeing a shift from savings to CDs to longer term CDs to 12, 18, 24 months So we will continue to see that. And as I mentioned, I think someone asked me earlier about the deposits. I think commercial deposits, large balance commercial deposits were also -- look at different ways to optimize their returns. So that's kind of what I see in terms of balances. I think internally, we'll have a little shift there. And we will then have to retain our customers and deal with them on a customer relationship perspective as we look into higher cost of deposits. Got it. And then the first part of my question tying this all together, should we expect the bond book to continue funding the loan growth meaning assets stay flat even though loans grow the 3% to 4%? Or are you envisioning an environment where you actually grow the asset base over and above that $10 billion in '23. So we're not seeing the bond investment portfolio to grow from these levels. We see our deposit balances optimized with investment in our loan origination efforts. So at this point I think we were very patient throughout the last part of the 0% interest rate environment and kind of kept everything except the liquidity in cash. And we've been very opportunistic in the last 12 to 15 months slowly but surely investing in higher yields. We're very comfortable with the current position and we have some repayments that will probably be invest as they come in, but we are not expecting to grow the investment book. Okay. And then last for me on credit quality. Net charge offs are in the mid 60 basis point range for the second consecutive quarter. And you guys are one of the few banks that actually release reserves in the fourth quarter. Maybe just some color on where you see net charge offs normalizing, how close are we to that point and then how should we be thinking about the allowance ratio going forward? Net charges offs for us are driven by the consumer book and the auto book and we saw the fourth quarter starting to show more normal rate post-pandemic significantly below pre-pandemic but still more of a more realistic way going forward. So depending on loan growth and depending on the macro scenarios, our provision should be driven mostly by replenishing the charge offs from the consumer and the auto book and it's a good guiding post to utilize the charges of the fourth quarter going forward and we'll be updating given the different kind of variables of CECL throughout the year. I noticed you guys ended up exiting the year at under 10 billion in assets again. Can you remind us what that implies in terms of the implementation of Durbin the timing of that, and also what sort of impact of fees that will have once it does go into effect. Yes. So, again, we did not cross the 10 billion by the end of the year. So Durbin, the effect of Durbin does not apply for 2023, as you pointed out, and the annual cost for us estimated for Durbin is $10 million. So we are and it usually start six months after crossing the 10 billion on December 31. So for this year, it would have been around $5 million, but yearly will be 10 million. Great, that's super helpful. And I know we've talked at length about the kinds of deposits and also is going down as customers use their funds and search for higher rate. But wondering if there was any kind of decline around year end to if Durbin was a factor at all, in some of that decline, we should perhaps anticipate coming back as you look into 1Q and build into sort of the size of the balance sheet with that? Yes, so that's a good point. That was more the case at the end of 2021. 2022 we started the fourth quarter at a lower asset level than 2021. So it was more natural end of the year, clients utilizing, mostly commercial clients utilizing their funds at the end of the year, and we did not have to press at all to be below $10 billion. So it's part of the natural attrition that we're seeing from higher interest rates and clients reallocating their cash to higher yielding investments. Got it. That's really helpful. And I think and please correct me if I'm wrong, but I think you had mentioned that client accounts are still like that overall balance of each account on average running higher than where they were pre-COVID. Do you have any sense of obviously, there has been a search and run off for rates, but has most of that occurred so far, in the taste of that pressure on the overall level of deposit should start to wane a bit? Or is there any way we can kind of ballpark the deposits that could still I would say, at risk of running off, but more likely to run off? I'm sorry. I just, I think in your presentation, please correct me if I'm wrong, but client account balances are still generally higher than where they had been pre-COVID. Obviously, as rates have risen, there's been pressure on excess deposits as they look for higher rate. Just wondering, in terms of maybe core checking accounts, if you have a sense of whether or not the bulk of the pressure for search for yield and higher rate heads has occurred? Or if there's any way to ballpark how much could still be at risk of potentially being accessed yield? Understood, understood. So the way we look at this is after or during the pandemic, we build up around a billion dollars of additional customer deposits. And that's kind of how the balance sheet was impacted. So far, I think we're at the early stages. I cannot say here in the market in Puerto Rico that we've had the same kind of behavior as I've seen in our peers in the state. So the premise of the Puerto Rico markets having a slower beta it's playing out and I think it will continue to play out. But having said that, I think commercial accounts and I think also the move towards CDs from savings is going to still play out at least the first half of this year as the Fed and its rate cycle hikes or as everyone expects. Still a hope I think. Got it. That's helpful. Appreciate the color, all the color there. Next turning to capital. It was nice to see the dividend announcement. Just wondering on kind of how you guys are viewing the buyback? And what's keeping you out of the market and what would be the circumstances that would get you back in buying your [stock] again. So I think throughout the last couple of years you have seen us move more towards increasing our dividend than doing the buyback. We feel that a longer term investors are better served by us increasing the dividend and having a higher payout from a dividend perspective and certainly a higher yield. So that's one reason. The other reason is also that we want to be opportunistic and be cognizant of the environment we operate in, or the macros are somewhat uncertain, and interest rates are going up. And we want to make sure that we don't deploy our cash into buybacks too soon. And just being prudent Kelly. Having said that, if there's an opportunity for us to go in and buy back shares, we have the authorization and we will execute accordingly. Got it. Understood. Thinking through your expenses, I appreciate the range you gave. I think it was, I still look back at my notes, maybe 90 to 93. What sort of builds of that incorporate in terms of, I know there's some technology initiatives that you're working on. And how confident do you feel that I know you've raised the minimum wage. How confident do you feel like inflationary pressures are hereby captured? A couple of factors here that I want you to consider and that are, I think, different than in the U.S. market. Number one, the Puerto Rico market comes from a significantly lower rate per hour in terms of the employee compensation on the hourly versus the U.S. So as you've seen from us, we've been gradually increasing the hourly rate for hourly employees simply because we need to make sure that we serve our customers well and that we reduce the attrition or the turnover that we were seeing. I think that goes across the entire market in Puerto Rico. So the level of hourly pay in Puerto Rico starts in this cycle at a significantly lower level than in the U.S. and it's catching up. So that's one component of why you're seeing higher non-interest expenses on the compensation side. Number two, we've also realized that we need to recruit a talent that has skills that we need to compete and we need to help us continue our transformation and our investments in our digital first division. So we need people with analytical skills. We need more talent with technology background so that we can leverage the technology and the investments that we're making. So that is another component of a increases in non-interest expenses. And lastly, for making investments in technology, we've been doing this. And if you look back for the last five years, we are being very methodical on how we look at the branch network, how do we look at transactionality in those branch networks and how do we leverage technology to provide self service digital solutions for our customers and we certainly come in Puerto Rico market that is significantly behind the curve as opposed to the U.S. market. So that's kind of the reason why you've seen us making these investments and making sure that we're thoughtful about them, vis-Ã -vis our strategy and that's the rationale behind us making these investments. Having said that, we're very cognizant about mid range 50s efficiency ratio and we would like to leverage the higher interest rates and the higher better economy in Puerto Rico to maintain a positive operating leverage as we've had for the last several years. Hi guys. I just have a follow up. I know you guys mentioned the technology investments and efforts you have in 2023. Just wondering if you could reveal like what direction like other technology efforts it is and specifically what the whether there the technology initiatives and investments you're making for the year are? So we're making investments as we've mentioned in interactive teller machines. We're making investments in digital solutions and upgrading our digital platforms for customers. We should be launching some of those in 2023. We've been looking at process improvement and how do we leverage technology to simplify processes. So we should see also efficiencies there. We look at underwriting and we're looking at how do we become more efficient in terms of our consumer underwriting processes. So all those things are being looked at and investing in for the last couple of years. And we continue to look at them. And again, we feel that all this is done for two main reasons. One is to deepen the relationships with our customers. And also to -- by improving the customer experience and number two, by also growing our market share in the products or services that we offer. And that is something that how we measure ourselves. Right. So, so far, we are very optimistic and encouraged with the progress we've made and I look forward to 2023 that continues to confirm that progress. [Operator Instructions] At this time, there are no further questions. I will now turn the call back over to Jose Fernandez for closing remarks. Thank you operator. And thanks again to all our team members for their hard work and dedication. We're extremely proud of what we have accomplished. We have more to deliver. Thanks to all our stakeholders who have listening today. Looking forward to our next call.
|
EarningCall_1165
|
Hi, everyone. Welcome to the Confluent Q4 2022 Earnings Conference Call. I'm Shane Xie from Investor Relations, and I'm joined by Jay Kreps, Co-Founder and CEO; and Steffan Tomlinson, CFO. During today's call, management will make forward-looking statements regarding our business, operations, financial performance and future prospects, including statements regarding our financial guidance for the fiscal first quarter of 2023 and fiscal year 2023. These forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those anticipated by these statements. Further information on risk factors that could cause actual results to differ is included in our most recent Form 10-Q filed with the SEC. We assume no obligation to update these statements after today's call, except as required by law. Unless stated otherwise, certain financial measures used on today's call are expressed on a non-GAAP basis and all comparisons are on a year-over-year basis. We use these non-GAAP financials measure internally to facility analysis of our financial and business trends and for internal planning and forecasting purposes. These non-GAAP financial measures have limitations and should not be considered in isolation from or as a substitute for financial information prepared in accordance with GAAP. A reconciliation between these GAAP and non-GAAP financial measures is included in our earnings press release and supplemental financials, which can be found on our Investor Relations website at investors.confluent.io. References to profitability on today's call refer to non-GAAP operating margin unless stated otherwise. For planning purposes, we will be holding Investor Day 2023 in New York City on Tuesday, June 13. Please save the date. We ended fiscal year 2022 with fourth quarter results once again exceeding the high end of our guidance on all metrics. Total revenue grew 41% to $169 million. Confluent Cloud revenue grew 102% to $68 million, and non-GAAP operating margin has improved 20 percentage points. We're pleased with these results, especially in light of the macroeconomic pressure we saw in the quarter. On today's call, I wanted to provide an update on how the macroeconomic environment is impacting our business, how we're adjusting for it and how we continue to drive innovation and differentiation and capture the massive market opportunity ahead. I'll start with a few things that haven't changed. As we've discussed in previous earnings calls, we began seeing customers institute additional budget inspection in pockets across geographies in June, and this dynamic has continued. The main impact on our business has been elongated deal cycles with customers. Our overall win rate remains robust, our pricing is steady, and we have been able to close a substantial amount of deals pushed from prior quarters. This is quite encouraging because it reflects the strong vote of confidence by our customers and the strategic value and cost savings our platform brings to them. Now here's what has changed. The increased level of budget scrutiny appears to have become the new norm. More deals took longer to get approval and some expansions were slower than in the past. This is evident in the number of deals that pushed to calendar 2023, which impacted our RPO growth and net retention rate in the fourth quarter. While the vast majority of the deals are still in our deal path, this does indicate that increased scrutiny continues to exert pressure on large deals and new business. We think that this combination of higher interest rates and economic uncertainty puts pressure on the purchasing environment. The result is a substantially different environment for tech than what we were operating a year ago. We are setting our plans for 2023 in light of this and making some changes in how we operate. We have taken steps to adjust our cost structure to accelerate our time to profitability by one year, while still maintaining approximately 30% revenue growth. Specifically, we've undertaken a restructuring of our workforce, optimizing for top strategic priorities and high ROI business areas. This includes a reduction of our workforce by approximately 8%. We're also taking steps to rationalize our discretionary spend and real estate footprint. We don't take the decision to restructure our workforce slightly. We're saying goodbye to many friends and colleagues across the company. We thank them for their important contributions to Confluent, and are making sure that the departing team members are taken care of. I want to be clear that we're making this change without reducing our focus on the long term. It's essential that Confluent dominate the $60 billion market in front of us, and the cuts we have made do not compromise that ambition. While the restructuring will help streamline sales and marketing spend, we're preserving quota-carrying capacity and continuing to prudently invest in our go-to-market to drive new business and durable growth in the years ahead. We will also continue to support appropriate levels of R&D investment to ensure our product is the long-term winner in our space. Despite the difficulty of the change, the resulting efficiency allows us to pull in our target of non-GAAP operating margin breakeven by 12 months. This means that exiting Q4 of this year, we will have shown a 41 point increase in non-GAAP operating margin in just 24 months. Exiting 2023, less than one year from now, we will be a market leader in a deeply strategic space, operating a profitable business and driving sustained high growth in a very large market. This market leadership is driven by our platform differentiation and the significant TCO advantages we deliver to our customers. To better illustrate that, let me share our customer story. Wix is the leading website development platform in the world, which in turn serves around 1 billion unique visitors each month. Data streaming is at the heart of many of the digital experiences their clients create from online bookings to e-commerce to personalized content. And Wix' data streaming journey, like so many others, began with open source Kafka. They quickly discovered, however, that the open-source approach required heavy DevOps resourcing and resulted in challenges with scale, time to market, reliability and latency. Ultimately, they chose Confluent Cloud to mitigate risk, reduce costs and increase productivity. That migration quickly resulted in a 90% ROI. This is just one of many examples that shows the strength in the underlying demand for our data streaming platform. This is because Confluent serves operational workloads and are directly responsible for driving the core operations of our customers, making this a key element of a digital strategy going forward. In fact, IDC projects that by 2025, event streaming technologies will be used by 90% of the Global 1000 to deliver real-time intelligence to improve outcomes such as customer experience. And in a separate study, IDC found that of the companies that are currently using streaming data, over 80% have plans to invest in new streaming capabilities in the next 12 to 18 months. Today, our product is the category leader in data streaming platform technology, bar none. The key focus for us is ensuring we continue to stay ahead as this category grows and evolves. One critical element of these investments that I want to discuss today is stream processing, that is technology to enable our customers to build applications on top of the real-time data streams that Confluent provides. A simple way to understand the importance of stream processing is by analogy to the world of data addressed in traditional databases. A database solves two problems. It acts as a store of data and it executes queries that process the data. This combination of data and processing is what a database is so easy and ubiquitous. A similar combination of capabilities is needed as we move from data at rest to data in motion. In the world of data in motion, data isn't just start. It's a continual stream that updates as the world changes. The natural complement to this is stream processing. That is building applications that continuously update, react or respond to changes in the world. The core of Kafka acts to storage streams and to be a hub for connectivity, kind of like a central nervous system that transmits the real-time impulses of what's happening in the business. Stream processing acts a bit like the brain, taking real-time action on the impulses the nervous system conveys. Increasingly, businesses of all kinds are leveraging stream processing to drive the data-driven applications that better serve customers and drive intelligence and efficiency in their operations. Confluent has long contributed to the emerging stream processing ecosystem around Kafka with Kafka Streams, an application development library for stream processing and ksql. This quarter, we took a major step in furthering these capabilities with the acquisition of Immerok, a stream processing company that offers a fully managed service for the open source project, Apache Flink. Immerok has joined Confluent to help us add a fully managed link offering to Confluent Cloud. This is a very exciting step for Confluent and I want to explain a little bit about our strategy in this area. We've watched the excitement around Flink grow for years. and saw it gaining adoption among many of the most sophisticated technology companies in the world, including Citi, Goldman Sachs, Pinterest, LinkedIn, Netflix, Uber and Apple. This popularity has been driven by a rich feature set, including a powerful processing model that generalizes both batch and stream processing. It is battle tested at scale on some of the largest real-time processing workloads on the planet. And perhaps most importantly, it has an incredibly smart innovative community driving it forward. In short, we believe that Flink is the future of stream processing and by adding it to Confluent Cloud, we can significantly advance our data stream platform and help our customers get again more value from their data streams. In terms of our product plans, we plan to launch the first version of our Flink offering in Confluent Cloud later this year. We want to follow the same key principles we've brought to our Kafka offering, building a service that is truly cloud native is a complete and fully integrated offering and is available everywhere across all the major clouds. We think this combination of an open popular interface offered with a deeply differentiated cloud-native core is the key to success for cloud data systems. We think that over time, this offering can be a substantial driver of growth in our business, comparable in size to Kafka itself. Adding this new offering will allow us to better monetize the compute and application development around data streams in addition to the core stream data, expanding spend of existing customers. Further, by making streaming easier, we pull more workloads into our streaming platform. In addition, the processing of streams generates more streams, helping to accelerate the growth of our Kafka, connector and data governance products. In this way, stream processing accelerates consumption in a multiplicative fashion, which we think will be a very positive tailwind for growth as these capabilities come to maturity. To help execute both this initiative as well as our overall product strategy, I'm pleased to announce that Shaun Clowes joined Confluent last quarter as our Chief Product Officer. Shaun joins us from MuleSoft, where he served as CPO. And before that, Atlassian, where he served as Head of Growth. Shaun is a technologist passionate about the space and is the right person to lead the team through the data streaming era. And finally, I'd like to share that Larry Shurtz has stepped down from his role as Chief Revenue Officer. Larry, we wish you all the best, and thank you for your many contributions in helping us scale and evolve our sales team. We will not be looking to backfill this role. Larry reported to Erica Schultz, our President of Field Operations, and we'll revert to our prior org structure with Erica managing the theater sales leaders directly. In closing, the demand for data streaming remains strong. We've accelerated our plan to become profitable by the end of the year, and we'll continue to invest in building the data streaming platform that will become the central nervous system of every company. I'd like to start with a brief recap of the full year results. In fiscal year 2022, we accomplished our stated goals of driving high revenue growth and improving annual operating margin. Total revenue grew 51% to $585.9 million. Confluent Cloud revenue grew 124% to $211.2 million with substantially improved unit economics, and operating margin improved 11 points. I'd like to take a moment to thank all of our team members at Confluent, our customers and partners for their contributions throughout the year. Turning to the fourth quarter. As Jay mentioned, the results exceeded the high end of our guidance on all metrics, highlighted by strong revenue growth, Confluent Cloud momentum, robust customer additions and substantial margin improvements. These results are a testament to the mission-critical and strategic role of our data streaming platform and our proven ability to drive high growth while improving efficiencies and profitability in a challenging economic environment. RPO for the fourth quarter grew 48% to $740.7 million. Current RPO, estimated to be 62% of RPO, was approximately $456.2 million, up 43%. Both metrics were lighter than we expected. In addition to what Jay discussed earlier, we saw less urgency by customers to sign deals in the last couple of weeks than we typically would see in a calendar Q4 primarily in our enterprise business as some customers evaluated macro and opted to delay their purchases to FY '23. We didn't see any material changes in discounting, contract duration or win rates relative to the previous quarter and I'm pleased to report that a number of these Q4 push deals have closed in Q1, which points to the underlying demand for our solution. Dollar-based net retention rate in the quarter was also healthy, just under 130%. NRR for cloud and hybrid were both comfortably above 130% with hybrid NRR continuing to be the highest. Gross retention rate remained strong and was above 90%, reflecting the strength of our product differentiation and TCO advantages against alternative solutions, including open-source Kafka. New customer additions continue to rebound since our paywall removal in March. We added 290 net new customers during the quarter, ending at approximately 4,530 total customers, up 31%. New customer additions were driven by Confluent Cloud. The growth in our large customer base was also robust. We added a record 70 customers with $100,000 or more in ARR in the quarter, bringing the total to 991 customers, up 35%. These large customers contributed more than 85% of total revenue. We also had a record quarter of customers with $1 million or more in ARR, adding 20 customers during the quarter, an all-time high, bringing the total to 133 customers, up 51%. And we ended FY '22 more than doubling our $5 million-plus ARR customers from a year ago, including a growing number of $10 million plus ARR customers. Turning to revenue. Total revenue grew 41% to $168.7 million. Subscription revenue grew 44% to $155.3 million and accounted for 92% of total revenue. Confluent Cloud as a percentage of new ACV bookings was greater than 70% in Q4, which represented our fifth consecutive quarter of Cloud exceeding 50% of total new ACV bookings. As Cloud accounts for a larger share of new ACV bookings, Confluent platform will have lower ACV and less upfront revenue. This upfront dynamic was reflected in Confluent platform revenue, which was $87 million, up 17% and accounted for 52% of total revenue. Confluent Cloud revenue was $68.4 million, up 102% and accounted for 41% of total revenue compared to 28% of revenue a year ago. This translates to a record sequential revenue add of $11.5 million for Confluent Cloud compared to $9.9 million last quarter and $7 million a year ago. Our Confluent Cloud momentum was driven by our continued focus on use case expansion, decreasing time to value for customers and supporting their mission-critical workloads with strong consumption across industry verticals. Turning to the geographic mix of revenue. Revenue from the U.S. grew 35% to $100.5 million. Revenue from outside the U.S. grew 50% to $68.2 million. Moving on to margins. I'll be referring to non-GAAP results unless stated otherwise. Total gross margin was 73% and subscription gross margin was 78.7%. The unit economics of our Cloud offering continued to improve, driving another quarter of healthy gross margin despite a continued revenue mix shift to Confluent Cloud. Moving forward, we anticipate total gross margin to fluctuate between 70% and 72%. Turning to profitability and cash flow. Operating margin improved 20 percentage points to negative 21.5% and through proactive expense management, productivity and efficiency initiatives and a disciplined investment approach, we drove improvement in every category of the P&L, with the most pronounced progress made in sales and marketing, improving 8 percentage points and gross margin improving five percentage points. Net loss per share was negative $0.09 using 286.7 million basic and diluted weighted average shares outstanding. Free cash flow margin improved four percentage points to negative 18.3%. And we ended the fourth quarter with $1.93 billion in cash, cash equivalents and marketable securities. Turning now to the Immerok acquisition. Immerok is a pre-revenue company and we'll be absorbing the company into our engineering team. We closed the acquisition in Q1, and we expect no material impact on our financials in FY '23. The additional expenses have been incorporated in our guidance. Looking forward to FY '23. As Jay discussed earlier, we've made a decision to accelerate our path to profitability by one year from Q4 '24 to Q4 '23 and while resourcing the company to deliver approximately 30% annual revenue growth rate in 2023. Over the last two years, we've made significant and prudent investments in the business as we address our $60 billion market. We've more than doubled our company head count, and we've actively been managing the growth rate of spend, and it has trended down from 68% in FY '21 to 39% in FY '22. And it's expected to go down to approximately 15% in FY '23. We're seeing strong returns on our investments as we continue to grow our market share and extend our product lead with a highly differentiated platform. On the go-to-market side, 50% of our sales reps are now fully ramped, and we expect the mix to be in the range of 55% to 60% exiting this year. Additionally, compared to last year, we have improved visibility into our FY '23 revenue streams as approximately 60% of revenue comes from current RPO, coupled with the strong growth in $100,000-plus ARR customers, which contribute more than 85% of revenue each quarter. And our NRR remained very healthy, just under 130%, which supports our growth. Given this backdrop, we believe accelerating our path to profitability by one year, while continuing to deliver high growth is the optimal decision especially as companies are now operating in an environment of high interest rates and macro uncertainty. Now I'll turn to our outlook. We believe our guidance appropriately incorporates both the macro challenges we see in the market and the impact of budget scrutiny as a new norm, which elongates our deal cycles in all customer accounts across geographies. For the first quarter of 2023, we expect revenue to be in the range of $166 million to $168 million, representing growth of 32% to 33%. Confluent Cloud's sequential revenue add to be approximately $5 million. As we expected, there is a decline in sequential add relative to Q4 and is consistent with what we've seen in prior years. Similar to last year, we expect Cloud sequential revenue add to increase every quarter with a more pronounced increase in the second half of the year. Exiting Q4 '23, we expect Cloud to reach the milestone of approximately 50% of total revenue. We expect non-GAAP operating margin to be approximately negative 27% and non-GAAP net loss per share to be in the range of negative $0.15 to negative $0.13, using approximately 290 million weighted average shares outstanding. For the full year 2023, we expect revenue to be in the range of $760 million to $765 million, representing growth of 30% to 31%; non-GAAP operating margin to be approximately negative 15% to negative 14%; and non-GAAP net loss per share in the range of negative $0.28 to negative $0.22 using approximately 297 million weighted average shares outstanding. As discussed earlier, we're now targeting to exit Q4 2023 with breakeven non-GAAP operating margin. We also expect the timing of breakeven free cash flow margin to roughly mirror that of our operating margin, with the exception of more pronounced seasonality in Q1 of FY '23, primarily due to our corporate bonus program and onetime charges associated with our restructuring. Finally, we'll continue to actively manage share count and stock dilution. And on an annualized net dilution basis, we're driving net dilution from 4.7% in FY '22 to 3% to 4% for FY '23. Our goal over the long term is to bring that dilution down even further. In closing, we've established a proven track record of delivering on our financial commitments in both stable and uncertain economic environments. With our leading data streaming platform and a unique go-to-market model that's showing increased leverage, we believe we're well positioned to capture our large market opportunity ahead. Looking forward, we're confident in our ability to drive another year of high revenue growth as we march towards non-GAAP operating margin breakeven exiting Q4 FY '23. Now Jay and I will take your questions. [Operator Instructions] And today, our first question will come from Sanjit Singh with Morgan Stanley, followed by William Blair. Sanjit, please go ahead. Thank you, Shane. And thank you for squeezing me in. I guess my first question -- and Jay, I think you addressed this in your formal comments just around some of the elongation and sort of the sales cycles that you saw at the end of December. Is there any sort of other patterns that you would sort of call out, whether it's more on the Confluent Cloud side of the house versus Confluent platform, any sort of market segments, industry segments on that were notably weaker than expected? Or was this kind of more of an across-the-board dynamic around budget scrutiny that you saw on like the deals in Q4? Yes. Sanjit, great question. So yes, the most pronounced thing for us was it seemed to mostly impact the enterprise segment of our business. The commercial segment didn't really feel it. The -- it was across geographies. So previously, I would say it was more pronounced in EMEA and APAC. We also saw a impact in the Americas. So beyond that, it was probably the larger transactions tend to feel, I think, a little more pressure scrutiny, et cetera, kind of as you would expect. So nothing beyond that. I wouldn't say that there's a strong industry pattern I wouldn't say that there was much beyond that, that would really show it. We were pleased that gross retention was really strong. Yet again, in a difficult environment. We saw no meaningful impact there. But it did slow down some of the expansions as well as some of the new lands. And then, Steffan, I could just sort of connect some of the dots on the financials. The Confluent Cloud revenue in Q4 was excellent, record quarter for Confluent Cloud revenue. The RPO was certainly weaker. And then when I look into the 2023 guidance, revenue guidance, it only came down, I think, $5 million. You sort of narrowed the range. What gives you confidence that like the revenue is sort of set at sort of the right level, just given some of the dynamics you're seeing out on the macro? Well, we took into consideration our current outlook on the macro, and we really focused on a few things. One is our current RPO exiting Q4 gives us about 60% visibility to our total revenue number in FY '23, which is actually five points higher visibility than we had this time last year. We also have more proportionally sales reps that are fully ramped than are ramping, and we see that growing out throughout the year. And then lastly, we just came off of a quarter where we saw a very robust growth in $100,000-plus customers and $1 million plus customers. And those cohorts contribute north of 85% of revenues. And so we have the right product for the right market, and we feel like '23 will be a decent setup for us. Yes, thanks Shane. Good afternoon, everyone. Obviously, macro issues are affecting everyone, including you guys. I do want to talk a little bit about sales execution. Larry is leaving. I know some other folks are leaving and then you have this reduction in force. How much is sales execution has been a contributing factor here to the performance? And if there are any issues, what are you doing to address those? And I have a quick follow-up. Yes. I think the bulk of what we're seeing is a very different macro environment than what we were operating in, call it, whatever, nine months ago. That obviously reveals opportunities for improvement, but I think the bulk of what's changed is that. Okay. And then as a quick follow-up for you, Jay, were you seeing something in deals where it was increasingly clear that you needed a Flink solution? Yes. There wasn't anything where it was like preventing us from winning, if that's kind of what you're getting at, where it's like a, we can't land this customer without this. We feel like stream processing is incredibly important to us strategically over the long term. So it wasn't like a defensive move, like, oh, if we don't have this, we're not going to be able to continue growing, based on Kafka. We're not going to be able to continue winning customers. What we felt was, there's an opportunity to go after something that could be as big as Kafka and has a very similar trajectory, has an extremely high attach rate to Kafka itself, and fits into our kind of overall vision. And where we could get really some of the key people who had helped drive it forward as part of the company, and that was kind of too good to pass up even in a tighter environment where we're being thoughtful about each dollar. Hi, thanks for squeezing in. Can I follow on there Jay a little bit -- like you're all trying to get to the bottom of same-story. If you think about what you're selling, it's very mission-critical, like these are kind of proper projects. You don't do this for fun. But I also really -- What are you seeing in the -- in your conversation with clients about like a -- that need that urgency to do things. And I had one follow-up for Steffan. Yes. I think that one of the things that's really an asset to us in times like that, this is exactly what you said, right? And I think that shows up in the gross retention. I think for us, it's also showed up in the consumption. Like we've seen consumption against commitments to track really well. So the projects are going forward. People are kind of getting the value out of it. But I think each of these projects now gets more scrutiny, and that is a drag on doing business. And it shows up in a bunch of different ways, whether that's pressure on the kind of analysis of TCO and ROI whether it's kind of the shift of projects around within organizations, I think companies are just putting more scrutiny on everything they're doing and that impacts us. But -- yes, I think it's a huge asset to serve production use cases, which are, in some sense, a direct part of how the company grows, operates, makes more money. And I think that's one of the good things about the streaming area. And then one quick follow-up on more numbers. So if I think about the -- you kind of moved to the profitability goal one year forward, which is kind of a big change and it takes a lot of effort from the organization. Can you talk a little bit about the compromises you have to think about there? Was that certain growth projects you kind of maybe kind of deemphasize? It doesn't sound like it's the sales force getting impacted. Like, just talk a little bit about like the puts and takes you have to kind of go through to get to that because that's quite a big effort. Thank you. Yes. Yes. I mean any change like this is a little bit disruptive. And so I think that's the -- probably the biggest impact for us is just making sure that we get off to a fast start at the beginning of the year. We're not so disrupted that, that impacts execution. It's obviously also just a harder thing to go through. We felt like, look, after a couple of years of very fast growth, where we kind of roughly doubled headcount in that time period, there was opportunities for efficiency, right? And despite being very thoughtful in planning and where we were deploying resources we thought there was opportunities to get more efficient. So for us, it was kind of a question of how do you do that. Are you going to do it more slowly, kind of in place? Are you going to do it more quickly? As we got, I think, a better read on just, what's the environment for '23, what's the environment overall in tech, what makes sense for us, we feel like it made sense to do it more quickly. And that kind of, I think, shows a little bit of what's possible for the business in terms of efficiency or is at least one good step in that direction. And it seemed like in the environment, it just made sense to do that now. And we're also doing it, preserving our ability to drive top line growth, and continue to invest in our innovation engine. And we are able to balance the moves that we made to preserve our long-term sustainable competitive advantage. Yes, I think that's exactly right. I mean as we went into this, the kind of key analysis would you have to give up on something that's going to make the company great, whether that's in the development of the product or how we're growing the business, how we're kind of capturing the opportunity. And we felt like we could do it without doing that. And I think that was one of the big things that was necessary for us to act on. All right, thanks Raimo. We'll take our next question from Brad Zelnick with Deutsche Bank, followed by Bank of America. Brad? Great. Thank you so much. It's nice to see you all. I've got one question for, I guess -- first for you, Jay. Jay, just as we think about the changes that you've made and you've got Larry moving on, what is it that gets you comfortable that there's not risks exiting this year with 55% to 60% sales rep productivity and it might inspire some additional unanticipated turnover? And then I've got a follow-up. Yes. I think we continue to have a kind of steady hand running the go-to-market organization. So Erica Shultz has run the larger field organization. Larry reported into her. She previously directly managed the three sales theater VPs and is kind of taking them over directly. And so actually, I feel like in a time where there's like a fair amount of macroeconomic uncertainty, that org structure is actually good. You want to have kind of a short path between leadership and what's happening out on the street. So I feel pretty good about that. Okay. That's good enough. And maybe just for you, Steffan, I'm just trying to reconcile Confident Cloud Q1 guidance versus the really strong results that you're coming off of in Q4. Is there any reason to think that consumption was perhaps unusually strong in Q4 in some way that might not repeat? And/or are there any reasons to be more concerned and conservative about consumption rates in Q1? Well, the dynamic that we called out relative Q4 to Q1, where the net sequential add is lower in Q1 than Q4 is a natural dynamic that happens in consumption models you as look kind of across the board. At companies in our peer group, you see similar fact patterns. We did see a very strong Q4. It candidly came in higher than we expected, and that goes back to the mission criticality and what we're driving in terms of consumption for our customers and the value that we're driving. When we look at the progression for cloud throughout the year, we are looking at seeing increased sequential net adds throughout the year post Q1 and for Confluent Cloud on exiting Q4 to be roughly 50% of total revenues. And so we're doing all of that in an environment that is just -- it's just more challenged to do business in. So we've reflected all of that in our guide, both in our total revenue guide and our Cloud guide. And we're adding effectively the same amount of revenue that we did Q1 of last year. In Q1 of last year, that environment was a lot different than where Q1 of this year is. So nothing to be like concerned about. We're looking at incredibly high growth rates for Confluent Cloud for the year, and that continues to show continue to show up in our numbers. And just to pile on that. One of the aspects -- we talked about this last year when we were in Q1. One of the aspects that leads to this is just the kind of life cycle of software projects, they tend to get funded at whatever the company's beginning of the year is and developed and then kind of roll out. And so obviously, there's expansion and consumption happening throughout the year, but it is more things -- more new things come out in, call it, whatever, Q3, and then a little bit less at the beginning of the year as kind of the new things are getting built. And so you would see this, I think, for like a MongoDB and some other companies as well, where it has a little bit of that patten. All right. Thank you, Brad. We'll take our next question from Brad Sills with Bank of America, followed by Piper Sandler. Great. Thanks Shane. Good to see you all. Question for you, Jay, or Steffan, on just investment priorities. Obviously, you're saying that this reduction will not affect those strategic investment areas. I think at the Analyst Day, you had outlined security, data compliance, enterprise -- just any update on those cycles? What -- how does this change that at all? Or are those still very much the focus areas? Yes, absolutely. So like on the product development side, there's no change. There wasn't a big product area that we cut or stopped developing. We're able to maintain the major investments that we had with what we planned for this year and those cuts taken into account. This did cut across different areas of the company and there's a number of factors that were included in kind of making cuts. But our priority, as I said, was kind of really making sure that we had full funding for what we consider the kind of key strategic priorities, both on the product side and on the go-to-market side. And in terms of markets we wanted to get into, that we wanted to drive growth both for this year but also for setting ourselves up coming into next year and beyond. So -- yes, no major change. Understood. No, that's great. And then one on Confluent Cloud please. Exiting the year at 50%, just a tremendous trajectory. I think in fiscal '20, you exited the year at 15%. So just a remarkable result there on the Cloud. If you could just articulate for us why have you seen such success in the Cloud? What is it about Confluent Cloud versus, say, other categories where we've seen perhaps a slower ramp in public cloud infrastructure and these types of mission-critical workloads that you guys are supporting? Yes. One of the things that's easy to miss is how high the bar is for a cloud product. And so if you look at our investment, you would have seen a pattern where you're like, they're putting a lot of work into this thing, and it's driving some small -- we were doing that for many, many years. And the reason for that is that this kind of cloud infrastructure, like a lot of the iceberg is below the water. And until you kind of meet certain minimum criteria in terms of security and scalability and operations and availability in different clouds around the world, it's just very hard to capture the market. And so coming into an area that's a big wall to climb, once you're on the other side of the wall, then it protects you, I think, from competition to make them up and want to do the same thing. So I think it's been a great thing for us. But -- yes it was I think just kind of reaching that critical threshold. And then in terms of how we operated that led to that, I would say it was mostly just full commitment, like we myself, some of the other people who founded the company or joined earlier had a background in running kind of data systems internally as a service. And we just kind of knew that, that was going to be the model in the public cloud that there was no future for licensed software as the delivery model once people have access to these kind of cloud services. So we knew it was kind of do-or-die on the conversion. And so we leaned in early on in a very significant way where really the whole engineering team moved to that. Every cloud metric was kind of elevated in importance to match a much larger number on the software side of the business and really kind of held to that internally, even though we're really pushing one part of the business up. And I think that was necessary early on. It's very hard to get what's effectively a very different product going in an early company because you have to effectively build two successful products. So I think that helped us kind of get it to that whatever escape velocity where it could then kind of grow and capture a lot of the opportunity that was, I think, always there for folks operating in the cloud. Thanks Shane, and good afternoon, everybody. Obviously, seeing pressure worldwide here, but just curious if there was anything unique to call out positive or negative from the various theaters that you're participating in? Yes. It's mostly what I described. The biggest unexpected thing for us has been just the continued strength for us at the commercial business. We kind of ascribe that to the fact that we think we're just still severely underpenetrated in that segment. So even though I think they are also feeling lots of pressure, there's just lots of opportunities. And I think it also has a very good product market fit with our cloud offering. And so, it's been nice to see that continue to grow because it was a part of the business we were very excited about, coming into this year, and it's nice to see its continued growth. But beyond that, yes, it was across different industries that we saw pressure. We were pleased to see that, like, by and large, we're not losing deals. They're delayed, they go through more scrutiny, they may slip out of the quarter, but a lot of the things that we saw delayed in previous quarters did close, either in Q4 or in the first part of Q1. And so, we've been excited to see that. It just exerts pressure. Great. And then, Jay, I know entering COVID, you saw a few customers actually revert back to an open source solution, and then come back to Confluent. And in your prepared remarks, you talked about it requiring heavy DevOps resourcing. So as we're seeing the global recession happen, are you seeing customers actually choose open source as a viable alternative at this point? Or is that kind of past behavior more so in the past? Thanks. Yes. It's past behavior. So, we've been -- that was a concern many people had. And the feeling was, hey, it must be cheaper just to use the open source. But one of the really important things to understand about this area is these cloud services are not like a premium offering of the open source. It is actually more expensive to hire a team of engineers to operate this stuff. It's more expensive in terms of people. It's more expensive in terms of cloud infrastructure. It takes longer. It's just more. And so for that reason, once you have a really good cloud offering, it's not very appealing to downgrade unless for whatever reason the customer is not like actually succeeded with it or somehow not getting the value. But just based on the kind of basic TCO of the two things, it should be a big win. And we've been pleased to see that actually play out in practice. That was the theory early on as we had, I think, a pretty immature cloud offering, we didn't always see that. We did see some customer losses earlier as there was pressure. We felt like we were in a very different situation as we were kind of coming into harder times this year. And we talked about that on these calls, but it's been nice to see that play out that we haven't seen the kind of churns at all of the same magnitude. And in fact, gross retention has held very steady throughout this. Thanks Shane. So my question is for -- it's for either Jay or Steffan. And it's a clarifying question about, Jay, a comment that you made in your prepared remarks about near-term spend rationalization not impacting Confluent's long-term growth opportunity. Because it seems like -- so Cloud is holding strong. And in your response to an earlier question, you said rationalization, it was really about optimizing operational efficiencies that I do identify but not necessarily impacting growth. So, despite the pull forward profit target, is your baseline growth assumption over the midterm now, is it necessarily lower than before? Or could there still be a scenario where your midterm growth expectations are unchanged, but you just figure out how to do it more profitably? I definitely think that there's an aspect of us just figuring out how to do things more efficiently and willingness to make adjustments faster in that respect. There's obviously areas where there's trade-offs. And so -- nothing in life is free. But -- like, yes, we felt that we were able to make this change without significantly changing. Now I would say, look, there is something impacting growth, which is -- we are in a macroeconomic environment that's very different from a year ago, and that's a headwind. And so, I think when we were considering what we were going to do on the expense side, we were taking into account that we were going to be facing this headwind and likely growing slower than we would be if that was not the environment that we were operating in. Okay. Thanks. And I just have a quick follow-up for Steffan. On the platform side, Steffan, I forget if you mentioned this in your prepared remarks, but if -- or I might have missed it. But was there any notable change in contract duration on the platform side that resulted in lesser license revenue recognition than in prior quarters? And also, is there any migration from the platform to Cloud that's worth calling out? Thank you. Thanks, Howard. There was no material change in contract duration. But what you're seeing drive the change in license revenue is really the profile of new ACV that's coming in the door. And the new ACV is Confluent Cloud. It was very, very healthy this quarter. And we saw just less new platform deals come in because as the industry is all heading towards cloud. With that said, Confluent platform is still an important part of our portfolio. And we're going to continue to see contribution from platform, but it's really about -- like, Cloud is the story here. And even going back to a prior comment that was made, even in a tougher macro environment, we just came off of a quarter where we posted record Cloud sequential growth. And we're calling for very meaningful Cloud expansion over 2023. And that goes back to the testament of the value that we're delivering in our Confluent Cloud model. Great. Thanks for taking my questions. I guess, first, Jay, I wanted to touch on the Immerok acquisition. What does Flink excel at that improves upon the capabilities of Kafka streams or ksqlDB? And how should we think about maybe the R&D shift as you bring Apache Flink in? Are there some technologies that you'll look to deemphasize going forward? Or what's the balance across the stream processing technologies that you have? Yes. Yes, it's a great question. So -- yes, Kafka Streams is effectively -- it's an application development library that helps you do stream processing with Kafka. So, it's very easy to use in embedded applications. It tends to serve more kind of micro service use cases. What Flink brings to the table is, I think, really the most complete, well-thought-out framework for stream processing, it generalizes batch processing with real-time streaming. So you can kind of run thing, something at a point in time and then have it keep running up into the future. It supports a variety of programming languages like Python, Java, SQL. It has probably the best scalability and performance. It has, I think, the most active community. So there's really a whole set of things that have brought together including the sophistication of the types of processing and applications it supports. And all of that together made us feel like has this really does add beyond what we were able to do with Kafka Streams and ksql and is kind of worth the investment. It doesn't change our support for those technologies. As with any cloud service, we'll continue to help customers with those really indefinitely. And Kafka Streams, in particular, has a nice kind of area as an embedded library for customers. But we do see this as very much the future of stream processing and kind of the technology of choice for customers over time. Got it. Very helpful. A couple of quick ones for you, Steffan. On the restructuring side, can you just give us a sense as to where the cuts are coming from? And in particular, I guess, it would be nice to now kind of like post restructuring, what kind of growth you have in quota-carrying sales headcount kind of year-over-year and how you're thinking about -- given the longer sales cycle, how you're thinking about the glide path for net revenue retention in 2023? Well, the restructuring was done with the lens of preserving our ability to continue to grow in high-growth mode and really getting to the efficiencies that we think that we can get to. And so what does that mean? We're looking at -- in sales and marketing, we did have, from a headcount standpoint, the most impact there. but those are primarily like non-quota-carrying folks. We also took a look at G&A and then lastly, I would say, R&D. But we were very much focused on ensuring that all of the decisions we made were in the preservation of us continuing to have high growth with improving profitability and efficiency. And one of the things that we mentioned earlier was -- if you look at the last couple of years, we have made very meaningful investments across the board in support of us growing into what is a very meaningful company in a very large market and there is always an opportunity to rationalize and get more efficient. So the theme that we have this year is efficient and profitable growth, and that's what we're driving towards. I'm sorry, what were the other couple of questions? Yes. So our net retention rate this quarter came in just a shade below 130%. We gave a little bit of color commentary that Confluent Cloud and our hybrid customers were north of 130%. We continue to see very strong progress with those two products and customer sets. As we think about the glide path over time, we very clear about being above 125% from a total company standpoint and also looking at just higher net retention rates for our cloud and our hybrid customers as that's like where the puck is going. Thanks guys. Thanks for taking the questions. Two quick ones. Maybe update us on just the customer behavior you're going into January so far towards the end of January. Is it deteriorating? And it's kind of stable? You did mention you have closed a few deals, so I was just wondering. Yes. Yes. I would say the results in January so far have been in line with the kind of plan we put together for the quarter and guidance. So we've been pleased to see that play out as we hoped. Got it. And great to see the acceleration to get to breakeven. I wanted to ask -- I think I was doing the math was about $55 million in terms of cost coming down, I believe. I was trying to understand how much of that is driven by the [ref], how much of that is kind of optimization of discretionary spend that you talked about, how much of that is kind of real estate. I would think that real estate optimization probably will take time. So trying to understand those mix. And then, I guess, how should we think of that profitability going forward? Yes. Yes. So it's definitely a mixture of all those things. We haven't broken out exactly how much is due to each thing. But -- yes, absolutely, we're kind of optimizing real estate footprint. Just kind of post COVID, we have a better of what we actually need. We had already a plan for the year prior to this action that would have shown very meaningful operating margin improvement. And so then this is kind of added on top of that, which is kind of what lets us make big improvements. And if you look at this last year, we had about 20 points of improvement over the last 12 months from Q4 to Q4 in non-GAAP operating margin. And so this is kind of roughly that again between the ref and the existing improvements and the additional growth in revenue. Thank you so much. Somewhat static here. Nice to see you guys, Jay, Steffan and Shane. Question for you. When you look at Flink, Jay, for you, how much work needs to be done to Flink to make it as solid as -- in terms of research and development, product development came pretty -- as a core platform is taking so many years to come to shape. What is the path ahead for Flink? And when you said Flink could be as large as Kafka, I'm curious to see if there's any pent-up demand that customers have been asking for. I know you highlighted a few customers, including us. What are they saying that you could do better with Flink that could cause them to allocate bigger budgets? And I have one for Steffan. Yes. Yes, there's a couple of things there. I mean, I -- Flink, the technology, I think, is in good shape. It's a successful piece of technology that it's in own right. To turn it into a managed cloud service is a ton of work. It's just a huge amount of work. That's something we'll work on for many years, right? And so we'll release a product, but there'll be more and more to do. That kind of cloud-native bucket that we talk about for the rest of our offering, it's a big bucket. It really matters to customers. And so -- yes, there'll be ongoing work in that dimension in the years to come. That's one of the reasons why it's really important to have these core people who are driving that technology forward. It's not just a matter of kind of getting the open source and putting it on some servers, which we wouldn't need an acquisition to do. You need to really kind of reimagine the technology as a cloud service and how would -- what -- how should that work? What would that be like? That's what kind of creates the good product. And then in terms of -- yes, what -- the reception from customers has been fantastic. People are very excited about Flink. They're very excited about Confluent. They're very excited about the pairing together. For many of our customers, they were already using Flink with Confluent. And so -- yes, absolutely, people are excited. Some people are like, what took you so long? So yes, it's great to hear. We think that there is -- as with Kafka, there is a substantial existing installed base. And in an environment like this where there's some pressure and there's less kind of net new software projects overall coming out, having that existing installed base to grow into is obviously a really nice second dimension of growth beyond just kind of landing with the new things. Got it. One for you, Steffan. Well, how do you look at the -- given the headcount reductions, how do you think about cost of customer acquisition, lifetime value? It looks at the commercial business did well, Cloud is definitely inflecting away from the platform. Given all that, how should we look at those metrics? Are they getting better or about the same pre-cloud? Thank you so much. Yes, thanks for the question, Kash. As we look through 2023 and beyond, as more of our business is coming from cloud and there's the self-serve option or onboarding, et cetera, our LTV to CAC should be improving over time. And we've made some progress this year, the year that just ended in terms of optimization. But when we look at LTV to CAC over the longer term, we see that improving on an annual basis. And that's a reflection of both the restructuring that we're doing, but then also the profile of the revenue streams that are coming in that are just a lower cost of customer acquisition. Great. Thanks Shane. Jay, this is for you. I wanted to get your thoughts on kind of how you keep that net expansion rate pretty strong in that 130% range going forward. Just given what is kind of a more technical sales as you kind of evaluate kind of the lower workforce going forward? Just how do you keep customers keep expanding at this pretty impressive rate while also trying to balance that profitability? Yes. I think there's a number of things that go into that. One is just we have a consumption model. So it's very possible for customers to use either other parts of the product or use the product for new uses, and making that as easy and frictionless as possible. There's a lot we can do and are doing to continue to drive that, making sure that, that folds well into the motion that the sales team has. We're actually at our sales kickoff event right now. And that's one of the big focuses for us is making sure people understand how to play well with that consumption motion, how the product help drive them into new use cases helped drive that expansion. I think it's a huge area of opportunity for us and then making sure that we have the right use cases that we have the right senior connections and organizations that kind of blessing is critical to really get broad in organizations and get to larger dollar spend in organizations. Especially in this environment, people need to know what it's for. And then we're coupling that with this -- we've really gotten very good in the last year, and I think getting better still at the kind of TCO and ROI story. What is it that you're getting out of this? I think all of that helps you kind of continue to expand in an account in a way that the customer feels good about and wants to accelerate rather than something that they see as a problem that has to be solved. Hi Jay, Steffan. Thanks for taking my questions. And Shane, thanks for fixing my Zoom just now. Listen, my question is also on the pull forward of profitability. And big picture, considering how early we are in streaming you have the confidence that you're addressing the market as completely as possible, not compromising any growth prospects? I know you've touched on this a little bit, but it sounds like you're reducing some sales and marketing coverage. Is this -- because if you think back to the GFC and you ask software companies then back coming out of 2008, the most they talk about the fact that they slowed down their investment. So again, the question is just around your confidence level that this is the right thing to do. Yes. What gave us confidence was just looking at it project by project and investment by investment in a very thorough way. And having, I think, a very clear picture of what we want the company to be in a year, but also in three years and five years and making sure we can solve for that we have enough people to go do it. I think you could look at this the other way. Companies that have been on this very fast growth trajectory, there is some opportunity for optimization. If we were cutting 20%, I think we would be giving up quite a lot, right? Cutting a little bit, I think, makes sense given the environment. It's a hard thing to do. It's hard to have people leave the company, but I think it makes sense given the larger environment. And I think it's possible to do that without making big sacrifices in terms of what we need to build and the product that we want to have and also in terms of how we want to go to market and where we want to be set up to expand. I see. And then just on the product side, I know it's new. But can you talk a little bit about some of the early adoption trends of Stream Design and Stream Governance? Yes. Yes. Yes, we've seen great results. They're a little different, right? So Stream Governance is a paid offering, the Stream Governance Advance that we just announced. And Stream Designer is free. So customers just use it, it accelerates their usage of ksql, of connector, of Kafka itself. And so -- yes, we've seen a ton of early adoption of Stream Designer. That's been very exciting for us to get -- to see people playing with this. We think that, that kind of easy to use interface is one of the keys to really stream processing go broad, whether it's with ksql or Flink or whatever. That interface on top is a really critical investment for us that makes this stuff really easy to deploy within customers and kind of take the stream processing area beyond these apex companies that have already really gone big with it. And then Governance is just one of these topics. It's top of buying for every customer. And we've seen really, really great results for that now emerging product as a business. We've seen a lot of consumption driven by that. And that was a little bit unexpected. We thought that was going to satisfy a need and maybe unblock customers and other things. But in fact, we've seen it actually really outperform our expectations so far, and we're excited about what's possible for that in the year ahead. And it's not surprising. I think there are kind of two pressures on organizations. On one hand, they need to like do more with data and put it to use to be successful. On the other hand, they have just increasing numbers of restrictions on how they do that. and the risk associated with it. So if you give them tools that help balance those two pressures, it obviously meets with a great reception.
|
EarningCall_1166
|
My name is [indiscernible], and I'll be your conference operator today. At this time, I would like to welcome everyone to High Tide Inc.'s fourth quarter of 2022 unaudited financial and operational results conference call. [Operator Instructions]. And I will now turn the call over to your host. Thank you, operator. Good morning, everyone. I'm Krystal Dafoe, Director of Corporate Governance, and welcome to High Tide Inc.'s year-end earnings call. Please note that the earnings discussed on this call are presented on an audited basis. Joining me on the call today are Mr. Raj Grover, President and Chief Executive Officer; and Mr. Rahim Kanji, Chief Financial Officer. Last night, the company released audited highlights from its financial and operational results for the fourth quarter and year ended October 31st, 2022. Before we begin, please let me remind you that during the course of this conference call, High Tide's management may make statements, including with respect to management's expectations or estimates of future performance. All such statements and other than statements of a historical fact constitute forward-looking information and forward-looking statements within the meaning of the applicable securities laws and are based on assumptions, expectations, estimates, and projections as of the date hereof. The specific forward-looking statements include, without limitation, all disclosures regarding future results of operation, economic conditions, and anticipated courses of action. For more information on the company's risks and uncertainties related to forward-looking statements, please refer to the company's press release dated January 30, 2023, released last night, our latest annual information form, and our latest management discussion and analysis each filed with securities regulatory authorities at sedar.com or on EDGAR at www.sec.gov or on the company's website at www.hightideinc.com, and which are hereby incorporated by reference herein. Although these forward-looking statements reflect management's current beliefs and reasonable assumptions based on the currently available information to management as of the date hereof, we cannot be certain that the actual results will be consistent with the forward-looking statements in the future. There can be no assurance that actual outcomes will not differ materially from these results. Accordingly, we caution you not to place undue reliance upon such forward-looking results. For any reconciliation of non-GAAP measures mentioned and discussed, please consult our latest management discussion and analysis filed on SEDAR and EDGAR. It is now my pleasure to introduce Mr. Raj Grover, President and Chief Executive Officer of High Tide. Thank you. Mr. Grover, you may begin. Thank you, Krystal, and good morning, everyone. Welcome to High Tide Inc.'s financial results conference call for the fourth quarter ended October 31st, 2022, and what a quarter it was. As disclosed in last night's press release, we generated record revenue, record adjusted EBITDA, and year-over-year same-store sales growth of 50% and 9% sequentially. I'll start this call by providing an overview of our results and other key developments in the fourth quarter. Rahim will discuss the financials in depth, and after that, we'd be pleased to answer any questions you may have. Before getting too deep into the quarterly numbers, let's take a step back and look at how this was yet another exceptional year for High Tide. We generated revenue of $356.9 million in fiscal 2022. This was up 97% versus fiscal 2021 and up 329% versus fiscal 2020. No matter what the short-term dynamics that the Canadian cannabis market has experienced from initial product shortages to COVID-related uncertainty to retail market saturation, the High Tide team has always found a way to grow our business through leaps and bounds. And this hasn't been just topline growth for growth's sake. It has also translated into handsome adjusted EBITDA increases. This fiscal year, we generated $14.6 million of adjusted EBITDA, up 17% versus fiscal 2021 and 83% versus fiscal 2020. Our business is currently on an annual revenue run rate of $450 million, further cementing our position as having the highest cannabis revenue of any Canadian operator. It's fair to say we expect the company to keep growing its top line, achieving its operational objectives, and continually generating value for shareholders. Now let's dig into the new information to the market, our Q4 results. Total revenue for the fourth quarter was $108.2 million. This was up 101% year over year and was up 14% sequentially. As it represents 87% of our revenue and with enviable same-store sales and new stores popping up regularly, it's no surprise that sequential revenue gains were led by our core bricks-and-mortar cannabis business. I note that our consolidated gross margin profile remained stable at 27%, while gross margins from selling cannabis in our bricks-and-mortar stores ticked slightly higher. Adjusted EBITDA for Q4 2022 was a record $5 million, representing our 11th straight quarter of positive adjusted EBITDA, up 18% versus Q3 2022 and up 206% versus Q4 2021, and we are extremely pleased to have set this new record. You will recall that in the second half of last year, we cautioned the market regarding two items: a new layer of costs relating to our NASDAQ listing and the initial impact of lower margins arising from our innovative discount club model. We advised shareholders that these two items would depress adjusted EBITDA in the short term. However, we said stick with us, and we will grow through it. And that's exactly what happened. We set a new high in adjusted EBITDA, and we expect it to continue to grow looking forward. In Q4, we completed the first full year since we launched our innovative discount club concept in October 2021, and the results speak for themselves. Our same-store sales alone in Q4 were up a tremendous 50% versus Q4 2021. In contrast, total national sales across Canada outside Quebec were up just 14% year over year in our fiscal Q4, including the impact of new store growth. Our customers continue to become more loyal to our Canna Cabana brand. Our average store in Alberta generates more than twice the revenue as the provincial average. While our average store in Ontario, the biggest price of all, generates almost triple the average revenue as the provincial average. In our view, we have the best retail concept in the country, which is significantly outperforming our peers, and we believe it will be well received in international markets such as Germany. Our same-store sales in Q4 rose 9% versus Q3, and with the increase in bricks-and-mortar gross margins previously mentioned, this is driving our improved profitability as shown by our consolidated gross margin dollars being up 15% sequentially. These very impressive same-store sales figures as well as rapidly opening new stores in high-quality locations has resulted in continued market share gains in Canada. We estimate our national market share, excluding Quebec, to have been over 8% in Q4, up from 7% in Q3, 6% in Q2, and 5% in Q1. We expect the string of steady market share gains to continue in Q1 of fiscal 2023. Our balance sheet remains strong. We ended the fiscal year with $25.1 million of cash on hand. As at year end, we had drawn $16.4 million of the $19 million facility we closed with Connect First Credit Union at a very attractive rate of prime plus 2.5%. While the stock market has yet to reward our solid financial performance, fortunately, the Connect First has, and we believe there's room to significantly deepen our relationship. Financial institutions tend to look at the last four quarters of adjusted EBITDA in assessing how much credit they can advance. With Q4 2021 now having rolled off this calculation and replaced with Q4 2022, our trailing adjusted EBITDA has increased by 30% from $11.2 million to $14.6 million. Accordingly, we expect upward movement in our borrowing capacity with our partner in the near term. In the first half of 2022, we communicated to the market that we wanted to reach 150 stores by the end of the calendar year. In typical High Tide fashion, it came right down to the wire, and we needed every day up to New Year's Eve to make it happen. But our hard-working team did it. We added 45 stores during 2022, reaching our target. Looking ahead, we plan on adding another 40 to 50 Canna Cabana locations in 2023, similar to last year. We expect this to come from a fairly even split between accretive M&A and organic store openings. While much of the capital markets was focused on what may or may not happen in Washington, we had our heads down plowing our business forward. Our Cabana club membership currently stands at approximately 950,000 members versus 379,000 when we announced our Q4 2021 results a year ago. Per Health Canada's 2022 Canadian cannabis service findings, we calculate that over 13% of cannabis users outside Quebec are members of our loyalty plan, a true achievement and by far, the largest such program in Canada. Not only does our base of loyal customers keep increasing, but the total addressable market, which we can draw from, keeps expanding as well. We note that Health Canada's 2022 survey found that the number of cannabis users, excluding Quebec, had increased by over the 2021 survey. That's over 900,000 new Canadians using cannabis, and we are disproportionately attracting them to our discount club model. In late November, subject to individual provincial regulations, we launched the first-of-its-kind paid membership program in cannabis called ELITE, where we begin monetizing our existing Cabana club membership base. For $60 a year or $5 a month, ELITE membership offers our customers access to exclusively ELITE flash sales, limited edition and exclusive ELITE branded products, discounts on delivery, and discounts across High Tide's global e-commerce accessories portfolio among other benefits at non-cannabis retailers and restaurant partners across Canada. And it offers our shareholders a base of recurring, high-margin revenue. Given these inflationary times, we wanted to be there for our customers. So for the first year, we are offering ELITE at half price, so just $2.50 a month. While it is still brand new, we have already signed up over 6,000 members, which we feel is a very good start. Over the long term, we will be gearing our SKU selection towards ELITE by having over 25% to 30% of our in-store offerings be ELITE only versus less than 2% today. And we expect to show a steady increase in members, which we have made the move -- this is why we have made the move to be elite. Accordingly, we will start seeing the benefit of ELITE over the coming quarters, which will further enhance profitability. As indicated before, our CBD e-commerce businesses have been softer over the past few quarters, driven by two main factors. Global inflation at multi-decade highs has crimped consumers' wallets. And compared to THC products, CBD purchases are simply easier to cut back on during inflationary times than other consumer staples. Also, the end of COVID restrictions has resulted the realization and pent-up demand for in-store restrictions for in-store shopping, which has impacted e-commerce sales across all retail sectors, including CBD. As a result of these factors, we had to take the unusual step of a $49 million impairment, which was primarily related to our e-commerce CBD businesses. This phenomena is in line with what several other major US CBD companies are experiencing. We note that this is a non-cash charge and in particular, a credit union has indicated that in no way impacts how they view the strength of our company. While we are not pleased with this charge, we note that it is not reflective of the strength of our ongoing operations. We continue to believe in the long-term outlook of our internationally leading CBD brands that have global potential as new markets open up. They provide higher gross margins and round out our overall ecosystem and value proposition. However, recall that 87% of our revenue is driven by our Canadian bricks-and-mortar business, which continues to motor ahead. And our online CBD platforms represented just 6% of High Tide's consolidated revenue. Despite the short to medium-term softness we are experiencing in our CBD business, we were able to deliver a record revenue and record adjusted EBITDA quarter for our shareholders. As promised during our last conference call, we entered a new vertical in late 2022 selling cannabis seeds online in the US initially on our Grasscity and Smokecartel online platforms and more recently on our Dailyhighclub and Dankstop e-commerce sites. The initial uptake has been going well, which we feel will only get better over time as we continue to add some of the most sought-after genetics in cannabis seeds from breeders in the US. This is a strategic move, which we believe is a first of its kind by a publicly traded cannabis company, which gets us one degree even closer to the US cannabis consumer without jeopardizing our NASDAQ listing and provides another high-margin revenue business line, all created organically. We continue to roll out fast and attack across our bricks-and-mortar portfolio. During our last quarterly conference call, on September 14, we had 28 locations equipped with this technology, and we ended calendar 2022 with a total of 120 locations outfitted with fast tender. Once we are finished with the rollout across our organization, we intend to license this exciting technology to cannabis retail outlets across the US, representing another high-margin, recurring, and NASDAQ-compliant revenue stream for us. We have already had inbounds from the US operators, but we need to outfit our own stores first. Another big announcement we made yesterday was our LOI with Sanity Group, a Berlin-based health and life science company. Investors will note that we don't typically announce LOI. However, in this case, given the long-term and strategic nature of our potential German expansion and frankly, how excited we are about it, we felt that our shareholders should have a good sense of our concrete plans as cannabis legislation in Germany is possible as early as this spring. Sanity Group has a well-established track record in Germany with respect to medical cannabis, finished pharmaceuticals, and cannabinoid-based consumer goods. They will help us with identifying and evaluating quality M&A opportunities in Germany as well as sourcing high-quality real estate for our Canna Cabana bricks-and-mortar stores. Sanity Group will also assist High Tide in navigating German regulatory compliance as well as a retail licensing process. In addition, High Tide and Sanity Group agreed to take a coordinated approach to German government relations activities. Sanity will also provide us with a right of first refusal to pursue similar arrangements as new market opportunities develop across Europe. In turn, High Tide will provide Sanity Group with expertise in building its retail cannabis brand strategy based on our decade-long experience serving cannabis consumers in Canada, the United States, and Europe. This way, both companies can help each other succeed by leveraging each other's complementary strengths. With 3.2 million customers across the country and now the ability to sell cannabis seeds online, we haven't taken our eye off the ball regarding the US opportunity. We continue to have many acquisition candidates in the US THC sector across many states in our pipeline, and we are keeping them warm with regular updates. We are monitoring company-specific and macro developments, and we will pull the trigger when we feel the time is right and not before. So far, especially with the drama in Washington in December, our decision to not hastily enter into an options deal has proven to be the right one Despite the turbulent environment both for cannabis operationally and the capital markets overall, 2022 was another monumental year for High Tide. We grew our revenue to be the first place in Canada amongst all Canadian cannabis companies, all while making sure this translated to record adjusted EBITDA and improved cash flows. Our reach with our customers has never been broader, and we are going deeper with the launch of ELITE. Despite all these achievements, we see room for much more growth ahead. We plan to open many more stores by cherry picking the best organic locations and engaging in accretive M&A. Further, fast tender, cannabis seeds, ELITE, and our white-label program are all margin-enhancing initiatives, which germinated in 2022 and should begin bearing fruit in 2023 and beyond. Our incredible team continues to deliver on our objectives and will be there cementing our leadership in the Canadian cannabis market while laying the groundwork for German expansion. Our team's tireless work and dedication is what allows us to outperform our peers, both operationally and financially every day. I want to give a huge shout out to our team for everything that they do for High Tide. Since Omar Khan joined High Tide two years ago, we have led the industry in many government relations initiatives, and we have had many incremental wins that add up over time. I'm very proud to note that earlier this month, we promoted Omar to the position of Chief Communications and Public Affairs Officer. Congrats, Omar. Well deserved. With that, I will now turn the call over to Rahim Kanji, our Chief Financial Officer, to discuss our financial results. Thank you, Raj, and good morning, everyone. I'm very excited to share the meaningful progress we made as shown in our record-breaking Q4 and year-end results, so let's go over the numbers. In the fourth fiscal quarter ended October 31, 2022, the company recorded consolidated revenue of $108.2 million, representing an increase of 101% year over year and 14% sequentially. While we are very excited about the Q4 revenue figure, we know that revenue has continued to grow significantly after the quarter. Recall that we opened eight new stores in December alone and had a very strong holiday season. As a percentage of revenue, gross profit remained relatively constant versus the prior two quarters at 27%. Of primary importance, however, is that our four-wall gross margins earned from selling cannabis in Canada, which drives the vast majority of our revenue, was up a full percentage point in Q4 versus Q3 and has continued to tick higher so far through Q1. Our gross profit was $29.5 million in the fourth fiscal quarter of 2022. While gross margin as a percentage of revenue of 27% was down compared to 33% in Q4 2021, this was fully anticipated and communicated due to our shift in strategy with the launch of our innovative discount club model, which aim to increase gross margin dollars by generating more sales. And this has undoubtedly worked. For example, I highlight the gross margin dollars in the last two quarters of fiscal 2022 were $55.3 million, meaningfully higher than the $34.2 million generated in the last two quarters of fiscal 2021. The more important factor for me is seeing that gross margins in our cannabis stores have not only stayed stable, rather, they have moved higher over the past 12 months. And as ELITE cannabis seeds and our white-label initiatives start to become more meaningful over time, they should each have a positive impact on our consolidated gross margins in the future. We hit new high in our adjusted EBITDA at $5 million in Q4, up 206% versus Q4 2021 and up 18% sequentially. On the costs side, we held our salary, wages, and benefits constant at 12% of revenue, which is among the lowest in the industry. Similarly, our SG&A was only 6.6% of revenue, which is a testament to our strong cost controls. One area we are particularly proud of and want to highlight for our investors is how our revenue growth has translated to improved cash flows. Our cash flows from operations before changes in non-cash working capital were positive in each quarter of fiscal 2022 totaling $9.1 million for the year and $3.5 million for Q4. This shows that our existing base of stores is generating cash. Cash flows generated from working capital were $4.8 million in Q4. Quarter-to-quarter cash flows will change based on how many stores we open in a quarter, which require working capital investment and the overall management of payables and receivables in any given period. However, with Q4 results now available, we can look at it on an annual basis and see that non-cash working capital changes represented a use of cash of $4.6 million in fiscal 2022, just less than half the drag compared to fiscal 2021, where it was $9.9 million. So total cash flows from operations, including the impact of working capital, were positive $4.5 million this year, a big swing from negative $2.8 million last year. Considering that total CapEx for the year, including intangibles was quite manageable at $9.1 million, you can see that we are not too far off from becoming free cash flow positive, a telling phenomenon for a company growing so quickly. We made significant improvements to our balance sheet during the quarter with the closing of the Connect First facility. Not only do we see meaningful near-term upside to the size of the facility, but with it place and other debt paid down, we now have no meaningful debt maturities until December 31, 2024, exactly 23 months from today. For context, I know that our adjusted EBITDA has almost doubled in the past two years from $8 million in fiscal 2020 to $14.6 million in fiscal 2022, and merely annualizing our last quarter puts us at $20 million run rate. Our total debt currently is at $38.7 million, less than two times this run rate. In closing, Q4 was another record-breaking quarter for High Tide. And based on what we have seen for Q1, we are at a $450 million annual revenue run rate today, cementing us as a market leader in Canadian cannabis. With that, I now turn the call over to the operator to open the lines for the question-and-answer session. Good morning, afternoon, wherever you may be. And congrats on the quarter. Just want to reiterate, you provided good color on M&A and organic store growth targets, remaining in that 40 to 50 stores a year. Although on your press release, you said that might slow down on M&A side. But just wanted to see where the strong growth -- store growth coming from in the different provinces. As you see some of these provinces reach saturation, do you see more organic growth or M&A store growth plan going forward? Just a little more color on the store growth coming out here into 2023 here. Good morning, and thank you, Scott. Absolutely. So Scott, as far as you know, this current year or this past calendar year, we added 45 stores to our portfolio. Most of that store growth came from Ontario, and we had a very even split between organic growth and accretive M&A that we executed on. And we believe 2023 calendar year will be no different. Our intention is to add 40 to 50 stores, pretty much an even split of organic growth and accretive M&A opportunities that we are seeing. We are constantly getting inbound opportunities that we are exploring. But we're going to be very opportunistic and only buy the ones that are most accretive and strategic. So we are the biggest players now, Scott, and we have been for some time, and we are practically setting the price for what these stores are worth. And we continue to get these opportunities, but we're going to be very strategic in terms of how we approach this. But I feel we can still add 40 to 50 locations this year. It's not going to be easy, like I said. We, in typical High Tide fashion, we needed the last day of the year to make it happen, but we did. Our amazing team always comes through. So we believe we can add another 40 to 50 locations this year. Okay. I appreciate the color. And then, my follow-up would be: You're early in rolling out your white-label product stores, your own stores here, but can you provide a little more color on the offering, the number of SKUs you have, and the ramp of your own products in the store, and what percentage of your own products will be sold in your own stores? And obviously, I think for longer term. White label could represent about 20% plus of the revenue -- the revenue mix. Buton that white-label growth plans as you see '23 playing out here. Sure. So, Scott, currently, we have 10 SKUs, a total of 10 SKUs in the market. Seven of them are Cabana Cannabis Co. products, and three of the SKUs are New Leaf natural products. And our average store in Ontario, let's say, for example, with all of these SKUs in the market, it's still only making 2% of our total inventory. So it's a very small percentage of sales, but that should grow over time as we have more offerings coming this year. We just added three additional SKUs and we continue to add more SKUs. So long term, Scott, we think we can get to 25% of all of our SKUs in our white-label products. And that's going to include Cabana Cannabis Co. That's going to include FAB CBD, New Leaf, and other brands that we continue to build. And we've already realized about 4% in additional gross margins from selling our current white-label SKUs. So it's -- all of this is going according to plan. We anticipate that the Alberta market might also open up to white label. There are considerations in Alberta regarding that. That will increase our market size even more. But we remain very excited about this margin-enhancing opportunity that we have for white label, and you're going to see constant rollout of more white-label offerings throughout the year from us. Hi. Thank you. Good morning, Raj and Rahim. Congrats on a great quarter, and thanks for taking my questions. My first question is on the cash flow side. You obviously -- you had a good year. You generated positive cash from operations. And I think, Rahim, you mentioned this a little bit in terms of free cash flow. I know that you might be approaching that, but any more color on when you think that could happen? It's pretty clear that you are reducing your burn in your improvement of business. But any guidance you could provide us to when you think you can reach that? Thank you. Thanks, Frederico. We've had a great momentum this year, moving towards a free cash flow position. Our Q4 cash flow from operations before working capital was $3.5 million, and our core -- Q4 cash flow from changes in working capital was $4.8 million. So Q4 total cash flow from operations, including working capital, we were able to generate $8.3 million. If you look at the whole -- if we look at the whole year of 2022, cash flow from operations before working capital was $9.1 million, better than 2021 of $7.1 million. And our cash flow from changes in working capital was negative $4.6 million, better than 2021 of $9.9 million. If you look at our total cash flow for the year from operations, including working capital, we ended the year with $4.5 million, better than 2021 of negative $2.8 million. Our free cash flow was $4.6 million negative in 2022, which is a huge improvement from negative $13.5 million in 2021. So things are definitely trending in the right direction. Okay. Thanks for that. And in terms of your margins, your gross margins were pretty stable this quarter, even though you had a higher mix of sales from retail in Canada, which is a lower margin than . So could you comment on that dynamic? What should we expect in terms of gross margins for this year? And what is the opportunity that you see for potential margin increases in Canadian retail? Thank you. Yes, sure. So our consolidated gross margins have stabilized over the last three quarters. Our CBD margins have come down given the environment. But more importantly, our brick-and-mortar gross margins have been ticking steadily higher, maintaining that balance. Looking ahead, we think we can increase margins by slowly increasing prices in certain markets, and other initiatives are gaining steam, such as our lead program, white label program, and introduction of seeds and implementing fast tender across all our locations. Hi there. This is for Matt Bottomley. Congrats on the quarter, and thanks for taking our question. So I just have a quick question regarding the Cabana ELITE program. I know it's only been two months since the program launched, but could you provide some color on how the program has been rolling out so far, and what kind of expectations you have for the program's ramp up in fiscal 2023, and what kind of drivers you have in place for -- to support the growth of the program over time? Thanks. Yes, good morning, Johan, and thank you for your question. So, Johan, we have signed over 6,000 members already in Cabana ELITE with less than 2% of our inventory in actual ELITE products. So we mentioned in the press release and also on the script that we're very excited about this uptake because we practically just launched this program. Again, it's the first-of-its-kind initiative that I don't see any other company doing or innovating like us. But we're super excited about the ELITE future because we feel that we can get the ELITE product line to reflect 30% to 40% of our in-store offerings long term. So just look at the delta, we're currently sitting at 2, we're going to 30 to 40. So you can understand the uptake that we can have once we get to this long-term rollout of ELITE products. In fact, a good 55 to 75 SKUs, I believe -- we just worked out internally with our team -- are becoming this week, and I think that is going to have an impact alone, not only considering what we're looking at two to three years out, but we're going to start seeing a little bit better intake of ELITE rollout as we start to introduce these SKUs. We are very happy with the intake so far because we're going to continue to introduce new ELITE offerings every quarter. And this is a very high-margin recurring revenue stream for High Tide and should increase customer stickiness even further because if I'm paying for something as a customer, I want to come back to that store and shop more because I'm already a committed paying member. We already had very sticky members, as you know, -- we were over -- 90% of our daily transactions in stores are conducted by club members. And now, when we're turning these members into ELITE, we think this goes even further. The current economical return that we're yielding on ELITE is over 70% gross margins. And this is selling ELITE at half price at $2.50 a month, like I mentioned, or $30 a year. But this is going to go up to $60 a year or $5 a month when the price goes up next year. So we think we can yield north of 80% gross margins to ELITE. Thank you for taking my questions. Congrats on the cash generation this quarter. I wanted to just get a little bit of clarity on the language. In the press release, you discussed slowing down M&A activity. But in your outlook for new stores, it seems that you're guiding for roughly the same number of acquisitions as last year. So if you could just clarify what you meant by slowing down M&A activity in the press release, that would be helpful. Yes, good morning, Andrew, and thank you very much for your question. I understand where the confusion is. So let me clarify a bit. So, Andrew, if you if you go back to 2021, we acquired six e-commerce platforms in the United States and internationally, one in the UK. And what we meant by slowing down an M&A activity, and I've said this multiple times, given the opportunity that -- given our equity prices remaining so depressed, we don't even want to pay 5 or 6 times EBITDA. And we are now focusing on more smaller, highly accretive brick-and-mortar M&A that we did last year. As you know, 87% of our revenue is derived from our brick-and-mortar operations, and we have no impairment in those operations. Impairment is not a norm for a High Tide. And considering the dynamics out there, our other complementary business lines supporting our brick-and-mortar businesses, our e-commerce platforms catering to the consumption accessories business, which remain very healthy because we have one of the -- some of the most searchable websites in the world when it comes to consumption accessories. So what we were talking about here is we are going to slow down on larger M&A transactions such as we have conducted in 2021. We explored many opportunities in 2022 but did not press the trigger on it, considering what was happening in the macro markets and given inflationary times that we're all living in and how it's affecting the macro environment and how it's affecting CBD sales and other items because consumers have to prioritize their spending. So we're just moving down on that portion of the business. Our brick-and-mortar is going very strong. Our strategy is working. And like I said, we have a ton of inbound opportunities. These are not also -- we're not even soliciting 10 groups that we want to do M&A. But given the right opportunity, the right location -- locations are very critical to us. If we get the right anchor locations we are looking for, we know when we put our model in there, it's going to do twice as much better. Like I mentioned, our Alberta average sales are over 2 times the average unit sales in Alberta, provincial average, and almost 3 times Ontario average. So we're going to continue on that trajectory, build upon our 87% of our core brick-and-mortar business accretive M&A, and the rest to organic growth. But we are going to slow down on online opportunities unless we get a very good one that we cannot refuse at a very, very good multiple. So that's where we're at right now. I appreciate that clarification. Thank you. And for my second question, just maybe following on something that you mentioned here. I'm talking about valuation multiples. I think, last year, you paid somewhere under one-time sales on average and between 4.5 to 5 times EBITDA for your stores. I'm wondering what are you seeing in terms of multiples now, and what your thresholds might be? And also attached to that is, how are you thinking about funding these? You just announced a credit agreement, and considering last year, I think only two had cash components -- two transactions Correct. So Andrew, just for clarification, most of our deals last year were between 3.5 and 4 times EBITDA. Most of them were conducted in Ontario and Saskatchewan and also some in Alberta. But only the one deal that we did in British Columbia was over a 5 multiple. I believe it was 5.25, which is commanded in the BC market because it's a very limited-license opportunity market. So we're very disciplined in terms of what we paid for these stores, and we are going to remain very disciplined. And to answer your question on what I see the multiples being this year, if our own stock -- in our opinion, our stock is very undervalued at the moment. So -- and our stock is, I believe, currently trading at enterprise value to current annual run rate sales multiple of 0.4 times. And if you take our EBITDA multiples of less than 9 times last quarter, annualized, plus with the addition of Jimmy, so not even including our obvious growth ahead. So, Andrew, we are very mindful in terms of how we do M&A, and the multiples are going to be relevant to where our multiples have come down to. So we may even do better deals than what we've done last year, but it doesn't get a whole lot better at 3.5 times EBITDA. If you looked at any other mature industries, you look at restaurants, you look at retail stores, there's nothing available for less than 3.5, 4 times EBITDA. I think these are very reasonable multiples to pay, and we are a fair acquirer. So it will remain along those lines. And now, look, there's two ways of doing M&A, right? You either buy them with cash, or you buy them with your currency. And so, others have raised a ton of money. We have not done that. And we have -- our total CapEx spend last year was about $9 million. So this is why we're going to be disciplined again. This year, we're going to do half of it through organic growth, so we can manage our cash really well. And the other half is going through M&A with our currency that we've been using very well. So it's going to be an even split between the two. Hi there. Good morning, and congrats to the High Tide team on the very strong fourth quarter results. I'm glad to see the continuing momentum in retail in Canada. First question here, just wanted to go back to, I guess, some of the prepared remarks about the e-commerce sales, and I really appreciate the additional color there. Based on my math, it actually appears that the e-commerce revenues are actually beginning to show a bit more stability, maybe down low single digits quarter over quarter compared to the double-digit declines you saw in Q2 and Q3. Do you believe the segment could return to growth in the year ahead, or is it too early to tell on that? Good morning, Andrew, and thank you for your question. So, Andrew, our e-commerce step was definitely stable quarter over quarter. And I want to highlight the fact that our accessories business because we have -- like I mentioned, GrassCity and Smoke Cartel are the two most searchable online accessories platforms in the whole world. And because of that searchability and being number one in the whole universe, they didn't really get too affected. And the rest of the platforms are smaller anyway. Really, where we felt the impact was strictly our CBD businesses, and it was across the board. It was in the United States, and it was for Blessed in the UK. And like I mentioned over the last earnings call, when people are prioritizing essentials, food, and gas, they're a little shy of buying a $100 bottle of CBD. That doesn't mean that our brands are not performing, or our brands are not there to take market share as more of these global markets open up. But I always like to under promise and over deliver and not talk about fluff that is not real. So we are stable, quarter over quarter. We've had a good holiday season, like we mentioned in our script and the earnings press release. But after the holiday season, sales always slow down, whether it's cannabis, whether it's CBD, whether it's consumption accessories. It's the same thing we saw with the ELITE as well. In the holiday season, people had money in their wallets. But as the spending finishes, and then you get into the next season, spending goes down a little bit. So we feel that our e-commerce platforms will remain stable. They're not like tanking by any measure, you're absolutely correct. But like I said, we like to be cautious about things. Our core business -- 87% of our business is brick and mortar anyway. The remaining 6%, 7% of our online accessories business is still thriving, given our searchability factor that we have on Google. And our CBD businesses, these are the brands that we're going to build into the future. I am very excited about them. As these new markets open up, many markets in Asia, including Japan, is now talking about a medical cannabis legalization, which means they're going to get more and more friendly towards CBD products as well. I'm having conversations in the Middle East as well. So we're not concerned about the long-term nature of our CBD business. It's just currently that we want to under promise, over deliver as usual, and just being cautious on that front. That additional color was very helpful. Thank you, Raj. Moving to another topic, I just wanted to touch on the German market. As you look to enter that potential market opportunity, do you have any views on how the German market may regulate adult-use cannabis retail distribution as of yet? Have those rules been made clear, and do you have any thoughts on timing? I know you said it's early as this spring, but as we go back to our models, how should we be thinking about timing after this potential opportunity? Sure. So, Andrew, this is all speculation at this point, but educated speculation, I will call it. So we're hearing that Germany will introduce legislation this spring. A draft legislation will come out, and retail sales could commence as early as first -- calendar first quarter in Germany next year in 2024. And we're keeping a very good eye on this, on all of the developments that are coming out of Germany. And this is why, we are very excited about this strategic partnership we are forming with Sanity. We wanted a solid partner on the ground to execute our game plan, and I think Sanity fits that bill perfectly. They are a leader in their home country in Germany, and our business lines are very complementary in nature. So we're a retail-focused company, and they're a producer and distributor of cannabis brands. And we wanted to put this out because we wanted our investors to understand that we're not just talking about things. We're very serious about entering the German market. And if you look at Sanity, they've been doing some incredible things in Germany already. They can assist us with high-quality M&A targets in Germany and other EU markets as well as -- for winning retail licenses organically. And also, both companies can also work together now in government outreach efforts, which we've already begun. And then, we will also assist Sanity on multiple things, helping them position and build their brands, obviously subject to provincial and federal regulations in Germany, as we have tons of experience in Canada as we have, by the minute, information on what these -- what kind of products are moving in Canada, and what is the cannabis consumer looking for? So it's a great partnership. We're very excited about the German market. We think it will open up first quarter -- first calendar quarter 2024, and we are going to be ready when that happens. That concludes today's Q&A portion of the call. I'd now like to turn the session back over to High Tide's Chief Executive Officer, Raj Grover, for final comments. Thank you, operator, and thank you to everyone for your interest and continued support for High Tide. We're very proud of what we achieved this quarter and remain excited about our growth trajectory.
|
EarningCall_1167
|
My name is Jason and I will be the conference facilitator today for Amgen's Fourth Quarter Full Year 2022 Financial Results Conference Call. [Operator Instructions] I would now like to introduce Mr. Arvind Sood, Vice President of Investor Relations. Mr. Sood, you may now begin. Okay. Thank you, Jason. Good afternoon, everyone and welcome to our call to discuss the results for Q4 and full year 2022. 2022 was once again a year exemplified by great execution despite some of the macro challenges. Our Chairman and CEO, Bob Bradway, will make some opening comments, followed by prepared comments from other members of our senior leadership team. You should have received a link to our slides that we have posted. Through the course of our discussion, we will make some forward-looking statements and use non-GAAP financial measures to describe our performance and just a reminder that actual results can vary materially. Okay. Thank you, Arvind and hello, everyone and thank you for joining our call. So beginning the year feeling confident about the long-term growth outlook for our business and let me offer 5 reasons why. First, we have a number of innovative volume-driven products that still have plenty of room to run and we saw that in 2022. Repatha, Prolia and EVENITY each generated double-digit sales and volume growth in the fourth quarter and for the full year. We expect continued growth from these products in 2023 and beyond with Repatha, in particular, helped by important new data from the FOURIER open-label extension study and new prescribing guidelines. OTEZLA delivered 7% volume growth in both the fourth quarter and the full year, benefiting from a label expansion that gives us the opportunity to reach millions of new patients in the U.S. with mild to moderate psoriasis. LUMAKRAS and TEZSPIRE collectively contributed more than $450 million in full year sales and we're pursuing additional indications for both products. We're especially pleased to see TEZSPIRE being utilized by patients across all types of severe asthma. Murdo will share more about the performance of our in-line products in a moment. Second, we moved 6 first-in-class molecules into Phase III or potentially registration-enabling trials in 2022, including Olpasiran for LP(a), rocatinlimab for atopic dermatitis, TEZSPIRE in eosinophilic esophagitis and of course, bemarituzimab, tarlatimab in BLINCYTO in cancer. We've also begun enrolling patients in a Phase II trial for AMG 133. Based on early data, this molecule, with its unique mechanism of action, looks like it may have an attractive profile for the treatment of obesity. And more on our pipeline from Dave Reese in a moment. Third, we have an industry-leading biosimilars business that will contribute to our growth over time. In 2022, we delivered positive Phase III data for our biosimilar candidates to EYLEA, SOLIRIS and STELARA, positioning us to be in the first wave of these launches which we know is critical to success. We're also less than 24 hours into the launch of AMGEVITA in the U.S. and AMGEVITA is the leading biosimilar to HUMIRA internationally. And with a 5-month lead over the next entrant, we're well positioned for success in the U.S. All told, we have 6 more biosimilar launches planned in the U.S. and markets around the world between now and the end of the decade, making this another source of long-term growth for us. Fourth, we've often said that we would look to licensing and acquisitions in our stated areas of strategic interest. And that's what we've done, building on our decades of experience in inflammation with 2 significant transactions that will strengthen our presence in this space. Through the acquisition of ChemoCentryx, we added TAVNEOS, a first-in-class treatment for ANCA-associated vasculitis and we're off to a strong start there. Our announced acquisition of Horizon Therapeutics will add several additional first-in-class early in life cycle biologic medicines, including TEPEZZA, KRYSTEXXA and UPLIZNA that will add to our growth profile through 2030 and beyond. We're working our way through the regulatory review processes for that deal and are confident that the deal poses no anticompetitive matters. And we have received a second request from the U.S. FTC and we'll work with them to answer their questions while remaining optimistic that we can complete the deal in the first half of the year. Finally, we've stayed true to our capital allocation priorities, investing in our business to drive long-term growth while also returning capital to our shareholders through share repurchases and a growing dividend. You'll hear more from Peter on this shortly. And everything we achieved last year and everything we will achieve going forward is due to the hard work and commitment of our people. They're passionate about our mission to serve patients. They're clear on how their work contributes to our success and they're ready to seize the opportunities and meet the challenges that await us. I'm grateful to all of them. Thanks, Bob. 2022 was another year of strong execution of our mission to bring [indiscernible] products to the millions of patients in the world who suffer from gravest illness. The evolution of our portfolio continue by record sales for 16 brands. We saw strong volume gains across our general medicine and hematology-oncology growth brands. Our inflammation therapeutic area expanded with the launch of TEZSPIRE and the acquisition of TAVNEOS, 2 first-in-class medicines that treat serious disease. In addition, our announced acquisition of Horizon Therapeutics will add several important medicines to our portfolio. In total, volume growth for 2022 was 9% with 7% growth in the U.S. and 14% growth ex U.S. as we continue to deliver on our international growth strategy. Excluding the impact of foreign exchange, full year global product sales grew 4% as our volume increases were offset by a 5% decline in net selling price. Including the 2% negative foreign exchange impact, product sales increased 2% year-over-year. In the quarter, we also saw strong volume growth with a 10% increase year-on-year. Starting with our general medicine business which includes Prolia, EVENITY, Repatha and Aimovig, overall revenue for these 4 products grew 21% year-over-year for the fourth quarter and 18% for the full year, driven by 19% and 21% volume growth, respectively. In bone health, Prolia sales grew 14% year-over-year for the fourth quarter, driven primarily by 11% volume growth. EVENITY which complements Prolia in our bone portfolio, had record sales of $225 million for the quarter, driven by strong volume growth across markets. Repatha sales increased 22% year-over-year for the fourth quarter with volume growth of 31%, partially offset by lower net selling price. In the U.S., we generated volume growth of 32% for the fourth quarter, aided by broad adoption of Repatha by cardiologists and increasing adoption by primary care providers. We saw declining net selling prices in the U.S. as we offered higher rebates to support broad Medicare Part D and commercial patient access. Looking ahead to 2023, we expect less year-over-year U.S. price erosion than we saw in 2022. Outside the U.S., fourth quarter sales of Repatha grew 36% year-over-year, driven by 31% volume growth. Globally, Repatha has treated over 1.5 million patients since launch. Repatha's strong prescribing history in cardiology and expanding use in the primary care setting position us well to bring Repatha to more patients globally. With the FOURIER long-term follow-up data, in addition to evolving and more aggressive treatment guidelines, there's a clear rationale that lowering LDL cholesterol as much and as early as possible with Repatha will reduce cardiovascular risk for patients around the world. Transitioning to our inflammation portfolio. Otezla sales decreased 2% year-over-year for the quarter and increased 2% for the full year. We saw 7% volume growth in both periods. This was offset by lower net selling price, stemming from enhancements to our co-pay and patient assistance programs to support new patients starting treatment as well as additional rebates to improve the quality of coverage. During the fourth quarter, our U.S. Otezla business was impacted by new patient demand from 3 drug programs by newly launched topical and systemic competition. We expect that impact to continue in Q1 of 2023. We also expect to see the typical pattern of lower sales in the first quarter relative to subsequent quarters due primarily to the effect of insurance reverifications, co-pays and deductibles for patients. The combined effect could lead to first quarter Otezla sales being similar to or below those from Q1 of 2022. Longer term, we continue to see strong growth potential for Otezla, given its established safety profile, strong payer coverage with limited prior authorization requirements and ease of administration. Otezla remains the only approved oral systemic therapy with a broad indication and is well positioned to help the 4 million U.S. patients with mild to moderate psoriasis, 1.5 million of whom have psoriasis that cannot be optimally addressed by a topical and can benefit from a first-line systemic treatment like Otezla. ENBREL sales decreased 1% year-over-year for the fourth quarter, driven by declines in volume and net selling price, partially offset by higher year-end inventory levels. ENBREL remains an important product for patients due to its long track record of efficacy and safety. TEZSPIRE continues its strong launch with $79 million in sales in the fourth quarter and $170 million for the full year. Allergists and pulmonologists have prescribed TEZSPIRE across a broad range of patients with severe uncontrolled asthma. We're also seeing initiation of TEZSPIRE in both biologic-naive and previously treated patients. Physicians acknowledge TEZSPIRE unique differentiated profile and has broad potential to treat the 2.5 million patients worldwide with severe uncontrolled asthma without any phenotypic and biomarker limitations. We're now preparing for the anticipated U.S. approval of the prefilled pen in the first quarter which will offer patients the convenient option to administer TEZSPIRE at home. Sales of TAVNEOS were $21 million in the fourth quarter. Our integration of ChemoCentryx is proceeding smoothly, confirming our belief that Amgen's deep experience in inflammation and nephrology and substantial market presence will allow us to bring TAVNEOS to more patients with ANCA-associated vasculitis. We're also excited about our announced acquisition of Horizon Therapeutics. Our combined portfolio which will include [indiscernible] will address serious inflammatory diseases and improve the lives of many patients. Amgen's commercial capabilities and global presence in approximately 100 markets [ph] will allow our combined team to deliver important therapies that will make a meaningful difference for more patients globally. Today, we announced the launch of AMGEVITA, the first U.S. biosimilar to HUMIRA, a medicine used by more than 1 million patients living with serious inflammatory diseases. With our track record of developing and manufacturing biologics and decades of experience in inflammation, Amgen is uniquely equipped to supply patients with this biosimilar medicine. AMGEVITA is the first significant U.S. biosimilar in the pharmacy benefit space and we expect gradual uptake in the coming months as this market evolves. Moving to our hematology and oncology business which includes LUMAKRAS, KYPROLIS, XGEVA, Vectibix, Nplate and BLINCYTO. These 6 innovative products grew 14% year-over-year with 17% volume growth for the quarter. Full year sales grew 13%, driven by volume gains. KYPROLIS sales grew 14% in the fourth quarter. Nplate sales in the fourth quarter included $207 million related to a onetime order from the U.S. government. Given the strong performance of our hem/onc portfolio in 2022 and the recent positive data on both BLINCYTO and Vectibix, I look forward to the future growth potential of this portfolio. LUMAKRAS reported $71 million in sales in the fourth quarter and $285 million for the full year. Quarter-over-quarter sales declined 5% with 12% volume growth, more than offset by a lower net selling price driven by a $12 million unfavorable price adjustment resulting from a reimbursement approval decision in France and unfavorable changes to estimated sales deductions. Outside the U.S., LUMAKRAS has now been approved in over 45 countries. We've launched LUMAKRAS in 30 markets and are rapidly pursuing reimbursement in the remaining countries. As we've noted before, the market for LUMAKRAS focused on the 7,000 U.S. and 20,000 ex U.S. patients in the second-line setting. Longer term, we expect LUMAKRAS growth to come from moving into earlier lines of therapy and expanding into additional tumor types. Sales of our oncology biosimilars declined 40% year-over-year for the fourth quarter and 30% for the full year, driven by lower price. While our biosimilars for MVASI and KANJINTI both hold leading shares, we expect continued net selling price deterioration and accelerating volume declines, driven by increased competition. The most recently published average selling price in the U.S. declined 38% year-over-year for MVASI and 51% for KANJINTI. Over time, we expect long-term growth in our biosimilars business to be driven by the addition of new molecules and additional launches. And as we start the new year, I'm inspired by the hard work of the thousands of Amgen employees around the world who wake up every day to serve our patients. Our expanding international presence and diverse portfolio of products, further strengthened by the integration of ChemoCentryx and the announced acquisition of Horizon, position us well to serve many more patients globally. Thanks, Murdo. Good afternoon, everyone. For research and development, last year was one of high-quality execution and on-time delivery of results as we continued to progress our innovative pipeline. In general medicine, we strengthened our cardiovascular franchise and emerging portfolio of obesity assets, 2 areas of significant unmet need, affecting millions of patients globally. Repatha, of course, is the cornerstone of these efforts. And last November at AHA, we presented FOURIER open-label extension data. These data were recognized by the American College of Cardiology expert consensus decision pathway which indicated there appears to be no LDL cholesterol level below which benefit ceases. Additionally, LDL cholesterol recommendations were updated to reflect a reduction in target LDL levels in highest-risk patients from 70 to 55 milligrams per deciliter. This is a level that is not attainable for a large number of patients without PCSK9 inhibitor therapy. Another molecule that we are excited about is Olpasiran. At AHA, we presented Phase II data where Olpasiran dosed 75 milligrams or higher every 12 weeks reduced Lp(a) concentrations by 95% to 100% in patients with established atherosclerotic cardiovascular disease with baseline Lp(a) levels of approximately 260 nanomolars per liter. Olpasiran appeared both safe and well tolerated in this study. We are encouraged by these data, particularly our dosing frequency, safety and tolerability profile and degree of Lp(a) reduction. We have initiated a Phase III outcome study and 6,000 subjects with atherosclerotic cardiovascular disease and significantly elevated Lp(a) levels of at least 200 nanomolars per liter. Now turning to obesity. In December, we presented data from a Phase I study where AMG 133 appeared safe, well-tolerated and demonstrated a 14.5% reduction in body weight at day 85 following 3 monthly subcutaneous injections. Body weight reductions were observed up to 150 days after the final AMG 133 administration. Given these favorable attributes, we are now enrolling a 570-subject Phase II study to explore AMG 133 in patients with obesity with or without diabetes and related comorbidities. The study will also investigate different dosing levels and regimens⦠â¦applying 4%. Recall our Q4 2021 results included approximately $200 million of favorable impact to other income and expense resulting from a gain on our Beijing investment. Full year non-GAAP EPS of $17.69 grew 27% versus our re-GAAP [ph] 2021 result. Non-GAAP Q4 operating expenses were unchanged year-over-year while full year non-GAAP operating expenses declined 12%. The full year includes the impacts in 2021 of the $1.5 billion 5-prime IP [ph] R&D charge and the $400 million licensing payment that KKC [ph] for rocatinlimab. We advanced our pipeline and invested in product launch activities in 2022 while delivering a 51% non-GAAP operating margin as a percentage of product of sale. On a non-GAAP basis, Q4 cost of sales as a percent of product sales decreased 1.2 percentage points on a year-over-year basis, down to 16.3%. For the full year, cost of sales as a percentage of product sales decreased by 0.5 percentage points, down to 15.9%. Both the quarter and full year improvements were primarily due to fewer COVID-19 antibody shipments and lower manufacturing costs, partially offset by changes in our product mix. Non-GAAP R&D spend in the fourth quarter decreased 2% year-over-year, primarily due to higher business development activity in 2021, including our upfront payments in connection with our Genera Biomedicines and Iraqis Therapeutics collaborations, along with lower marketed product support. This was partially offset by higher support for key assets in early- and late-stage programs. However, adjusted for 2021 BD activity, Q4 2022 R&D investment increased 7% year-over-year. And for the full year, non-GAAP R&D spend declined 8% based on the same drivers of the fourth quarter. However, adjusted for BD activity, full year 2022 R&D investment increased by 5%. Q4 non-GAAP SG&A expenses increased 2% year-over-year, driven by higher marketed product support, including investments in our priority products, TEZSPIRE, EVENITY and Repatha. For the full year, SG&A expenses were unchanged year-over-year as increased investments for all priority brands were offset by productivity gains, continuous improvement and reallocation for mature brands. Non-GAAP other income and expenses were about $470 million in expense in the fourth quarter, a $250 million increase year-over-year, primarily driven by the previously mentioned gains in 2021 that we recognized from our investment in BeiGene. For the full year, non-GAAP other income and expenses were approximately $1.7 billion. So now turning to the outlook for the business for 2023. Our outlook is Amgen-only on a stand-alone basis without any adjustments for the announced Horizon acquisition. It's important to remember that currently -- that current publicly available consensus estimates are derived from a combination of estimates of Amgen as a stand-alone company, along with estimates from some analysts who have already added Horizon into their estimates. So our 2023 revenue guidance is $26.0 billion to $27.2 billion and our non-GAAP earnings per share guidance is $17.40 to $18.60 per share. So now let me review several key points related to our guidance. For total revenue, we expect the year-over-year comparison will not include about $700 million related to several items from 2022 that we do not expect benefit from in 2023. We assume we will not generate COVID-19 antibody revenues in 2023. We also assume a lower amount of Nplate sales in 2023 compared to 2022. Recall, 2022 included a significant purchase of Nplate by the United States government in the second half of the year. Also several favorable changes to estimated sales deductions that occurred in 2022 and the sale of our generics business in Turkey which closed late in 2022. For product sales, we project volume growth at a portfolio level, driven by strong growth in our priority products, TEZSPIRE, EVENITY, Repatha, Prolia and TAVNEOS. Consistent with industry trends and our recent history, we expect mid-single-digit price declines in our portfolio in 2023. Turning to Neulasta and our oncology biosimilars. We expect the recent trends to continue through 2023. This will likely result in full year Neulasta sales less than $700 million. Further, we expect less than $750 million in combined product sales for our oncology biosimilars, KANJINTI and MVASI. And finally, we expect product sales of less than $300 million for EPOGEN as we transition through the expiry of our contract with DaVita. For the full year, we're guiding other revenues to a range of $1.2 billion to $1.5 billion. Note that we recognized about $300 million of revenue from our COVID antibody collaboration with Lilly in 2022 that we don't anticipate repeating in 2023. So we will continue to manage our operating expenses consistent with our historical cost discipline. So even with increasing 2023 sales volumes, declining net selling prices and inflationary pressures on costs, we still project full year non-GAAP operating expenses to be flat versus 2022 as we continue our focus on driving productivity and cost efficiencies across the enterprise. We project non-GAAP cost of sales to be in the range of 16% to 17% as a percentage of product sales. Recall that we mentioned during our Q3 earnings discussion that tax law changes enacted by Puerto Rico in June 2022 replaced the Puerto Rico Excise Tax, the PRET, in favor of an income tax. This change will increase our income tax expense beginning in 2023 while reducing our cost of sales by roughly an equivalent amount. Note, however, there will be a negative impact in 2023 of approximately $125 million related to the amount of the PRET that is currently capitalized in inventory that will be charged to cost of goods sold in the first half of 2023, with most of the charge recognized in the first quarter without a corresponding tax benefit. We expect non-GAAP R&D expenses in 2023 to increase 3% to 4% year-over-year compared to our 2022 expenses as we advanced a number of the programs Dr. Reese referenced earlier. This is consistent with our first capital allocation priority to invest in the best innovation and our operating expense discipline provides us the capital to do just that. And for non-GAAP SG&A spend, we expect 2023 amounts as a percentage of product sales to slightly decrease year-over-year, driven by productivity improvements. These all lead to a projected non-GAAP operating margin as a percent of product sales of roughly 50% on a full year basis. We expect non-GAAP other income and expense of approximately $1.4 billion. The expected year-over-year improvement is driven by a change in our accounting for our BeiGene investment we are making in 2023. Beginning in January 2023, we'll no longer record our share of BeiGene results in other income and expense under the equity method of accounting on our non-GAAP income statement. We'll now mark to market our investment with the impact recorded only on our GAAP income statement. We expect a non-GAAP tax rate of 18% to 19%. This rate reflects the new Puerto Rico income tax which as I explained earlier, replaced the PRET beginning in 2023. We expect share repurchases not to exceed $500 million in 2023 and we expect that we will continue to meaningfully increase our dividend. We expect capital expenditures of approximately $925 million in 2023, consistent with our capital allocation priority to invest in our business, including in our new environmentally-friendly facilities in Ohio, North Carolina. And after we complete those facilities, we expect our capital expenditures to return to their historical levels. I'd also like to make some specific comments around the first quarter of 2023. I'm encouraged that our business is performing as expected through the first month of the year. However, consistent with our historical revenue patterns, we expect revenue in the first quarter of the year to be the lowest revenue quarter of the year and slightly below revenue in Q1 2022. At a portfolio level, we expect product sales to be unchanged from Q1 2022 and other revenues to be lower on a year-over-year basis due to the reasons set out above, including about $225 million related to COVID antibody sales in the first quarter of 2022. We anticipate about $80 million of foreign exchange headwinds in Q1 2023 compared to Q1 2022. The total of all these items creates greater than $400 million of headwinds versus the first quarter 2022. So these revenue patterns, along with the timing of expenses, are expected to translate into our Q1 non-GAAP operating margin being below 50% as a percentage of product sales, although we continue to expect operating margin as a percentage of product sales to be roughly 50% for all of 2023. Recall, this is all Amgen stand-alone. We will continue to focus on our legacy of execution excellence. In summary, despite macroeconomic headwinds, we delivered another strong year of financial results in 2022, keeping us on track with our long-term commitments to deliver through 2030 and beyond. Our confidence in the long-term growth of Amgen is strong and we look forward to completing the announced acquisition of Horizon during the first half of 2023 which will only strengthen our growth prospects. We would expect to provide updated guidance as appropriate at some point after the transaction closes. This concludes the financial update. My thanks to our 25,000-plus colleagues at Amgen around the world for their commitment to serving patients and their tireless efforts in 2022. Okay. Well, thank you, Peter and Dave, for soldiering on despite the technical difficulties. And again, apologies to all of you who've dialed in to join us on the call and who found some disruption in the proceedings here. A number of you have e-mailed your questions to Arvind. What I'd like to suggest is that any of you who have questions, directly e-mail them now to Arvind and Arvind will read them and we'll try to answer them here in the room. And let me just assure all of you that we will rearrange our schedule and be available to answer questions if we don't get to it on this conference call, be available to Arvind and his team to answer questions you may have after we wrap up. Yes. Thanks, Bob. And apologies to everybody for the technical difficulties that we have had. And as Bob said, just please e-mail your questions to me directly. So the first question that we have is from Yaron Werber of Cowen and he submitted 2 questions. His first question is that Amgen will move to fair value from equity method of accounting for BeiGene. As you also now own less than 19.9% equity in BeiGene, will Amgen stop consolidating BeiGene's losses and profits from now on? And then the second question is, can you discuss when you plan to file the high concentration of AMGEVITA once you get the Phase III interchangeable data in the first half of 2023? Yes, quick question -- quick answer. Thank you, Yaron, for the question. On BeiGene equity method of accounting, as I said in my remarks, we will record, in our GAAP income statement, the mark-to-market but that won't be recorded in our non-GAAP income statement. So the answer is we will not include any earnings from -- or losses as our share of BeiGene going forward in our non-GAAP income statement. Okay. And then on AMGEVITA, why don't we do a 2-parter there? Dave Reese and then Murdo, you may want to add some thoughts. Yes. In terms of the filing time lines, once we have the data in hand, we'll be then giving guidance as to when we expect filing and potential approval of that after the appropriate regulatory interactions. It's important, I think, as Bob were put this in context, let me ask Murdo to comment here. Yes. Thanks, Dave. We have had some inbound questions on this, as you can imagine, during the day, given that we are launching. So far, launch is progressing well. We have product making its way into the channel and we're already receiving inbound interest in AMGEVITA from payers, prescribers and patients. One thing that's important to remember is the current product that we have in the market is a lower concentration, original concentration AMGEVITA or adalimumab but it is citrate-free, meaning that the patient experience here is still 1 where we minimize the injection site pain by having a citrate-free formulation. And patient experience here has been positive in our clinical trials and we anticipate that not having a high concentration will not be a barrier in the market. These are very low volumes that are injected through an auto-injectable pen. And we've seen very, very good reliability of patients being able to administer. In addition, of course, we provide nurse support for patients. And then while it wasn't asked, I think it's also important to note that we are providing financial assistance, support and reimbursement support for both prescribers and patients as we launch the product. So really a full suite of services and support that you would expect for a branded launch being applied to the launch of the first biosimilar, adalimumab, to launch in the U.S., that is AMGEVITA. So the next question is from Geoff Meacham [ph] from BofA Merrill Lynch. And his question is, he said, I know you have AMGEVITA but are you expecting an indirect impact in the second half of '23 or the first half of '24 from all the HUMIRA biosimilars and STELARA, on Otezla and ENBREL mainly? And he is interested in the volume and price impact. It's hard for me, obviously, to comment on what competitors may do as other biosimilars of adalimumab enter the market beyond July. But what we have seen coming into 2023 is a good cycle of reimbursement negotiations and we've been able to secure a very broad coverage for both ENBREL and Otezla. We expect that insurance coverage to continue throughout the course of 2023. And as is usual, we had small concessions on net price to secure that broad reimbursement but nothing unusual compared to prior years. The next question is from Chris Raymond from Piper Sandler. And he has 2 questions. The first 1 is on Otezla. And Chris says, I know there are a lot of puts and takes on this market and I know you guys have highlighted a tailwind of mild-to-moderate psoriasis patients coming into therapy. But Otezla is kind of unique in that there is a sizable discontinuation rate. Just with that, if you're probably not going away, talk about why we shouldn't be more concerned about [indiscernible] and maybe just as importantly, the next-generation molecules that are coming behind it. Especially noticing that a decline Q-over-Q both in the U.S. and rest of the world, even with a 9% inventory build, any color on how you grow through this coming competition would be very helpful. And then he has a question on AMGEVITA. Okay. So first on Otezla, I would start with the fact that we are the only systemic product indicated for a broad range of psoriasis patients without regard to the severity and really makes us the ideal first-line first systemic post-topical choice of therapy. And that is the positioning of the brand. The size of that market is very large. There's 4 million patients with a mild to moderate form of psoriasis. About 1.5 million of those patients would be regarded as not doing as well as they could on topical treatment by potential switching to a systemic like Otezla. As I mentioned just a few moments ago, Otezla also enjoys very broad frontline access, that is it doesn't require that you step through another systemic therapy. And it also means that prescribers can make it the first choice. And these are busy dermatologists. They want something that's easy. They don't want a lot of prior paperwork. And they want to be able to provide an ability for patients to start quickly on their therapy. Only Otezla offers that in the psoriasis market. I think what we're seeing right now is an effect of a number of free goods programs that were launched at the end of last year and continue into this quarter. When physicians have free goods programs or sometimes referred to as bridging programs, usually used at the beginning of a product launch when there hasn't been an opportunity to secure access with pharmacy benefit managers, physicians will sometimes use those to try novel therapies coming into the market. However, as those novel therapies go through the negotiation process with PBMs and payers, oftentimes, it becomes more difficult to try those novel therapies because of the nature of the access that they result with. And I think that's really where the sustained advantage of Otezla in that first-line systemic post-topical prebiologic patient population really allows us a long-term growth opportunity. And we continue to feel confident in the long-term growth of this brand. And we have a very strong commercial presence in a number of markets around the world and we continue to feel good from what we're hearing from our prescribing base of dermatologists. I will say that the short-term impact of these free good programs, we're watching it very closely and we're making sure that we continue to be competitive in the marketplace. Okay. Chris, the second question is the same as the question that we have from Salveen Richter of Goldman Sachs. And she says on AMGEVITA, could you offer more details on how the dual pricing option will work and drive uptick? And how should we think about net pricing? What are your expectations for the market in midyear once more biosimilars enter? Well, maybe I can answer the second part first. We don't comment on product-specific pricing and so I really can't answer the net price. I think it's fair to say that as additional entrants come into the market, net prices usually go down. We've seen that in our other biosimilars business but we would expect that to happen here. With respect to the 2 list price approach that we've employed here at this launch, this is really to address the complexity of the U.S. market. Pharmacy benefit managers have a business model that requires that they negotiate rebates with manufacturers and so they would prefer a high list price and negotiate rebates to net the price down and then pass those rebates through to their upstream employer clients. There are other stakeholders and customers in the health care system that prefer a net price-based model and don't care about the difference between list and net or gross price and net price. And so for those, we have the lower net price product available. So just a reminder, we have a high list price at 5% below HUMIRA and then we have a low list price at 55% below HUMIRA. We also intend to ensure that AMGEVITA is an affordable medicine for patients by providing co-pay assistance as well as helping patients secure reimbursement through the insurer. We are also pleased to report that we enjoy broad access out of the gate on day 1 of launch with the 3 national pharmacy benefit managers, so broad parity coverage alongside HUMIRA. Let me just -- I note that we're up to the half past the hour but we will continue to take questions for as long as necessary here to answer those questions and until there is a recording of this that will be available in the form of a transcript for those of you that have conflicts and can't stay beyond the set time. So Arvind, why don't you go to the next question? Yes. The next question is from Colin Bristow for UBS. And here's a question on the obesity pipeline. What update should we expect to get this year? Will we see data from the remaining 3 cohorts from the Phase I study? And then on AMG 786, when should we expect updates, more disclosure on this asset and program? Yes. In terms of the obesity pipeline, AMG 133, the 2 additional cohorts you're referring to, I don't know that we'll see data over the course of this year on that. If that changes, of course, I'll provide guidance. AMG 786 is a small molecule with a different mechanism of action, as indicated to GLP-1 or Gipper receptor agonist or antagonist. So that's going through dose escalation over the course of the year. I'll provide guidance in terms of when we may see data from that program. And of course, at the time of data availability, we'll talk about the target as well. So the next question is from Evan Seigerman from BMO Capital Markets. And Evan wanted to know, he said with slowing LUMAKRAS sales, can you expand on how you may have revised your commercial strategy to better align with the commercial potential of the assets? Yes. I'm not sure we have a slowing overall volume growth. I think what we saw and I mentioned this, it might not have come through clearly on the audio but in the quarter, we did see a price effect based on reaching reimbursement decision finalization in France. And so we had a $12 million charge in the quarter against LUMAKRAS. It grew 7% volume in the quarter. But I think we anticipated the opportunity for LUMAKRAS in second-line being limited to the incident population. And we are commercially and medically sized appropriately for that opportunity. I think as we expand into earlier lines of therapy or other tumor types, we will continue to invest behind the product. Okay. The next question is from Michael Yee. And Michael wants to know, he said, on 2023 guidance, can you clarify what the input is for revenue growth versus EPS growth range? Specifically, is there a positive impact from BeiGene accounting? And does the tax rate of 18% to 19% negatively impact EPS? Or is COGS offset, as explained last year, is 2023 OpEx growing more than revenue? Arvind, let me start by working our way from the tax question. So on the tax side of it, the 18% to 19% is increases by the amount. Although, as I have highlighted both last year and this year, we have a small carryover effect of about $125 million that's currently capitalized in cost of goods sold that will be released that -- excuse me, currently capitalized in inventory that will be released in the cost of goods sold, primarily during the first quarter without a corresponding tax benefit. So the answer is, going forward, after that $125 million works its way through cost of goods sold, it will be roughly equivalent to move from the Puerto Rico Excise Tax or the PRET which was recorded in cost of goods sold down to the actual income tax rate. The question on guidance. And I think the question was, what's included from BeiGene and what's not. As I said earlier to Yaron's question, what won't be included now is our share of either losses or gains in BeiGene's income. So we will include, on a mark-to-market basis in our GAAP income statement, the results of BeiGene and then the movements in the security but not in our non-GAAP income statement. We will no longer record our share of losses or their income. Let me just say, Michael and to the prior question from Evan, if you need more detail on that to make sure you fully understand what we're saying in our response, just let us know, we'll get back to you. I think particularly, Evan, for your question, if you're not familiar with that mechanism that's common to us in France, happy just to provide more color for you. Again, Michael, I know a lot going on here and apologies for the disruption and don't know if you were able to follow all the slides earlier. So if you need more color, let us know, we'll call you back after the conference call. Okay. Go ahead, Arvind, to the next question. Okay. Then we have a second question from Salveen asking, could you put the upcoming TEPEZZA Phase IV data and chronic context for us? What do you need to see? How would positive data expand the opportunity for the drug? We are subject to the restrictions that we have on our ability to say anything on what's in the documents. You want to address that? Yes. I mean, I think we're restricted, of course, by Irish takeover rules here. What we can say is that it's worth reminding everyone that the current label is broad and encompasses patients with thyroid eye disease, the -- due to autoimmune thyroiditis. This is primarily a study that will generate data in a population that we believe will help with reimbursement and with payers. And let me ask Murdo to comment on that. I would point out that mechanistically, there is no difference between chronic thyroid eye disease and the acute form of the disease. In fact, it's a semantic definition as to when the disease progresses to the chronic form but the underlying pathogenic mechanism of being driven in large part by IGF1R [ph] is intact. And therefore, based on prior data and mechanistically, we're optimistic about that study. Murdo? Yes. Look, I think the Horizon team is doing a very good job commercializing this product and continue to help many patients within the broad current indication, as Dave mentioned. And I think additional data here could be additive to the already very promising growth of the product. The next 1 is from Christopher Schott of JPMorgan. And Christopher is saying, can you elaborate on our Otezla in 2023? Bristol suggesting that they are seeing some strong initial uptake in their bridge program and would be interested how much of this market expansion for orals versus something you're seeing in Otezla. And you mentioned an impact from competitor free drug impact over the next few quarters. Do you anticipate that will lessen as the year continues or an impact for much of the year? Yes. It's a similar question to 1 asked earlier but perhaps I can elaborate a little bit for Chris. It's fairly clear that dermatologists want to use the easiest product and safest and well-understood product when moving to a first systemic treatment post topically. Many of these topical patients are hesitant to try a systemic agent. And so I think this is where Otezla's profile studied extensively with over 700,000 patients globally having experienced this product, the safety and efficacy of Otezla is extremely well understood. As I mentioned earlier, the frontline access coverage that we've secured in the U.S. without a lot of prior authorization requirement, the convenience of that for dermatology practices is very clear and it makes it a really good first-line treatment, systemic treatment, especially for a patient with milder or more moderate disease. For moderate or severe disease, it is likely that you're going to need to use something like a biologic or a second-line agent. And we think that given that [indiscernible] has yet to go through the market access process and secure payer reimbursement, we're not really seeing how it's actually going to be used longer term in the marketplace. Then Murdo, there is a second question from Chris. He's asking, how are you thinking about ENBREL pricing dynamics over time, given the expected significant price declines in the HUMIRA market? I know you've talked about price continuing to erode but not accelerate. Can you remind us why we shouldn't expect a bigger step-down in price in 2023 or 2024 as the HUMIRA market price resets down significantly? Well, as I mentioned before, we're primarily through our 2023 cycle and we've secured very good access. We've had to concede a bit of price, as I mentioned but not anything that looks precipitous compared to prior years. So we're pleased with that. ENBREL is an important product for many indications. We see that the safety and efficacy profile of ENBREL is well understood. I think physicians also want choice. And I think that's where PBMs are also open to having more than 1 TNF product on their formulary. And I think that's really what we've been able to secure and what we continue to think we'll be able to achieve in the future. The next question is from Mohit Bansal from Wells Fargo. And his question is, could you talk a little bit more about your HUMIRA biosimilar negotiations thus far? Seems like AbbVie has parity access with majority of them and the pricing is different for the first half versus the second half and there's more competition. Are your contracts similar? And how should we think about the cadence of launch as the year progresses? Well, I can't comment on a competitor's contracts with PBMs and payers. What I can say is we've secured broad access for AMGEVITA at the 3 national PBMs. We continue to work with other customers to provide access for providers and patients alike. And we'll continue to compete effectively as we have done everywhere else in the world with this product. And outside of the U.S., we were able to establish a leadership position with AMGEVITA. And we think, given the services that we've provided and the commercial footprint we have, we're in a very good competitive position vis-à -vis other biosimilars. I know a number of you have submitted questions, so we're continuing to work through the list. Anybody who hasn't yet shot Arvind an e-mail, we're going to go through those and we've got couple of handfuls still to go. So let's, Arvind, go to the next question. Yes. The next 1 is a question by Greg Renza of RBC Capital Markets and Dave, this is for you. We were interested in hearing some color on the antibody drug conjugate strategy in light of the recent deals. How is the team approaching the space? Yes. Thanks, Greg. What I view this is as another modality in our toolkit. We've been watching the antibody drug conjugate technology quite closely for the past several years. It's advanced, so what we feel is that we'll use ADCs on appropriate targets. I view it as an addition and an extension of our modalities. These collaborations bring together our experience on target identification and validation as well as, of course, antibody generation with some of the newer conjugation technology. So as that progresses, more to come but you should view this as additive to our armamentarium. Okay. The next question is by Tim Anderson of Wolfe Research. And his question is on AMGEVITA in the U.S. And he's asking, any commentary and your comfort with sell-side consensus for U.S. sales which seems to be around $600 million in 2023? And anything you can say about contract specifics such as whether there's price protection, if any of them go beyond 2023? Yes, we don't give product-specific guidance. And this is a new event in the U.S. biosimilar market, given this is the first big pharmacy benefit product to go up. So we will continue to update all of you as the launch progresses. We have said we think this will be gradually slope on this launch and I'm going have to keep you apprised as we go forward. Okay. The next 1 is by Dave Risinger of SVB Securities and he has 2 questions. The first 1 is for you, Dave. Please discuss key novel drug candidate readouts to watch in 2023. And the second 1 for you, Murdo. How do you expect formulary positioning for AMGEVITA to potentially change in January of 2024 after AMGEVITA is assigned an interchangeability designation? Yes. Thanks, David. This is a year where certainly my focus, my team's focus will be on execution, a huge amount to carry forward in the pipeline. So things that I would keep an eye on, how well are we enrolling the Phase III Olpasiran trial? How well are we enrolling the AMG 133 Phase II trial? In the general medicine portfolio, in inflammation, how are the suite of rocatinlumab trials enrolling? How are we delivering on TEZSPIRE additional indications? And then finally, in oncology, things to keep an eye on are the tarlatumab program, not only the Phase II potentially registrational trial readout in the second half of the year but also initiation of a Phase III trial in second-line disease. These are some of the top line things that I'll be paying attention to. And then there are, of course, a host of others earlier in the pipeline and in discovery research. And just on the AMGEVITA question, I would say that we have a commitment to continuing to make sure that the product attributes of our biosimilars provide payers, providers and patients with all of the benefits that they're looking for. And we're also trying to ensure that there is no reason to switch away from AMGEVITA in the long range. So we hope that interchangeability, the high concentration and the fact that we already have a citrate-free product on the market, along with the services we provide, along with the fact that this is an Amgen team of people who understand the inflammation indications of this product very well and they have relationships with the customers that prescribe HUMIRA, we feel really good about the durability of AMGEVITA long term beyond 2024. Okay. The next question is from Umer Raffat from Evercore and he has 2 questions. The first 1 is for you, Dave, on OX40 and the monthly dosing in Phase III. He said and I don't see an arm investigating extended intervals quarterly or biannually. I'm just trying to tie the Phase III dosing interval versus the durable efficacy seen through 6 months post last dose. And the second question is for you, Peter, that the tax rate stepped up from 14% to 18% to 19%. Just wanted to get some additional color. Yes. Regarding the dosing of rocatinlumab. As we've indicated before, we will explore different dosing paradigms here. And as that suite of Phase III trials fully launches, I think it will become clear what we're looking for there based on both the mechanism of action of the molecule as well as patient convenience. Peter? Umer, good question on tax. Again, it's just a change in what I would say the real estate on the P&L which is the PRET moves from the cost of sales line down to income tax expense in connection with the change in Puerto Rico for us from a PRET to the actual income tax in Puerto Rico which began here in 2023. So that's the nature of that change and that's where the 18% to 19% comes in from where we've been here historically. Okay. The next question is from Jay Olson of Oppenheimer. And Jay is asking, can you talk about your plans for geographic diversification? It seems like ex U.S. revenues have become a small percentage of Amgen's total revenues over the past few quarters. And we were wondering what underlying dynamics drove that shift in geographical mix and if there are any future launches or other dynamics that might push the geographical mix back in favor of ex U.S. growth. Yes, we are actually very pleased with the expansion internationally of the Amgen footprint being in over 100 markets. We continue to launch products and secure reimbursement around the world. I talked about LUMAKRAS. And most recently in China, we've been able to secure national reimbursement drug listing for both Prolia and Repatha. Our Japanese affiliate is growing well. In the recent history, I think what you're seeing is a function of just timing of launches coming a bit earlier in the U.S. and also some of our partnering products. I think longer term, what we've got is a very interesting portfolio of products that will continue to make their way around the world. The announced Horizon acquisition has a very large opportunity internationally. And we see our JPAC region is actually our fastest-growing potential opportunity longer term. So I wouldn't look at short-term movement from quarter-to-quarter. The long-term prevailing trend is that we will grow quickly outside the United States. Okay. The next question is for you, Murdo, from Michael Schmidt of Guggenheim Partners. And he's asking, how confident are you in achieving low double-digit Otezla growth in 2023 and beyond, given the current pattern of essentially flat sales since 2020 of $2.2 billion? Yes, I think we remain quite confident in our long-term growth of Otezla. We are in a period where there's a lot of new product entrants in the market competing for new patient starts. I think the unique positioning of the product, as I mentioned, allows us to source a very large pool of patients. And our coverage around the world and particularly in the U.S. from an insurance reimbursement perspective allows us to penetrate that market. So we feel very good about the continued prospects to grow Otezla. Okay. The next question is from Robyn Karnauskas from Truist Securities. So she's asking, big picture, your guidance implies potentially flat growth. Given biosimilar pressures and pricing pressures, do you think 2023 is a trough year? And regarding the guidance range, can you give pushes and pulls on the biosimilar range? So Robyn, maybe I'll start on the last piece and then Pete, you can reiterate what we said about '23. But as I said in my remarks, Robyn, we have 6 further similar launches planned between now and the end of the decade in the United States and other countries around the world. And it is the launch of those molecules through time which will enable us to continue to grow that franchise. So I would reiterate what I said earlier in my prepared comments. I think you've heard Murdo address as well the attractive opportunities that we think we'll have here, in particular, with AMGEVITA though we're in the first day of launch. And with respect to '23, Pete, I don't know whether you want to say anything in addition to what you already have about the outlook for the year. Thanks. I think we covered it earlier. I'd just note a couple of items that happened in 2022 that we didn't expect benefit from in '23, just to reiterate those. We don't expect any and assume any COVID-19 antibody revenues in '23. We're assuming a lower amount of Nplate sales in '23, Robyn, compared to '22. Recall, '22 had the significant purchase by the U.S. government in the second half of the year. We had several favorable changes to estimated sales deductions that occurred in '22 and we sold the generics business in Turkey which closed late in '22. So a couple of puts and takes around those. And so we look forward to a year in 2023 with strong growth in our priority products, since of, Repatha, Prolia, TAVNEOS. And also -- and that's in light of -- consistent with the industry trends we talked about in our recent history with mid-single-digit price declines in our portfolio but good volume growth. I think maybe to go back to the question Jay asked, too, we expect strong volume growth outside the United States in 2023. So we're looking forward to taking on '23 with a lot of aggressiveness. Okay. The next question is from Matt Phipps of William Blair. And Matt's saying the oncology biosimilar 2023 guidance suggests a year-over-year decline of 38% versus a 30% year-over-year decline from '21 to '22. Is the rate of erosion in the oncology biosimilars expected to continue to get larger beyond 2023 or will this eventually hit something of a floor? I wouldn't say we expect it to get larger but we will continue to see a decline in that business which is a function of the average selling price decline that we've seen thus far. Yaron calling. He said I'm confused by the tax rate going up to 18% to 19% while COGS are 16% to 17%. Hence, I don't see any offsets in the COGS line. What am I missing? I think the answer to that is that our volume growth, the volume growth is quite large and that's really the offset, Yaron. That's a good question. And so we see that happening. We also -- in terms of the move of the PRET down there, recall, too, in cost of sales this year, we've got $125 million coming in off of the release out of inventory into cost of sales without any corresponding tax provision. And so the percent of sales versus a percent of pretax too, you've got to be thinking about that in terms of the income tax provision itself. So that's the puts and the takes on that. But when you strip it all back, it's really that move of the PRET down into the income tax expense that increases that effective rate to 18% to 19%. Okay. The next question is from [indiscernible] from Credit Suisse. Thanks for the comments on Otezla and ENBREL. So can you add a bit more color into the dynamics in immunology? Are there any changes in the channel and mix of patients? Has there been any formulary disruptions? Overall, our immunology business looks very good. I think we're very pleased with the TEZSPIRE launch. We continue to see broad phenotypes of patients regardless of biomarker status being treated. We are seeing de novo patients who haven't seen a biologic before in their treatment of their uncontrolled asthma. And we're also seeing patients being switched from other products within the class. And so we expect that area of autoimmune disease growing in terms of the biologic penetration of severe uncontrolled asthma. And we're well positioned to compete for that expanded treatment pattern. ENBREL continues to serve many patients. And the trends there are fairly predictable and fairly consistent. Otezla, as we've mentioned, is seeing some pressure from new free drug programs, both for our topicals as well as new entrant oral And then we also have just picked up TAVNEOS which we're really excited about, a product that treats a severe autoimmune disease, ANCA-associated vasculitis, very young product, very early in its life cycle and I think a lot of growth there to be had. And then, of course, last but certainly not least, on the branded side, the announced acquisition of Horizon. So I think the inflammation area, along with our own innovative pipeline and the pipeline of Horizon is a very good growth opportunity for us long term. And last but not least, here we are on the first day of launch of a novel biosimilar to the largest product in the U.S. and that's HUMIRA. So I think we've got a lot of opportunities for growth ahead. Yes. Let me read the last question, Bob and after that, you might have some concluding comments. So the last question is from Brian Skorney of Baird and Brian wants to know, do you expect this to be more of a longer-term tax rate, assuming no major changes to corporate tax rates in the U.S.? Yes, Brian, I think, as you know, we don't give long-term guidance on tax rates. And so we won't go beyond this year, so 18% to 19%. And go back to your own just to make sure we understand the change in the PRET. The PRET is a percentage of its cost of sales as opposed to the income tax rate which is pretax income. So that's a little bit of the difference to that Yaron asked about. So 18% to 19% this year is where we're at and that's where we'll -- that's what we'll give you for now. All right. Well, thank you very much, again, for your patience. Apologies that we had a little bit of difficulty with our vendor's connection earlier on the call. So if you have any further questions, shoot them into Arvind. We'll be around here this afternoon, Peter Murdo, Dave and myself, to answer any further questions you might have. And we appreciate your joining the call and look forward to talking to you during the course of 2023. Thank you.
|
EarningCall_1168
|
Good morning, and welcome to Diageo's 2023 Interim Results Q&A Call. Your call today will be hosted by Ivan, Diageo's CEO; and Lavanya, Diageo's CFO. This conference is being recorded [Operator Instructions]. We are now ready to start the call. Ivan, please go ahead. Thank you. Hi, everyone, and thank you for joining our interim results call. I hope you've had a chance to read our press release and watch the presentation webcast on diageo.com. I'm pleased with our results for the first half of fiscal '23. We delivered organic top line and operating profit growth above our medium-term guidance. Net sales up 9% with growth across all regions. Volume grew 2% even as we implemented strategic price increases, operating profit up 10%. Organic margin expanded 9 basis points. We generated GBP800 million of free cash flow, fueling continued investment in long-term growth. We expect to deliver stronger free cash flow in the second half as we lap more normalized working capital movements. We continue to gain or hold share in the majority of our markets, 75%. Our Super Premium Plus brands grew organic net sales by 12%. I'm particularly pleased with the strong growth in scotch, up 19%; tequila up 28%; and Guinness up 17%. On a constant basis, Diageo is 36% bigger than before pre-COVID and with a 4-year CAGR for organic net sales of 8%. In North America, organic net sales grew 3%, lapping strong double-digit growth in the first half of fiscal '22. U.S. Spirits net sales grew 2% on top of strong double-digit growth for 4 consecutive halves and we had depletions ahead of shipments. Our U.S. spirits business is 44% larger than fiscal '19, with net sales growing at a 4-year CAGR of 9.4%. We took price and held share of TBA. As expected, growth in the U.S. spirits category is normalizing, trending towards a historical mid-single-digit range. Consumer demand remains resilient and the market continues to premiumize. 33% of American drinkers surveyed said they had spent $50 or more in a bottle of alcohol in 2022, and that was up from just 24% in 2021. In Europe, organic net sales grew 10%, and we maintained volume despite the challenging economic environment. Asia Pac grew 17%, despite Greater China, which only grew 2%. Latin America grew sales by 20% and delivered the highest margin across all our regions in the half. This business is 64% larger versus fiscal '19 with net sales growing at a 4-year CAGR of 15%. I'm very proud of our performance in Latin America. In Africa, net sales grew by 6% with growth across all markets. And we're delivering consistent returns for shareholders, increasing our interim dividend by 5%. And today, I'm pleased to announce an additional return of capital to shareholders up to GBP500 million in fiscal '23. As I look ahead to the second half of fiscal '23, I am pleased with our start in January and the resilience of our business. I'm confident in our strategy and ability to deliver our medium-term guidance. And with that, I'll turn it to the operator, let's take our first question. Ivan, Lavanya, a couple from me, please. Firstly, could you just give us a sense of where you see U.S. spirits sellout trends at the moment? And how that contrasts with inventory levels and the numbers you've given us on the shipments and depletions so far in the first half. And secondly, would just love some early thoughts on how Chinese New Year has gone? Sure, Sanjeet. So the U.S. consumer is robust. If you look at the industry, we see it growing at about 4%, 5%. And I've said this for a long time, a couple of years or more, that post-COVID, we expect the industry to come back to that mid-single-digit growth range. And what I'm really pleased about is the consumer through the last 6 months has come to that rate. So we're feeling very good about it. Within that, premiumization remains strong. You see in our numbers, our Super Premium Plus business grew 10% in the U.S. So feeling really good about the health of the U.S. consumer. The spirits industry has 20 years of volume growth, taking share of TBA, outperforming beer and wine, premiumization is strong. And I quoted those numbers of the robustness of above $50 a bottle. So overall, strong, robust and pretty much where we expected it to be. If I turn to Chinese New Year, clearly, the -- I mean there's three pieces to Chinese 2 years. The sell-in before what happens in a couple of weeks and what happens after. The sell-in before we were cautious obviously, with the lockdowns and the COVID conditions in China. Actual Chinese New Year itself is subdued in terms of socializing and consumption. And certainly, the large events is more subdued, but we remain optimistic about China recovering fast, both for our scotch business and for a Byju. And as we go into Q3 and Q4, we're very much playing and into assuming a strong recovery. Obviously, we have to watch it week by week, but I'm feeling positive about the China consumer environment going forward. Got it. And just a quick follow-up there on the U.S. If you think the industry is growing 4% to 5% in sellout terms, do you think Diageo is outperforming that? And just a quick word on where you think inventory levels are and how comfortable you are with that in the U.S? I'll answer your question on inventory in a bit. But in terms of our performance in the U.S. itself, I mean we are holding share of TBA in the U.S. And so that's -- we're feeling good about that. Obviously, not we were growing share, and we plan to go back to that. And I will have a very strong point of view about that I know. But coming back to inventory levels, fiscal '22. We ended fiscal '22 with healthy inventory levels. We talked about this in July when we announced our results and inventory levels were to back to close to where it was pre-COVID, right? A little bit higher on imports just because the supply chain was longer, but broadly back to pre-COVID levels on inventory levels. Where we ended the half, we ended with inventory levels that distributed slightly below where we ended last fiscal year, not because we wanted to destock or we needed to do stuff, but just because December was with a really good month. And so a lot of depletions happened towards the end of December, especially which just led to inventory levels being a little lower. We feel good about where inventory levels are. And the -- we're lapping the [indiscernible] of inventory last year because if you go back to the start of fiscal '21 -- fiscal '22, sorry. We were coming off of a very, very, very high growth rate in fiscal '21. Fiscal '21, we grew 24% on U.S. bills so when we started fiscal '22, it was very low levels of inventory across the entire supply chain, which we recognized through the year. Some brands came in faster, some brands came in a little later in terms of when supply was available. And so that's what we are lapping here on ships versus depletes. I'd just add, we've helped TBA share. I think if you look below that, what I'm really pleased with is we're gaining substantial share in the on-trade. So the on-trade in the U.S. -- and NAPCA has the most reliable data here. So if you look at NAPCA on trade, it's about 20% bigger than pre-COVID. And we've gained outsized share. So -- and to me, that's a huge measure of the health of our brands and the portfolio. And even in the last 6 months, we gained over 100 basis points of on trade share in NABCA. Just a couple of questions, please. First, on the U.S., just following up there. As comps normalize, should we assume a stronger sales performance in H2 in North America in terms of organic sales growth? And then if we think about the margins, obviously, your margins was done in H1 in North America. Should we -- when could we expect a stabilization in margins in the U.S., what least kind of gross margin inflection to start with? And then just on FX, a quick question for you, Lavanya. You [indiscernible] that you were expecting GBP300 million positive impact on FX for this year. How much transactional FX impact do you expect this year? And is it fair to assume further transactional FX impact in fiscal '24? Yes. So maybe I'll take the first part on U.S. top line and Lavanya margins [indiscernible]. So yes, we do anticipate, as I talked about earlier, the U.S. industry should be in solid mid-single-digit growth in the second half. We expect to perform in line ideally better, but that's going in [indiscernible]. So focusing on the consumer, I think we feel positive about our ability of consumer offtake to be in the mid-single-digit range. Now we have an intense sell-out culture, right? So as we look at managing the depletions and shipments, you will recall from last year's results because we were in the restocking phase. We had shipments ahead of depletions three points when we closed out the year. So we will lap through all that stuff, but to me, that's just supply chain. The main thing -- most important thing is ensuring we're well positioned to win with the consumer. And we've got phenomenal marketing plans, great innovation. We've got Super Bowl coming up and Crown Royal is going to be on the Super Bowl for the first time. Really excited about that. So the team has a significant ammunition behind our brands going into H2. So I'm feeling good about our ability to win with the consumer. Olivier, to your question on margins in North America. I mean, look, I'll just start off by reminding us that North America is -- has very, very strong margins, 41% operating margin. It was the highest margin region for this business just got coupled by Latin America who surpassed them by 30 basis points. But it is -- one of our strategies has been to invest in North America for growth because every point of growth in North America comes with really, really strong margins. And so what you're seeing in the margin story is a bit of that. And we have invested strongly in A&P, also in digital and capabilities to enable continued strong growth of the business in North America. The gross margin -- some of it is inflation and the impact of that is what we're seeing there. But again, we have many levers to offset inflation, premiumization, volume growth, pricing and the work that we do on revenue growth management, all of that helps us to offset inflation. So I'm not concerned about where the margins are in North America. I think it's a very healthy P&L and business in the U.S. On FX, that was your second question. In terms of transactional FX, in fact, not really expecting much in terms of transactional FX impact, our major currency pairs are hedged. And as you saw in the first half, we really did not have any impact from a transactional perspective on FX. I have one on marketing. Byju invested very significantly into marketing in recent years, and you're indicating that the investment will rise faster than sales in H2. How do we reconcile that with your expectation of moderating sales growth across all regions? And specifically in the U.S., are your market shares evolving in line with your expectations given the investment that's gone into this region? And then two quick clarifications, I guess. One is on free cash flow. Can you please take us through the different moving parts here? Why have the creditor balance has shifted so large and so on? And then on capital allocation, has your thinking evolved at all now that the cost of borrowing has gone up substantially. Does that change how you approach buybacks, M&A and so on? I'll take the first two on marketing and share. So marketing, we -- as you know, we built a lot of sophistication in the data and analytics and tools we now have to assess marketing effectiveness. And as we look to the second half, we see very good opportunities to step up the investment behind our brands, and that's why we indicated in the second half we intend to increase our reinvestment rate. This is built up by market, by brand and very much with the degree of confidence on returns. Now our marketing is not just to make the second half sales number, it is about the next 3 years, right? So everything in our business, upweights and marketing are not for short-term return alone. You do get some short-term impact, but the bulk of the impact really comes down the road and in line with our goal to be a very reliable top-tier compounder. This flywheel of Diageo of upweight investment, drive efficiency and get quality top line growth. So it's really in that context because we really want to ensure we're setting ourselves up well for the quality of growth through the medium term, but it's going against very specific brand opportunities where we have a high degree of confidence in the return that we will get for this investment. And I have to say the quality of our marketing continues to step up significantly, and I feel really good about that. On market share, I mean, we are especially at a global level where 75% of the world is in green. That's a high benchmark, and I'm pleased with that. In the U.S. context, we're holding share at BA we're coming off a period where we've grown significant share. And we've also taken price ahead of the industry, if you look at the last 3 years. And so flat share in the first half, but fully expect and want to do better Lavanya alluded to earlier. So we want to get back into the share growth mode in the U.S. And I expect in the medium term, we will do that. And that also takes me to the point when you look at our portfolio in the U.S. We've got a phenomenal tequila portfolio, which has still a long way to run. We're the leader in whiskey and whiskey is a hot category. Innovation, we've got a lot of exciting things in the pipeline that are going to be coming in to second half and into And our execution and investment levels in the U.S. So I do feel good about our -- the ability of our U.S. business to outperform the industry going forward. So Pinar, on your question on -- you had two other questions, one on free cash flow and capital allocation. I'll take the free cash flow question first. So what we are seeing on free cash flow is working capital specifically, is the lapping of what happened last year. So again, I go back to reminding us of what happened in fiscal '22. We were coming off a very low inventory levels in the entire supply chain. We had a phenomenal growth year in fiscal '22. We grew 20% with 10 points of that coming from volume. We were buying a lot of stuff, like bottles, grains, marketing spend. Our total spend increased dramatically. And with that, our creditors increased tremendously in fiscal '22. Our creditors have increased in fiscal '23 in half 1 as well, but not -- just not to the same extent that it increased in fiscal '22. So what we're lapping is that huge increase in creditors that happened in fiscal '22 and that's about GBP500 million of lower creditor increase this year than the increase of last year. In addition to that, we have invested more -- a little bit more on inventory, mainly to ensure our ability to support continued growth of the business across as APAC has grown tremendously. Latin America has grown tremendously. So there's been about GBP150 million of increase in inventory. And the third piece is investing in maturing stock. And this is something that I had spoken about as we announced results last year. It is a part of our capital allocation strategy is to continue to invest in maturing stock to support the growth of our business, almost -- around half of our business today is in aged inventories. I mean with the growth of tequila, et cetera, and the growth of scotch, the 19% growth of scotch that we've seen this half is a good example of that. And so we are investing behind that. So that explains the three moving -- the three pieces to the moving parts of free cash flow. As we've indicated in the press release, I do expect that working capital will increase in the second half, simply because what we are comping in the second half of last year is a little easier. This business remains a very strong cash-generating machine, so no change to that. In terms of capital allocation and has our thinking evolved? The short answer is no. We have a very consistent and disciplined approach to capital allocation, and we will invest, first, in the business. Lots of room to grow. We still have our ambition of going to some 4% market share to 6% market share. And so we will continue to invest in CapEx, maturing stock, A&P, as Ivan discussed. And then M&A, we will be looking for interesting bolt-on acquisitions as we have done in the first half, where we just announced [indiscernible] we're very excited about that, and we will continue to look for opportunities there. We'll also be disciplined on the other side from a divestiture portfolio as we have been dividend, we will continue to be a progressive dividend payer, and we've announced a 5% dividend increase in this first half of this year. And then return of capital, we've announced an additional GBP500 million of return of capital for this year, and we will come back at year-end results with a further update for next fiscal if the Board decides to do so. Just one on the U.S. and just to make sure that I'm clear. When we think about U.S. underlying trends, we're thinking kind of 4% to 5% right now with Diageo outperforming, given the [indiscernible] portfolio. Is that the best way to think about growth for the U.S. market? And then I'll come back with other questions afterwards, if that makes sense. The U.S. market at mid-single digits, yes, that's what we've always said the market will return to, and that's what we're seeing, and that's what we feel confident about going forward. And it's driven very much by demographic state preferences. It's a long-term secular trend, which -- that is right, that level of growth for the industry. Great. And then when we think about marketing investment in the U.S., I guess, because there's been unprecedented pressing levels coming through, is the best way to think about marketing investments still market as a percent of NSV? Or should we think about it more in absolute terms when you are modeling? Any thoughts there would be helpful. I mean if you look at the last 3, 4 years, we've massively upgraded investment in the U.S. market. We don't target a percent of reinvestment we actually build our plans, bottom up, right? So you take a brand like Crown Royal, I mean, we put in place a very rigorous process of what is the right level of spend behind Crown Royal and what mix of activities we put it behind. And so we built our marketing budgets bottom-up, but what you see in the trend is -- our orientation is to lean in and spend more because we do believe there's plenty of attractive growth to be had. And we're very focused on the sustainability of the growth. As I talked about earlier, this is not just about delivering a return in the next 6 months. So that's the approach we take. And the U.S. market, I've always said it, if there's any opportunity to spend more we will. Final question. I think back in last August, you were talking about share gains for Diageo on-premise one of the reasons why, obviously, maybe there's a disparity between the Nielsen and NABCA data and what Diageo was reporting. Is on-premise share gains still continuing? Yes, very much so. I said we had over 100 basis points of share gains in the last 6 months. So we're feeling really good about our on-premise momentum Claudia and the team made some really big changes in our approach to the on-premise about 3 years ago. And you just see the consistency of performance coming through now. And that's a phenomenal indicator of the health of the business. So I'm really happy to see the growth in the on-premise, the share growth in on-premise. Van. I have three, please. Firstly, sorry to labor the point, but can I just come back on the U.S. depletion trends first item. Obviously, you said that you held TBA share in the first half, am I right to read that a share loss in spirits and a share gain in beer from a depletion standpoint? And if that's true, what's really been driving that relative depletion share loss in spirit in the first half? And what gives you the confidence that we'll see the pickup so you'll be growing spirits depletions at least in line with the wider market in the second half of the year? That's the first one. Secondly, at the group level, I think price/mix is running 7.5%, 7.6% in the first half. You indicated that pricing was up high single digits. So perhaps the implication of that is that mix, overall, was a bit negative globally. Is that correct? Is it geographic mix that's driven that some channel shift? Just some color there would be handy. And then just finally, for Lavanya with regards to share buyback outlook for the year. Obviously, you said that given the macro uncertainty, we might be at the lower end of the 2.5x to 3x leverage range sort of for now. How do we think about sort of how you'll think about buybacks when we get to the full year and beyond? Does it make it more difficult in the current environment to perhaps commit to a multiyear share buyback program? And perhaps therefore, we should more think about rolling 6 months or 12 months forward commitment to capital return from here? Okay. I'll deal with the share question and then turn it to Lavanya. So firstly, the share is consumer offtake, right? It's not depletion. So depletions is wholesaler -- distributor sales to retailers. So when you look at us holding share of TBA that comes in part from spirits doing better than beer and wine, right? So we are benefiting from the 20-year trend of spirit steadily gaining share of total TBA. And we've held share there. Now when you -- to your question on channels, we did gain share in the on-trade, as I talked about earlier. We are marginally down in spirits in the off-trade. But you have to remember, we're stronger in NABCA, which is a very stable channel to measure. Nielsen tends to be more promotional. And we've taken, as I mentioned earlier, we've taken -- if you look at the last 3 years, we've taken more price. We've led the industry on price on spirits. So net-net-net, we're about flat. And our intention is -- as we go forward, is very much to look at getting back to sustainable share growth. So that's how I would characterize the share performance. Lavanya? Thanks, Ivan. So on price, Simon, what we said was that price contributed to high single-digit growth of [indiscernible] right? So I think that's the clarification to your question on price. On share buybacks, I mean, look, if I just point to the fact that prior to fiscal '19, Diageo did not have a multiyear share buyback program for well over a decade, but we have been very consistent in returning value to shareholders. And our TSR is on a 5-year and a 10-year basis is extremely strong. So we will come back as results with further guidance on share buybacks, but our approach to capital allocation continues to be very consistent. My first question is on your margin bridge. So we've seen gross margin under pressure in the first half. Can you help us how we should look at your cost setup in the second half? And maybe as well in terms of the pricing cycle, are we expecting further price increases? And I was looking at that bridge, I think marketing, you said will be up. So how should we think about the SG&A bucket in the second half? My second question is on trying to come back on Chinese growth, you said that you expect a very strong Q3, Q4. I think compared to the growth rate of the market for international spirits in your [indiscernible] what do you think the growth rate could be in China? And what are you planning for not only for fiscal year '23 than H2, but as well for the fiscal year -- the first half of fiscal year '24. And can I also ask on another number if you said a normalization of growth in Europe in the second half what is the normalization of the market growth you are looking for? Okay. Celine, let me deal with China and Europe and then Lavanya cover margins. So in China, just to be clear, I'm not saying we're going to have a massive acceleration in Q3, Q4. I'm saying -- I said earlier, we are ready for the recovery of the Chinese consumer. I don't have a crystal ball on the pace at which that will happen. We're confident it's going to happen. Whether it takes 1 or 2 or 3 quarters, we'll need to see. So -- but we're certainly our approach to the marketplace in terms of marketing support, distribution is very much counting on a recovery of the Chinese consumer. And so the phasing of it, I think we'll obviously need to watch in the next 3 months. I think longer term, we remain confident about double-digit growth in China for our business, both in international spirit, which is primarily top end scotch and in Byju. And so we feel confident about China being accretive growth engine for Diageo. And as you know, it's at very high margins. We have very good margins in China. So we're encouraged with the reopening of China that we shall see good momentum. And the phasing and timing of it, obviously, we will watch very closely and stay very agile to respond to. On Europe, I mean, I'm delighted with our performance in Europe. I mean, 10% growth in the first half, strong market share gains in spirits and phenomenal performance on Guinness. And I know it was in the presentation, but I have to say it again. Guinness is now the #1 beer in the British on-trade. I never believed I'd see this day. It's fantastic. The brand is really healthy. So we're gaining share. We're going to watch the European consumer, obviously, is something that we put a lot of scrutiny behind, but we're confident we will continue to maintain the share momentum, what the external world does we will deal with. But we've been pleased with the resilience of the sector as we've gone through the first half with all the negative news flow on consumers in Europe, our category and our sector has held up very well. And we hope to see that continued resilience going into the second half. Celine, your question on cost in the second half price increases and operating margin in genral. On cost -- look, we've seen higher inflation in the first half of this year than we did through last year. A lot of it was driven by energy costs. And -- but then on the other hand, we've -- we also have a lot going for us in terms of the levers that we have that helps us deal with inflation, volume growth point of our growth this half has come from volume. And that gives us operating leverage all the way through the P&L, premiumization, revenue growth management. We have taken more pricing and smartly while holding market share at -- in 75% of our measured markets holding or growing market share in 75% of our measured market aged liquid is definitely gives us some hedge as well in the sense that any inflation that is -- that happens on our aged liquid gets deferred to the P&L. Productivity, I do want to remind [indiscernible] we've delivered GBP220 million of productivity in this half. And that's a great way for us to offset inflation as well. Cost -- in terms of what I see coming forward in the second half, I mean inflation, it's persistent. It's not increasing, but it's not going away either. We are hedged from a commodity exposure perspective, so for the second half and beyond. Price increases, we take price increases across markets at various points in time. And so especially when you think about the emerging markets that are -- there will be pricing actions that will be -- that will continue to happen through the second half of the year. Overall, from an operating margin perspective, what I say that, look, we have a medium-term guidance out there to consistently grow operating profit ahead of net sales. And that is what we're reaffirming our medium-term guidance. Two questions from me. The first is just a really sort of big picture question. You set out medium-term guidance range to grow sort of 5% to 7%. And I know that's a medium-term range, but you've clearly delivered growth in excess of that after a couple of really big years, you're aging about 8% since pre-pandemic levels. How confident are you that you can grow off this higher base? Or do we need to go through a period of digestion given these significant gains and the very, very strong momentum after the last couple of years? And then the second question is sort of what evidence are you seeing of weakening consumer spending power so far some of the volumes amongst certain consumers? Is it certain countries? Are you seeing the down trading? And how are you really adapting your business and getting ready for a potential weakening environment? Sure. So I'd say -- to the first part of your question, we are confident in the 5% to 7% top line growth. And I think the way to think about it, Ed, is TBA worldwide has very positive trends, right? You've got premiumization that's strong. You look at the emerging markets and penetration is still low. You've got 600 million new consumers coming into the market, you take places like Latin America and India, Southeast Asia. In the developed world, we feel really good about the continued gains of spirits from TBA are performing beer and wine. So we pressure test this all the time, right? We're not just sitting here. So we do -- our strategy teams kind of run through a very rigorous kind of modeling of world economies, consumer behavior, sensitivities to shifts. And putting that all together, we do feel confident in the . On the big -- so we've got market dynamics. I mean we've got tough markets, right? Nigeria is a tough market. Africa, as you can see, is a bit slower in growth at 6%. We put the focus there on margin improvement and not chasing the lower end of the portfolio. So we've got different dynamics at different places. But by and large, the trend of premiumization is strong and intact. Our Super Premium Plus business, I think it was in my presentation, every region grew double digits in the first half. So we're not seeing a weakening of the premiumization trend. I mean, really anywhere, Latin America, Asia, India and certainly in the developed world. But we have the portfolio. I mean, I think what you see in these numbers is Diageo's footprint is a real advantage, the brands, the categories, the price points and the geographies. And at any point in time, when certain parts of the world are going through corrections or markets have slowed down, et cetera, we've got the ability to deliver this resilient performance and consistent performance. And that's very much. So of course, we've got challenges and in certain geographies, but we can offset it with outperformance in others. And that's where I believe the culture of our whole approach to this is being very agile operating as one Diageo. Debra and in her role, overseeing the markets, the supply chain and marketing. We're making very quick decisions as we see shifts in end markets. that enabled us to sustain this quality growth. Going back to the U.S., you said you're holding share of TBA in the U.S. and that Spirit is gaining, which, I guess, implies that you're currently losing share of spirits despite the strength of tequila. And if I look at NABCO/Nielsen, the big difference appears to be prepared cocktails, which, as a category, is growing something like 50%. And I think you're ready to drink in the U.S., which I appreciate may not be all prepared cocktails is about plus 18%. Can you maybe comment on what you're doing to close that gap and whether that's going to be a strong driver of growth for you in the U.S. going forward? And then just to come back on margins for the group. Obviously, you've got marketing to sales being a drag in the second half having been a tailwind in the first half. Lavanya, I think you said input cost pressures are likely to persist. Can you therefore comment on where you think margins in the second half are likely to be up or down year-on-year? Sure. So I'll take the first part of the question, Mitch. Firstly, you are right. The acceleration in RTD spirits has been the important piece of the spirits market growth. Our strategy there is, we're not chasing RTD growth. We want to be in the premium end of premium convenience is the way we look at the opportunity. So we're very focused on building a sustainable quality premium business in this space. And there's a lot of growth right now happening in RTDs, which is we're not interested in. The second thing I would say is actually, if you look at our share performance within bottle spirits, it is strong. We're gaining share. So -- and we absolutely believe having a healthy core spirits business is fundamental to our long-term health and outperformance in the U.S. So I'm really pleased with that. So that's to your question, and I'll turn it to Lavanya. Yes, on -- so, Mitch, on your question on margins in the second half. I mean we're not giving guidance here for the short term at reiterate our medium-term guidance of growing operating profit ahead of net sales on a consistent basis. But as I said, I mean, like there's many leverage that we have in the portfolio. that helped us to grow margins. Yes, input cost inflation is -- we're not seeing it coming off. But as I also said, we are hedged -- and that does protect us. We have taken pricing in. We will continue to do so in the second half. Some of the work that the teams have been doing on revenue growth management, which is really helping to move the mix to more premium end to Johnnie Walker Black Label and above, it's a strong driver of margin improvement for us. And we're seeing this happen across all regions. You see our scotch growth in -- even in Africa, in Latin America and APAC Scotch in total has grown 19% and contributed to 50% of the growth of Diageo. Scotch is a highly profitable category. So there are many levers to get to -- that we are working on all simultaneously, including productivity. And so I feel confident about our ability to deliver a consistent, healthy shape of the P&L. A couple for me, please. Firstly, on the U.S. business, you've -- your tequila performance continues to be very strong, but perhaps there was quite significant weakness across Crown Royal, Vodka and the Scotch portfolio, with the expectation of getting back to that sort of mid-single-digit level if tequila -- I think it's reasonable to assume that Secular performance still outperforms the wider spirits category, but that then assumes that you're comfortable with slightly lower growth, particularly in those three major categories for you. Is that the case? And is there anything you can do about those three categories, in particular, to accelerate the growth and get them back into positive territory? And then secondly, on LAC, the Slide 15 shows your CAGRs over the past few years. And generally speaking, most geographies were around sort of 7% to 8%. And lack was the standout at around 15%, and you've highlighted the improved margin performance in that market as well. Over the past few years, that market has had a bit of benefit from government stimulus checks. And is there any other reason why you expect the LAC market to continue at these sort of levels? Is it reasonable to continue to see LAC drive double-digit growth on accelerated margins? Or is that something we should expect to slow down over the next few years? Sure. So why don't I take the U.S. and Lavanya, you can [indiscernible]. The U.S., we're playing a total portfolio game, right? We are very happy with the quality of our portfolio. When you look at the disposals of the brands we made a few years ago, -- and then obviously, the additions of tequila and aviation in and some of the smaller whiskeys we're adding now. So tequila still has a long runway, as we've talked many times before, whiskey we're very excited about. And bullet in these numbers, you can see bullet has performed strongly, growing double digit. [indiscernible], our depletions growth is positive. What you're seeing in the sales numbers is what Lavanya talked about earlier, just the lapping effects and our sell-out orientation on keeping the shipment to depletion profile right. But we're growing share. Scotch, actually, both Johnnie Walker and Buchanan's are growing share of the scotch category in consumer offtake terms. So whiskey for us remains very attractive. We're investing strongly behind it. Crown Royal, Bulleit, Johnnie Walker, Buchanan's, malls -- where if you remember, we've always underperformed in malls. I'm really happy to see mall performance now come come through strongly. I think in the U.S., we were up 60% in our single mall business. So whiskey will be an engine. On vodka, I think if you -- there's one factor which is consumer-led, Ciroc has clearly has more pressure with the urban multicultural consumer. But Ketel One is solid. I mean, if you -- we were -- and Smirnoff is solid. So -- and Ciroc, I believe, will come back. So we do see the Ciroc business stabilizing over time. And then we've got other brands like Baileys and captain and our new additions to the portfolio, gins with aviation. So when you plot the entire North American portfolio, we play a portfolio game to deliver the total outcome. It's not counting on tequila. So Laurence, I'll take your question on Latin America. Indeed, a standout performance in Latin America, 3-year compounded annual average growth rate of 15%. And in fact, if you even go back before this, you look at fiscal '17, fiscal '18, fiscal '19, high single-digit growth in the Latin American business. And what we're seeing happen in Latin America is we've been growing the business the right way with strong A&P investment driving taking price driving premiumization, it's really the flywheel in action. I mean, I think this is one of our -- it's a great example of where that -- how that flywheel works in pretty much every geography around the world. And if you -- our business in Latin America is predominantly scotch. We are growing the premium end of in Latin America strongly. The work that the team has been doing in Latin America in terms of on digital on consumer-centric advertising, bringing our brands to be front and center of a very dynamic, young consumer base who is really interested in brands that are part of culture has been really fantastic. And really, the single biggest thing that I would say has driven this great performance, consistent great performance over several years has been our approach to looking at the market from a lens of total beverage alcohol. And we are a very small player and last from a total beverage alcohol perspective. And what the team has been extremely successful in doing is recruiting out of premium beer into premium spirits. And that's what has driven the growth in margins, the growth in share and the consistent growth of our top line. And you mentioned stimulus checks. I mean, look, this is growth that the business has delivered over the last 3-plus years and 3-plus years before that. So it's anchored in fundamentally good business delivery versus any short-term tailwinds that may have existed. Two, please. earlier, you were talking about the good momentum you're seeing across the business exiting the half year period and the trends in January were also looking encouraging. You referred to December having been good, I think, in the U.S., more broadly in other regions? What sort of momentum are you seeing as go into the second half. Everybody thinks about the inflection point, which doesn't seem to have happened yet in Europe. So in particular, on Europe where you had another strong half year. How do you see those markets like Ireland Southern Europe, which continue to be good, but there's a -- you have a large on-trade exposure there. And then if I may, my second question is just on Ciroc, which you mentioned that earlier, Ciroc was down substantially in the half because you said distributors were were destocking the brand. I think it knocked about points of your total U.S. growth. Has this destock been completed? Should we see an improvement already in the second half? Sure. I'll deal with the first one and ask Lavanya to comment on the Ciroc. The -- we have seen as we said in my statement. I mean, January has started well pretty much around the world, including Europe, Andrea. So I'm really pleased to see the consistency of consumer momentum for our brands and our category continue in Europe. And we -- obviously, we track it very closely. One of the things we've learned through the COVID years is you've got to be extremely agile, and we have also the consumer to really see if any shifts happen, we will adjust. But what has been really encouraging, I would say, through the last 6 months of, as I mentioned earlier, in Europe, is we've seen the cocktail culture really thrived and premium brands within that do really well. And so we expect the momentum to that underlying consumer case preferences as well as orientation to socialize and celebrate coming out of probed is solid across Europe. So I'm feeling good about our ability to deliver a solid second half. Obviously, there's uncertainty out there, but we focus on just making sure we emerge stronger and continue to keep the share momentum there. And as I talked about earlier, Guinness is in really healthy shape. So feeling good about the Guinness business in Europe too. On Ciroc specifically, Andrea, yes, we have seen a slowdown in consumption on Ciroc and shipments were lower than depletions on Ciroc as the slowdown has resulted in distributed. And with our allowed culture, wanting to make sure that we have the right levels of inventory, healthy levels of inventory in trade. In terms of -- and if I kind of look back at the brand itself, I mean the brand has performed really well over the last 3 years. I mean what you're seeing over here is a bit of an impact on what's happening with multicultural consumers in urban imports, but it's also the growth of tequila, the growth of U.S. whiskey, I mean, these categories don't -- it's not like people are drinking so much more, but you're getting that growth of tequila is the shift happening from one part of spirits to another. I mean that is a large part of what's contributing to that. And so Ciroc is impacted by that to a resin extent, but we -- our focus would be to be where the consumer is with the interest -- with whatever the consumer is most interested in. We have a very broad portfolio across price points, and we moved back quickly to win with the consumer. . Okay. Well, thank you, everyone. Really appreciate you taking the time. And the questions, Lavanya and I will be out on the road show next week, so look forward to meeting with many of you. Thanks very much for your interest in the company and belated, but happy new year to all.
|
EarningCall_1169
|
Thank you, operator. Hello, everyone. Welcome to our full year and Q4 2022 conference call and webcast for investors and analysts. The presentation was sent to our distribution list by e-mail earlier today, and you can also find details under gsk.com. Please turn to Slide 2. This is the usual safe harbor statement. We will comment on our performance using constant exchange rates, or CER, unless stated otherwise. As a reminder, the Consumer Healthcare business was demerged on 18th of July 2022 to form Haleon. But today, we're presenting continuing operations for GSK. Please turn to Slide 3. Today's management presentation will last approximately 30 minutes with the remaining 30 minutes for your questions, and this is to ensure that we get you to your next call, given it's such a busy day for those on the street. [Operator Instructions]. Our speakers are Emma Walmsley, Tony Wood, Luke Miels, Deborah Waterhouse, and Iain MacKay with David Redfern joining the rest of the team for Q&A. Thanks, Nick, and welcome to everyone. Please turn to the next slide. 2022 was a landmark year for GSK. We successfully delivered the most significant corporate change in 20 years and began a new chapter of competitive and profitable growth. GSK is a most global biopharma company with the ambition and purpose to unite science, technology and talent to get ahead of disease together. We are a world leader in the prevention and treatment of infectious diseases with an industry-leading vaccines franchise that continues to strengthen and expertise in HIV that is pioneering in innovation, and we have an exciting emerging pipeline based on the science of the immune system. Through ongoing focus on R&D productivity and operating performance, we're unlocking the potential of this company. We are realizing our bold ambitions reflected in our commitment to attractive growth and a significant step change in delivery. And through the demerger of Haleon, our world leading consumer healthcare business in its own right, we've strengthened our balance sheet, creating additional flexibility to invest in continuing growth and innovation. Turning to Slide 6. I'm delighted with today's results, which demonstrate that our strategy is driving the step change in financial performance we committed to with continued strong momentum as we enter 2023. In 2022, we delivered double-digit sales growth of 13%, 10% if you exclude COVID solutions, including the more than GBP 2 billion sales of Xevudy; adjusted operating profit growth of 14%, 17% excluding COVID solutions; adjusted EPS growth of 15% and strong free cash flow of GBP 3.3 billion, further strengthening our financial flexibility. This outstanding performance was driven by strong sales growth across both Specialty Medicines and Vaccines, alongside continued pipeline progress and underpins our guidance today. In 2023, excluding COVID solutions, we expect sales to increase between 6% and 8%, adjusted operating profit to increase between 10% and 12% and adjusted EPS growth between 12% and 15%. Please turn to Slide 7. The strong delivery in 2022 and commitment to do so again this year supports our increased confidence in all dimensions of these 26 outlooks and demonstrate the continuing successful momentum in our transformation of GSK. Our portfolio mix has meaningfully shifted to Vaccines and Specialty Medicines, now approaching 2/3 of our sales in 2022 compared to 46% in 2017. This evolving portfolio shape and our prioritized investments in innovation and product launches with good cost discipline are reflected in our continuing margin expansion. Please turn to Slide 8. Before handing over to Tony for more detail, I'd like to share a couple of headlines on our progress in reshaping and advancing our pipeline, our #1 priority. We've built a pipeline of 69 vaccines and medicines, many with the potential to be first or best-in-class. We've also had over 20 new approvals in the last 5 years, now representing nearly 1/3 of our 2022 sales, excluding COVID Solutions, and we anticipate more regulatory decisions this year. Our 2022 achievements include the launch of Apretude, first and only long act injectable for HIV prevention, alongside Cabenuva, the first and only complete long-acting HIV treatment regimen. We intend to continue to lead in changing the landscape for people living with HIV around the world over the coming years. In Vaccines, the key highlight was our exceptional RSV older adult data that led to a prompt regulatory submission and priority review acceptance by the U.S. FDA. Our vaccine candidate has a potential best-in-class profile and represents a significant commercial opportunity with multibillion Shingrix life potential. We also made some important advances in the clinical development of 2 late-stage assets, gepotidacin and new novel antibiotic for uncomplicated UTIs and bepirovirsen, which has the potential to provide a first-in-class functional cure for chronic Hep B. Strategic business development also played an important role in reshaping our pipeline, the acquisitions of Sierra Oncology and Affinivax complement our portfolio, and in the case of Affinivax, give us access to not only a Phase II next-gen 24 million new COVID vaccine, but also the Novamax platform technology to target complex pathogens that have multiple serotypes. We have a world-leading profile in infectious diseases and an exciting portfolio and pipeline based on the science of the immune system that we're confident will sustain growth through this decade and beyond. Thank you, Emma. Next slide, please. Today, I will talk about recent R&D developments and preview important events that will shape our pipeline. In 2022, nearly 1/3 of our sales came from assets launched in the prior 5 years, and we are confident that our early-stage pipeline is well positioned. In terms of continued strong commercial execution to deliver our 2031 ambitions. This slide illustrates our focus in 4 key therapeutic areas, shaped by our world-leading capabilities in infectious diseases, our understanding of the science of the immune system and human genetics. In 2022, we progressed 60 novel candidates into the clinic, added 9 to Phase II and started 5 Phase III programs, which reflected our core therapeutic focus, including the initiation of Phase III life cycle innovation trials for depemokimab in eosinophilic disease and cobolimab for the treatment of non-small cell lung cancer. So today, our pipeline comprises 22 vaccines and 47 medicines, many of which are potential first or best in class. These novel programs will form the basis for our next wave of pipeline innovation and growth. I'm pleased with our continued progress and the next slide shows some highlights from last year. In 2022, our highest profile result was the publication of the Phase III data for our RSV older adult vaccine candidate. This demonstrated 94% protection against severe disease with consistent and sustained high efficacy against both RSV A and E strains in people in their 70s and in those with comorbidities. Our global regulatory submissions include data showing that the vaccine can be safely co-administered with a flu vaccine without diminishing the effect either. Following regulatory submission, we received a priority review from the U.S. FDA, and we anticipate a regulatory decision in early May. Our ongoing Phase III trial continues to collect data and will determine if protection extends beyond one season. We anticipate generating second season data in time for the June ACIP meeting. Additionally, we're also recruiting a Phase III trial examining effectiveness in protecting adults aged 50 and above who are at higher risk of developing severe disease. It's important that I mention the ongoing development of Shingrix. We presented data last year showing that Shingrix provides overall efficacy of greater than 80% over a follow-up period of 6 to 10 years after the initial vaccination. These 10-year data were generated as part of our ongoing life cycle innovation, and we regularly review Shingrix's duration of protection and the potential need for a booster. These data will inform the next steps in clinical development, and I'll keep you updated with progress. In HIV, we are committed to improving the existing treatment options for people living with HIV. We have an exciting pipeline including options for self-administration and ultra long-acting medicines. We're also investigating new approaches to HIV treatment. Last year, we presented proof-of-concept data from the Phase II banner trial for N6LS, our broadly neutralizing antibody. This is one of several exciting opportunities within our HIV portfolio, and we remain on track to move this into Phase III development in 2024. Oncology is an emerging therapeutic area. We reported positive high-level results for Jemperli Phase III RUBY trial, which met its primary endpoint, the first trial to show a PFS benefit for an I-O agent in the treatment of women with primary advanced or recurrent endometrial cancer. These data may support the use of Jemperli in the first-line setting. We also decided to progress all arms of the COSTAR lung trial into Phase III. This compares cobolimab and dostarlimab combinations in treating patients with advanced non-small cell lung cancer, a large patient population with significant unmet medical need, and we expect to see data from this trial in 2024. In 2022, we progressed several Phase I programs and reported positive proof-of-concept data. Revax last year, includes data from our randomized Phase Ib trial of CCL17 in osteoarthritis, demonstrating evidence of efficacy at the end of the 8-week dosing period. We plan to progress development and we'll share more later this year. Our partner, CureVac also announced interim Phase I data for flu and COVID mRNA vaccines. These preliminary data provide promising evidence of activity, which included a monovalent flu vaccine that successfully boosted antibody titers against a matching flu strain even at the lowest dose. Based on these promising data, we believe there is a significant opportunity to accelerate the development based on this technology. We're excited about the potential of doublet vaccines, and we're pleased with the progress we're making on both the COVID and influenza projects. As Emma mentioned, we also completed several business development deals in 2022, enhancing our portfolio and platform technology. These deals supplement our late-stage pipeline to support further growth and deliver our R&D strategy. BD and capital allocation will be a strong focus in 2023 and beyond. We also announced a collaboration with Wave Life Sciences to enhance our discovery and development capabilities using novel oligonucleotides. Now I'd like to provide a brief details on the progress of our most advanced oligonucleotide, bepirovirsen. Next slide, please. I'm particularly excited to disclose that the first patient has been recruited into the B-WELL Phase III program for bepirovirsen in the treatment of hepatitis B patients with low baseline surface antigen. Remember that in our Phase II trial B-CLEAR, we observed that an unprecedented number of patients treated with low baseline surface antigen experienced sustained Hep B surface antigen and DNA loss at the end of the 48-week study period. Hepatitis B infection is a significant unmet medical need with over 300 million people having this chronic disease and around 900,000 who die from liver disease-related consequences. The current standard of care achieves functional cure in fewer than 5% of patients, and managing the disease places a significant burden on global health care systems. Our aim is for bepirovirsen to become a backbone of future therapy. Around Moderna, I also look forward to sharing data from B-TOGETHER. A Phase II trial that administers bepirovirsen followed by interferon therapy with the goal of improving functional cure rates still further. Next slide, please. In November, we reported that 2 Phase III gepotidacin trials for the treatment of uncomplicated urinary tract infections were stopped early for efficacy after a successful interim analysis. Data collection and analysis are ongoing, and we anticipate making a regulatory submission later this year. The world needs new classes of antibiotics, treatment failure increasing community resistance rates and increasing safety warnings for existing medicines, including fluroquinolones are reducing the available oral options for uncomplicated UTIs. If approved, gepotidacin would become the first new oral antibiotic for the treatment of uncomplicated UTI for over 20 years. Unmet medical need is significant with around 15 million episodes of uncomplicated infection in the U.S. alone, a 1/4 of which occur or have some level of resistance. Gepotidacin would be positioned as an oral option for patients at risk of treatment failure. In September last year, to complement the development of our antimicrobial franchise, we announced a license agreement with Spero Therapeutics to commercialize tebipenem, a novel antibiotic in Phase III development for the treatment of complicated UTIs. There are around 3 billion complicated UTIs in the U.S. each year, and 40% of these infections are resistant to broad-spectrum oral antibiotics. Tebipenem could be the first oral carbapenem approved for the treatment of complicated UTI reaching the market by 2026. Our goal is to develop 2 novel oral antibiotics that cover the spectrum of urinary tract infections and address increasing recurrence and community antimicrobials. Next slide, please. This slide illustrates some of the pipeline news we anticipate over the next year or so. We expect 2023 to be a busy year across the portfolio. We look forward to presenting our RSV older adult vaccine as the forthcoming U.S. FDA VRBPAC meeting in March, followed by a U.S. FDA regulatory decision in early May. We also anticipate Phase III data from our invasive meningococcal vaccine in the first half. There are around 1.2 million cases of invasive meningococcal disease each year, and if successful, this vaccine would target the 5 most common serotypes in 1 product. As I mentioned earlier, we expect to present data from the gepotidacin Phase III program and data from the bepirovirsen Phase II trial B-TOGETHER around midyear. In oncology, momelotinib has been submitted with regulatory authorities, and we expect to hear from the U.S. FDA during the first half. We'll also present the Jemperli RUBY data at a medical conference later this year. Finally, we also anticipate regulatory decision from the U.S. FDA on daprodustat for the treatment of anemia of chronic kidney disease, with a decision from European regulators around midyear. Thanks, Tony. Please turn to Slide 16. In 2022, we delivered 13% sales growth or 10% excluding COVID Solutions, and we're proud to report that 10 products exceeded GBP 1 billion in sales for the year, including Shingrix, Trelegy, Nucala, Benlysta and Dovato. This is a great example of strong commercial execution. Benlysta remains the market leader with 85% of new patient starts in Q4, and we continue to see a strong growth globally in both SLE and lupus nephritis with only 25% buyer penetration in the U.S. Nucala continues to lead the IL-5 class across all major markets, and Nucala remains the first and only biologic approved for 4 esinophilic diseases with new indications driving growth and differentiation. And Xevudy delivered GBP 2.3 billion in sales, although based on the trajectory of the pandemic, we expect limited sales in 2023, and Deborah will comment on HIV shortly. In oncology, sales were up 17% for the year, with label changes to BLENREP and Zejula in the U.S., we expect to see a short-term decline before oncology returns to growth in 2024. In General Medicines, Trelegy had an excellent year, up 32% versus last year, retaining leadership in key markets. This was also bolstered by the post-pandemic rebound of the antibiotic market globally and increased demand for Augmentin. Turning to our Vaccine's performance on Slide 17. In 2022, Vaccines had a strong year, up 17%, excluding pandemic-adjuvant sales. This reflects strong commercial execution across the portfolio, including a record year for Shingrix and increased contributions from Bexsero in the U.S. with higher CDC demand and increased market share. Shingrix sales grew significantly across all regions, reflecting post pandemic rebound and new market launches through geographic expansion. The U.S. saw higher demand in both the retail and non-retail setting and favorable channel inventory movements, while ex U.S. delivered around GBP 1 billion in sales for the year. Shingrix has launched now in 9 markets in 2022 and is now available in 26 countries, and we expect to continue to expand our geographic footprint in line with our goal to be in 35 countries by 2024. Turning to Slide 18. Here, you can see that prioritization of R&D and commercial investment in Specialty Medicines and Vaccines, plus optimization of the General Medicine portfolio is delivering strong growth and drive our progress. Our '22 results demonstrate that our strategy is working, and we're delivering on the commitments we made at the investor update in 2021. And the data on the right-hand chart show this shift up from 7% to 42% today. Looking ahead to 2023, for the Specialty portfolio, including the short-term impact of oncology, we expect sales in 2023 to increase mid- to high single-digit percent, excluding Xevudy. In General Medicines, we expect 2023 sales to decrease slightly and remain on track with our broadly stable sales outlook between 2021 and 2026; and in Vaccines, overall, we expect to increase mid-teens percent, excluding pandemic-adjuvant sales and expect to see Shingrix momentum continued with double-digit growth with another record year of sales. Thank you, Luke. Our HIV business delivered sales of GBP 5.7 billion in 2022, growing 21% in Q4 and 12% for the year with our U.S. and European businesses both reporting significant growth. We achieved a notable acceleration in our innovation sales, delivering GBP 2.5 billion, representing 43% of our portfolio for the year and 48% in the quarter, up from 29% in full year 2021. Our performance benefited from strong patient demand for our innovation HIV medicines, Dovato, Cabenuva, Juluca, Rukobia and Apretude, contributing 9 percentage points of growth. U.S. pricing favorability and year-end inventory build together contributed 4 percentage points of growth, which was partially offset by international. Sales of Dovato delivered GBP 438 million in the quarter and GBP 1.4 billion for the full year, and this medicine is now firmly on track to become our biggest selling HIV product. We see the opportunity for Dovato as being balanced globally with around 50% of the potential sales in the U.S. and the remainder split between Europe and the rest of the world. Turning to our portfolio. Cabenuva is our first-in-class long-acting treatment regimen for HIV. Sales for the quarter were GBP 129 million and GBP 340 million for the full year, reflecting strong patient demand with high levels of market access and reimbursement across the U.S. and Europe. Moving on to prevention. Apretude is the world's first long-acting injectable for the prevention of HIV dosed every 2 months. Launched in the U.S. in January 2022 Apretude delivered GBP 21 million of sales in the quarter and GBP 41 million in the full year. HIV prevention is an area of significant unmet need as current options are associated with stigma and adherence issues. Apretude addresses these challenges and has demonstrated superior efficacy over daily oral tablets. Looking ahead to 2023, we expect to see continued strong patient demand for our new HIV medicines. We expect the year-end inventory build to burn through the first half of 2023. We are confident of delivering mid-single-digit growth this year. We're excited by our pipeline focused on innovative long-acting regimens, which we believe illustrates our ability to maintain our leadership beyond dolutegravir. By the second half of the decade, we expect cabotegravir to increasingly replace dolutegravir as the foundational integrated inhibitor in our portfolio. We have 3 clear target medicine profiles: to provide the world's first self-administered long-acting regimen for treatment and to provide ultra long-acting regimen for treatment and prevention with dosing intervals of 3 months and longer. We are looking forward to presenting further data on our pipeline, including the SOLAR study, a head-to-head trial between Cabenuva and ViiV and data on N6LS, our broadly neutralizing antibody at CROI in Seattle later this month. Our Q4 results demonstrate continued progress against our ambition to achieve a 5-year mid-single-digit sales CAGR to 2026. By 2026, we estimate that long-acting regimens will be generating around GBP 2 billion, which equates to around 1/3 of HIV sales. The changing mix of our portfolio towards long-acting and the success of our pipeline offers the potential to significantly replace the revenue from dolutegravir post loss of exclusivity. Thank you, Deborah. As I cover the financials, references to growth are at constant exchange rates unless stated otherwise. As Luke and Deborah covered the main revenue drivers, I'll focus my comments on the income statement, including the main cost drivers, margins, cash flow and guidance for 2023. Turning to Slide 21. This slide shows the bridge from total to adjusted results includes the effect of the successful consumer health care demerger in 2022. Total earnings per share were 371.4p, which earnings per share from discontinued operations were 260.6p. This primarily reflected the gain on the demerger and the gain on the retained stake in Haleon. Turning now to continuing operations. For 2022, turnover was GBP 29.3 billion, up 13%, and adjusted operating profit was GBP 8.2 billion, up 14%. Total earnings per share were 110.8p, up 18%, while adjusted earnings per share were 139.7p, up 15%. The main adjusting items of note between total and adjusted results for continuing operations in the year were in transaction-related, which primarily reflected the contingent consideration liability movements, the majority of which related to foreign exchange and in divestments significantly than other, which reflected the upfront income received from Gilead in the first quarter as well as a fair value mark-to-market gain and the retained stake in Haleon. Pandemic Solutions reduced growth of adjusted operating profit by approximately 3 percentage points and growth of adjusted earnings per share by around 3 points. The full year currency impact was a favorable 6% in sales and 12% in adjusted earnings per share. Turning to Slide 22. The 2022 adjusted operating margin of 27.8% reflected an improvement versus last year. The positive margin dynamics reflected the sales growth with a favorable mix, excluding Xevudy, higher royalty income and favorable currency movements, which are a 1.2 percentage point benefit in the full year. These factors were offset by the impact of lower margin sales of Xevudy and commercial investment behind launches and key products. Overall adjusted operating profit grew 14%. COVID Solutions reduced adjusted operating profit growth by approximately 3 percentage points and adjusted operating margin excluding COVID Solutions, was approximately 1.3% higher constant exchange rates. Turning to key dynamics of the year. Within cost of goods sold, the increase primarily related to sales of lower margin Xevudy, which increased the cost of sales margin by around 2.5 percentage points, mainly reflecting the profit share pay away to biotechnology. Excluding Xevudy, cost of goods sold benefited from a favorable business mix with Specialty Medicines and Vaccines comprising 62% of commercial operations sales ex pandemic. So this mix benefit was partly offset by increased supply chain costs, including in commodity prices and in freight. SG&A increased the rate slightly above sales, which primarily reflected launch investments in Specialty Medicines and Vaccines. We're particularly focused on HIV and Shingrix to drive post-pandemic demand recovery and support market expansion. The SG&A growth also reflected an unfavorable comparison to a beneficial legal settlement in 2021. These factors were partly offset by continued delivery of restructuring benefits with around GBP 900 million of annualized savings to date from the separation preparation program and tight controlled ongoing costs. R&D spend grew 6%, with increased investment across several programs, particularly in vaccines, clinical development, including in our mRNA technology platforms and MAPS following the Affinivax acquisition, along with investments in early discovery programs. In Specialty Medicines, with assets like depemokimab and bepirovirsen and within oncology, there was an increased investment in our early-stage immuno-oncology assets and momelotinib following the Sierra Oncology acquisition. These increases were partly offset by the lapping of now completed late-stage clinical programs and reduced investment in COVID-19 assets relative to 2021. Royalties benefited from the Gavi contribution and higher sales of Gardasil. Again, it should be noted that our Gardasil royalty stream will cease at the end of 2023. Turning to Slide 23. Moving to bottom half of the P&L and highlight that net finance expense was higher, reflecting the net cost associated with the November sterling notes repurchased, higher interest on tax, partly offset by increased interest income due to higher interest rates and larger cash balances as a result of the consumer health care demerger. And the effective tax rate of 15.5% reflected the timing of settlements with various tax authorities, which was favorable versus the expectations set out of Q3. On the next slide, I'll cover cash flow. In 2022, we generated GBP 3.3 billion of free cash flow from continuing operations. Within free cash flow, cash generated from operations increased around GBP 700 million, up 10% to GBP 7.9 billion, with higher operating profit being the key driver, partly offset by other factors, which you can see on this slide. Below cash generated from operations, there were higher tax payments and lower proceeds from disposals along with higher CapEx, partly offset by reduced purchase of intangibles. In 2023, we expect cash generated from operations to be slightly lower, primarily due to the positive impact of the Gilead settlement in February 2022, partly offset by improved operating profit growth. We remain firmly on track with our medium-term outlook, driven by higher adjusted operating profit and working on improvements. Turning now to Slide 25 and guidance for 2023. We expect to build upon the step change in performance we delivered in '22. As a reminder, all of our guidance excludes the contribution from pandemic COVID-related solutions and references to growth at constant exchange rates. We expect sales to increase between 6% and 8%, and we expect adjusted operating profit to increase between 10% and 12%. This is influenced by expected cost dynamics where we expect cost of goods sold and expect to increase at rates slightly below sales, SG&A to grow broadly aligned to sales and for royalties to grow versus 22%. Below operating profit, net interest payable is expected to be between GBP 750 million and GBP 800 million and the effective tax rate is expected to be around 15%. In light of these dynamics, we expect adjusted earnings per share to increase between 12% and 15%. We do not expect any significant pandemic-related sales in 2023. With regards to phasing of the year, due to phasing in 2022 and resulting comparators, we would expect operating profit growth to be lower in the first half of the year and higher in the second half, relative to full year expectations. This reflects strong comparisons in the first half, including stock build in ViiV and Shingrix U.S. channel inventory build in the first half of 2022. We would also expect SG&A to grow at a higher rate than sales, reflecting investments to support recent and anticipated launches. Q1 is expected to be a more challenging quarter in the ViiV stock building at the end of 2022. In the second half, we would expect the growth to be higher due to expected launches of new products, including RSV as well as momentum across existing product drivers. Regarding dividends to shareholders. We anticipate a 56.5p dividend per share aligned to our dividend policy and prior disclosure. We started 2020 with excellent momentum from a highly successful '22 and remain firmly on track to deliver our medium-term financial commitments. Thanks, Iain. Turning to Slide 27. We continue to be guided in this by our purpose: to unite science, technology to go ahead of disease together. Integral to this is running a responsible business, one which builds trust and reduces risk to deliver sustainable health impact at scale, shareholder returns and to support our people to thrive. To do so, we prioritize our resources to focus on the 6 material areas affected here. This quarter, our leadership and progress in Access were recognized once again as we top the Access to Medicines Index for the eighth consecutive time, and we continue to lead in innovation to address antimicrobial resistance. Also, we announced an investment of GBP 100 million to help strengthen health systems in lower-income countries, along with our commitment to invest GBP 1 billion in global health innovation where it's needed, as evidenced by our progress with the new first-in-class candidate medicine for patients with tuberculosis. Turning to Slide 28. So in closing, I do want to thank our people for delivering this tremendous performance, a landmark year for GSK as a newly focused global biopharma company with big ambitions. We are delivering a step change in performance, and we enter 2023 confident that we will keep delivering again this year for our medium-term outlook and with the momentum to sustain growth through this decade and beyond. So my real focus on the overall feedback specifically about the patient cohort. So I wonder if you can just use the commercial opportunity you see within that 50 to 59 year old group, if we assume the Phase III data that you are going to publish later this year is positive and the vaccine is ultimately approved in that age group. Do you think an age set recommendation population is a realistic scenario? And I'd be interested to know whether your existing in terms of target for that asset that brought us GBP 3 billion excludes any potential sales in that younger cohort. Thanks, Kerry. Well, I think we'll come straight to Luke on that one. Obviously, an asset we're very excited about a lot of opportunity here, but Luke. Thanks, Kerry. I mean, yes, it's in that immunocompromised population. It's a sizable population, but the primary benefit is from a contract negotiation point of view for the 2024 season because we'll be the only one with that profile and evidence in that group, which, along with older individuals is obviously -- bears a significant burden from RSV infection. The previous guidance we've given includes that study is the full life cycle program. It's on the outlook for Vaccines, for mid-teens. I wonder if Luke could give us some idea in terms of the usual sort of update into the Shingrix doses and where we are with returns to inventory and in terms of burning through that, particularly, I guess, given as well, presumably we're back to a more normal seasonality, if you like, of Shingrix, presumably with the sort of flu season, if you like, towards the end of the year. And what have you assumed in that mid-teens for RSV in the outlook as well? Should we be assuming is any modest contribution? Or how should we think about mid-teens in the context of obviously this being the first potential year of RSV sales in the U.S. All right. Great. So I think as Luke said, it's going to be -- and I'm going straight to him, but another record year of Shingrix expected with double-digit growth and obviously, the first season for RSV, but for a major contributor to growth for the years ahead. But do you want to give a bit more shape on Shingrix, Luke? Sure, Emma. So Peter, thanks. I'll give a sort of an overarching answer first and then give you more detail on the U.S. dynamics around stock levels, et cetera with Shingrix and then also incorporate RSV into that answer. So I mean, our strategy remains the same. I mean, we tried to decouple Shingrix from the flu season. And yes, there is still volume associated with that just with people coming into the pharmacy. I think the Inflation Reduction Act in the U.S., taking away the co-pay in that 65-plus group will be helpful. We know from our data, around 8% of patients reject a Shingrix shot based on co-pay concerns. It's probably understated, but we'll -- because pharmacists may self-select into proposing that to patients, but we'll see that in time. I think for Europe and Japan, where really things are starting to move, we just had a record month in January in Germany. Things are moving in Italy and other European markets. And I think if you look at the rest of the world, as China starts to normalize, the potential for that over the next couple of years remains very, very sizable. And then ultimately, we've got the opportunity to go back and rechallenge these populations with a booster in the second half of this decade. In terms of short term now in the U.S., I mean, the retail-nonretail split has stabilized. It's about 53% retail, 47% nonretail in Q4. The growth is evenly balanced between retail and nonretail. Stock levels have -- they came down in Q4. They're very much within the normal range of 1.1% to 0.9%, so we ended the year at 0.9 levels in the U.S. Now in terms of RSV, I don't want to give too much color on RSV, but I think Pfizer has made statements around penetration similar to flu. We agree with that. I think this product is going to build over multiple years in the U.S. and then as we follow a similar strategy that we've done with Shingrix, which is maintaining price discipline and then expanding into Europe and rest of world over the next few years. Thanks, Luke. I also like the fact that we published it. I think you said that we're 15% more likely to get Shingrix post-COVID as well. My question is on pricing. So if you look at the January list price rises for GSK and indeed the industry as a whole, price rises have been in line with the historic price rises. So -- and one could have expected price taking to be a bit stronger given the high levels of inflation. And it looks like there is still room to take further price throughout the year before you hit the limit imposed by the inflation price cap in Medicare as well. So how should we think about pricing through the rest of the year? Could we get maybe smaller, more frequent incremental price rises through the year? Thanks. So look, GSK has got a long track record of being very responsible around its pricing. Let's hear, and as you know, on a net basis over the last few years, I think would be even very slightly down and really thoughtful about how we take this all. But Luke and maybe Deborah, a comment, please. Yes, completely agree, Emma. We're playing the long game here. I think past patterns over the last 2 years are probably a good indicator of our behavior going forward. And I would just -- obviously, I agree with what Luke said. I think the other thing that people should be giving some thought to is what's happening outside the U.S. So if you look at our HIV business, for example, and many others will be experiencing the same thing, we're seeing significant additional net price pressure from clawbacks and price cuts. So from a pricing perspective, I think we've priced fairly and appropriately and playing the long game in the U.S., and I think we need to be aware and very vigilant about what's happening outside of the U.S. in terms of economic challenges leading countries to put pressure on pricing. I've got a question on HIV. So could you give us an idea of the amount of stocking that you saw in the fourth quarter and which of the key products were impacted clearly for the full year, Tivicay and Triumeq seem to fare better in the U.S. than the next U.S. So with those 2 products as well, what are you sort of assuming for next year in the guidance? And then can you also give us a bit more color on the dynamics for Cabenuva and Apretude in terms of take-up, patient attitudes, physician attitudes and how that's changing with greater experience and how you expect the growth curve to look for the 2 long-acting drugs next year? Brilliant. Okay. So let's talk about stocking. So we entered last year with about 3 days of stock, which was low. Normally, we exit each year with about 7 days of stock. So we entered this year with 3 days of stock, 2022, with 3 days of stock. We exited with 13 days of stock. So as you can see, there's been a material shift between where we started '22 and where we exited. If we assume that we're going to just have a normal 2023 and that there will be 7 days of stock in the channel at the end of the year, you can see that we've got 6 days to burn, and we believe that's going to burn in the first half of the year. So that's kind of the details on the stock evolution. In terms of Tivicay and Triumeq, I mean we're seeing Tivicay and Triumeq at a relatively kind of steady evolution. Triumeq is declining quite significantly as it's cannibalized by Dovato but also competitors. Tivicay is pretty stable actually. It's declining, but obviously, it's the only second-generation integrase inhibitor that you can have as a stand-alone and not as part of a triple or a doublet. So we continue to see a strong and sustained business with Tivicay. Triumeq, we think that business will decline as better opportunities are now there for people living with HIV. In terms of Cabenuva, so we've seen really strong patient demand. We're seeing excellent execution from our commercial teams, which is broadening the prescriber base and deepening the number of prescriptions each physician is writing. And we're doing a lot of work in the environment to overcome some of the barriers that you see when you introduce an injectable into a new therapy area for the first time. And we're really happy about the progress we're making. The level of access is significant. And as I've said before, the quality is also really, really positive as well. So I think Cabenuva is doing really well. Apretude was slower last year. As we said in the first year of any new medicine and particularly in injectable, it takes a while to secure access and get all the big accounts signed up, the specialty pharmacy signed up on the product. That is now in a very, very positive place, and we've got very strong ambitions for Apretude in 2023. And again, all the research we do in terms of physician and patient. We know that the demand is very strong for this product as it offers something very different to the other, and obviously, we've got superiority data. So I hope you take away from that a lot of ambition and optimism for our long-acting injectable portfolio. I think also, as Deb referred to in our comments, I mean, the overall momentum on 2DRs across the board, I think, is up to like 40% between Dovato and with long-acting of the business. That's why we've done what we said we'd do in the shift of the portfolio, and we completely expect to do, again -- to do so again through long-acting, as Deb said, with the profile of the business by '26, but also to continue to shift beyond that ahead of the patent challenge on dolutegravir. And that's what's so exciting about what's coming through in the next generation pipeline, which we'll give -- Deborah and team will give you more insight on the 18 months ahead. Staying with Cabenuva and given the profitability of this product even with the profit share, it's obviously hugely important for GSK going forward. Could you just give us a little bit more information on the source of the switching to date? And by that, I mean, just in the U.S. market, how much from Medicare, how much from 340B, how much is there for inventory? I know it may not represent long-term what things look like and its dynamic, but I would be interested. And then second, in relation to the new generation of cabotegravir line extensions, including the subcu, we're going to get data in '24. How long will it take, do you believe, to secure approval, assuming that you do PK/PD bioequivalence trial starting in '24? Should I be assuming '26, '27 by the time you hit the market? Thanks, Andrew. So straight back to Deb. Just as a reminder for everyone, part of our portfolio shift strategy, which is evidence is working when you see that shift from 46% of the portfolio up to 2/3 and our confidence by '26 is getting to 3/4 towards vaccination -- Vaccines, sorry, and Specialty Medicines is so that we're continuing to drive leverage in the P&L and affording our ability to keep investing at the same time in R&D and in our launches, too. So as well as within HIV through the innovation as we talked to, but also on the broad GSK agenda, we're seeing an important area of focus there for us. Deb? So just to quickly cover your points, Andrew. So in terms of the source of business, there's 2 ways we look at this. So first of all, where are we getting the business from and I can confirm about 60% of our Cabenuva business from our competitors and about 40% from our own portfolio. Second point, which is around what segments of the market are we getting Cabenuva from. Actually, we've got really good coverage across all the payers and all the key accounts. So actually, there's the split that we see for Cabenuva is broadly in line with the split of the overall market, which, as you know, is 40% kind of commercial payer in HIV and 60% government. So there's no unique attribute to Cabenuva versus how the market normally plays out. In terms of the pipeline, so there are 3 time lines that we've laid out in our business investor update. So we've talked about a self-administered treatment and a longer-acting prevention between '25 and '27. Then we've talked about a longer-acting treatment, so 3 months-plus after 2027 probably in the '27, '28 period. And then we've got, which we're very excited about, our third-generation integrase inhibitor, which will either be teamed with our capsid or with our bNAb , and that is where you've got the potential for 6 months plus in terms of gap between administration. And that's towards the end of the decade. So that's kind of what we've set out in the update that we gave. And we're still absolutely on track for that. Very excited about the future. And just to reiterate our shorter-term goal, we are very confident in our ability to deliver that GBP 2 billion of revenue in 2026, which is 1/3 of our overall business in HIV at that point. I have a question on COVID flu co-formulated vaccine. So Pfizer yesterday suggested the launch of a combo product in 2025, talked about it as a compelling durable offering. Does Glaxo see an opportunity here for itself? And what's the time line of launch for a similar product from Glaxo? And then if I can just sneak in one quick housekeeping question. Zejula, when do you expect mature overall survival data from the PRIMA trial in frontline ovarian? Right. Well, both of those to come to Tony. And just as I think what he did refer to in his remarks, obviously, we're pleased to see the data that's come through from our partners at CureVac, and the potential for doublets here is definitely interesting. And we'll update more on our actual specific plans, I think, later in the year. But Tony, I'm sure you want to add to that as well as the Zejula question. Yes. Let me just build on the question about doublets. And I think I'd start with just giving you a sense of the exciting data that we're generating with our partner, particularly CureVac, in the context of establishing the opportunity for a therapeutic window between immunogenicity and reactogenicity. And in a doublet vaccine, particularly with regards to flu, for example, you can think about this as the majority loading of that doublet vaccine coming from components that are addressing flu. We very much see the opportunity in the second half of the decade associated with the high-dose flu market, where an 8-valent vaccine covering both hemagglutinin and neuraminidase antigens is really the opportunity at hand. So let me just quickly address what we're seeing in these early monovalent data that gives us the opportunity for excitement. And that is in the flu vaccinations, you will have noted that in a comparator -- a monovalent comparator, we see immunogenicity at the lowest dose, which is consistent or better than that comparator and seroconversion, which is also better than the comparator. In our COVID studies, which have a slightly different comparative basis, we see reactogenicity, which is at the low end in terms of distribution of grades and severity at the highest doses involved. What that is doing for us on the back of monovalent construct is creating an opportunity for a window and therapeutic index that I think makes a valent flu plus COVID doublet a practical possibility. We're now accelerating studies from monovalency into multivalency in a Phase II study the aim of targeting a multivalent seasonal vaccine focused on 8-valent flu in the second half of the decade. As far as PRIMA is concerned, look, obviously, this is an event-driven outcome study. So it's something that's going to -- I'm reluctant to give data on. We're not expecting OS data before 2024. So it's going back to RSV vaccine. I think you sort of referred to this requiring a lot of education, obviously, having more than one player in the market can help there. We've also referred to probably a launch trajectory below Shingrix. I was just wondering if there's a lower bound analog for launch that you could point to that you would think is appropriate, whether it's pneumococcal vaccines or perhaps one of the older pediatric vaccines. And any thoughts you've got on the recent Moderna interim data and the level of competitive threat that you see from having 3 vaccines in the market just from a contracting and pricing point of view more than anything else. Yes, Graham. I mean, I think lower bound pneumococcal, again, it's not a perfect comparator but I think that's a fair one. I think you'll get more information with the pricing being presented at the Feb ACIP by ourselves and Pfizer on the 23rd, 24th of February. Look, I think that having 3 companies there, you're definitely going to drive awareness and a more rapid uptake. So the pie will be larger but obviously shared 3 ways. Our expectation is that it will only be Pfizer and ourselves at the June ACIP and that remains the same. I think from a strategy point of view, as always, you need to anchor in your own evidence base. And I think the 94% efficacy that we have in adults with comorbidity is impressive and the similar range that we have in the 70 to 79 year-old group who obviously bear the brunt of RSV infections. I mentioned earlier from Kerry's question, the 50 to 59 year population that will also have evidence of that for the 2024 cycle. So all of these things help contracting. And I think there's just 2 big variables that remain unknown. One is the final label that people ultimately get. Again, we've only seen headline data at this point. And then secondly, ourselves and Pfizer are likely to have that second year of exposure data just before the June ACIP, and that's a variable that remains unfactored at this point. But net-net, I think it's still a very exciting opportunity. And what is striking is just the level of awareness and just the depth of the RSV infections that we've seen this year post-COVID. You've hear me. Brilliant. Lovely. Two questions, please, both on vaccines. One was on RSV. So just in terms of multiyear protection, based on what you've seen so far, have you seen things that are encouraging just in terms of the efficacies you've seen through the year that suggest you are likely to get multiyear protection? And if you do, is that something that would actually be upside to the share assumptions you already had? Or was multiyear protection somewhat baked into the projections you've already given for this vaccine? That was the first question, please. And the second one was on Shingrix. So there was the potential need for a booster mentioned. What data would you actually need for that? Do you have some data that's already telling you when you think you might need revaccination? And would you have to do a study that actually showed a statistically significant benefit on symptoms from revaccination? Or would it be more just about antibody titers? Is there like a quicker route to get such a recommendation? Right. Well, I'll give both of those to Tony. But just as a reminder on Shingrix, we launched it in 2018, I think. So -- or '17. So -- and we've got good data for 10 years. So the cohorts coming through, the boosting is more for later in the decade, as Luke alluded to. But definitely something that we'll look at. But Tony, do you want to respond on both the RSV durability and Shingrix. Yes, sure. So first of all, in terms of duration for RSV, obviously, we have solid coverage across single-season vaccine efficacy with our existing data package. And James, you may remember, we also have titers that are elevated above baseline as measured at the end of first year. As Luke indicated, we're planning -- and indeed the study was designed with this purpose in mind, to be able to bring second season data to ACIP in June. Obviously, that is depending on the dynamics of the second season. And so we'll be able to report more on that when we get to the June date. Can you just remind me -- in terms of was it incorporated, second season data was not incorporated in the baseline model, so it would be an upside. And then can you just -- sorry, what was the second question? Shingrix booster, yes. Okay. So obviously, we have 10-year data from Study 049 and that shows outstanding duration of protection. That's cumulative vaccine efficacy of greater than 82% over the 6- to 10-year period of follow-up, 89% vaccine efficacy over the 10-year period. Study 049 was designed to continue to generate data in order to answer the booster question. Remember that the vaccine was launched in 2018. And so we're reaching a point now with 10 years subsequent to that, we'll be looking to later in the decade. It's reasonable to expect that we will see some waning in vaccine efficacy associated with an aging population. But to your point, James, we're also engaging in ongoing conversations with the regulators to understand what the design of a study required to show the need of a booster would look like and for whom. But I don't want to go into any greater detail about that at this stage. The level of detail provided on the ongoing Zantac litigation release was very helpful and particularly following the MDL update in December. And the time lines on California were also helpful. I was just wondering if perhaps you could put in context how you're thinking about the rest of the state cases and just for -- on our side, it's been tough to follow kind of what follows the dower standard and what doesn't. But just outside of California, if there's any states where cases could be moving to trial in the near future that we should be mindful of? Right. Thanks, Emily. Obviously, we were delighted with the outcome in December. We've got some things to navigate through this year. But Iain, perhaps you could update on the different state situation? Yes, absolutely. Emily. So obviously, MDL was incredibly impactful. That took out the equation, 46,000 claims within the suits filed at the federal level. So I'm delighted with that decision, as Emma said. You reflect on the bulk of claims in State Court, they sit in Delaware with more than 70,000. And although it's clearly for the courts and Delaware to decide there is a pattern of behavior where they tended to follow federal precedent in that regard. So that is probably an encouraging indicator. Then across the other states, we've got a little bit less than 6,000 claims out there, which about 3,000 are in California and the rest are spread across sort of half a dozen other states. We've got 4 bell weathers that will -- that we expect to take place in California this year, the first of which will kick off a little bit later this month or early March. The Sargon hearing for that trial has actually been pushed back another week to the 16th of February as the judge reflects on input from both plaintiff and defense attorney. So look, again, the really important thing here, the MDL decision, the diverse decision was incredibly helpful. It was informed by the strength of the epidemiological independent studies of which that are now 13, the consensus of which is there's no causality between the consumption of ranitidine in any form of cancer. And it's clear from Judge Rosenberg's decision that was the significant factor in informing our decisions. So we'll continue to defend vigorously and first up or a couple of trials in California, we'll keep you posted. I promise I'll be quick. A question on BLENREP. Tony, back in November on the Q3 call, you mentioned that there was ongoing analysis involving soluble BCMA as a prognostic indicator. I just wonder if you could give us any update on the findings from that. And related to BLENREP, I see DREAMM-7 and DREAMM-8 have moved from H1 into H2. Is that shifting here for event-driven studies or is there anything else we should be aware of? You cut out just to the second part of that question, but I think it was 1 of the implications in the first half, second half on 7 and 8. But -- sorry, for you, Tony. Yes. Look. So Simon, the analysis that we discussed in terms of soluble BCMA and other markers that might explain the crossover that we see in DREAMM-3 is still ongoing. As far as DREAMM-7 and DREAMM-8 outcomes are concerned, we're now targeting a more complete picture of those. And if I remind you, these are 2 studies that are looking at BLENREP in combination versus standard of care in contrast to DREAMM-3, which was BLENREP and monotherapy. We're expecting to be able to provide a deeper update on those at the end of the year. And not much more to say at this stage, Simon. The analysis is ongoing. We'll bring this, when I've got a clearer picture. Thanks. Great. Well, thank you, everyone. I hope this has been an efficient call for you. We're delighted with the momentum and progress in the business. We look into 2023 with confidence and do so also for our medium-term outlook and beyond. We look forward to staying connected and keeping you updated in coming quarters and along the way. Thanks very much. Bye.
|
EarningCall_1170
|
Hi, everyone. Thank you for joining us on todayâs webinar. Before we begin, Iâd like to announce that we will be referring to todayâs earnings release, which was sent to the newswires earlier this afternoon. Iâd also like to remind everyone that this conference call could contain forward-looking statements about Destiny Media Technologies within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based upon current beliefs and expectations of management and are subject to risks and uncertainties, which could cause actual results to differ materially from those forward-looking statements. Such risks are fully discussed in the companyâs filings with the SEC and SEDAR and the company does not assume any obligation to update information contained in this call. During the webinar, we will discuss certain non-GAAP financial measures. The non-GAAP financial measures are presented in the supplemental disclosures and should not be considered in isolation of or as a substitute of or superior to the financial information prepared in accordance with GAAP and should be read in conjunction with the companyâs financial statements filed with the SEC and SEDAR. The non-GAAP financial measures used in the companyâs presentation may differ from similarly titled measures presented by other companies. A reconciliation of the non-GAAP financial measures to the most comparable GAAP financial measures can be found in the earnings press release. Thanks, Rebecca. Good afternoon, everybody. Today, we have myself, Fred Vandenberg, and Allan Benedict, who leads our business development and marketing teams. I will take you briefly through the summary of operations and financial results for the quarter and some revenue driver discussions. And then I will turn it over to Allan to talk about business development efforts. We are going to follow a format thatâs similar to what we did at year end with a slight simplification and modification to just how we form the narrative on growth. And then Allan â when Allan has done the conversation on business development, he will turn it back over to myself to talk about things looking forward. For the quarter â sorry, I missed a slide there â for the quarter, revenue fell by 10%. The majority of this decline is the decline in the value of the euro. It hit us a little bit hard there. Itâs starting to come back towards the end of the quarter. The secondarily independent revenue from sales fell generally. We think that this is a function of government funding associated with COVID that impacted smaller artists running out post-pandemic. But I think Allan will touch on that a little bit more. On the positive side, our major label revenue is up 5% after adjusting for FX. We think this is a sign of the growing value that we are providing. This is really on the strength of solid growth with both Warner and Universal globally. EBITDA for the quarter is $324,000, about 32% net EBITDA margin. Now one thing I want to mention here is the capitalization of software development costs, which was about $248,000 for the quarter. These are â this is really for new products and services that we are developing and we think it will provide long-term additional value. We are really investing for growth in the core Play MPE platform and with new services. Income similarly was up to $258,000, up 56% from previous quarter. The overall expenditures have declined by 25% in part because of favorable FX. If you look at the P&L solely, salary and wages are down 22% and thatâs by far our largest component of costs. Some of that is favorable FX. When it comes to FX, the euro is down relative to the U.S. dollar affecting our disclosed revenue. Similarly, the U.S. dollar is higher relative to Canadian dollar, which is impacting our costs. So salary and wages going back is down 22% for the quarter. Some of thatâs FX, some of its lower staffing, we are not cutting costs here, we are just trying to make sure we are spending where we get a return. Overall, if you include capitalized software development costs, salaries and wages were up 4%. And again, this is because we are making a significant investment in new products and product development generally. One thing I think people have noticed is the drop in sales and marketing costs. This is associated with salaries and wages. I will touch on it lightly. There were real reductions in staffing. As I described a little bit before, but there is a lot of movement of resources over to product development and there is the FX impact as well. So thatâs the overall expenditures plus capitalized investments is actually down 3%, thatâs just including all P&L items. We have discussed business development or product development in the past as something that can really heavily influence our ability to grow and thatâs by new products or services or by adding things that facilitate growth within the platform. The difference makers here are really platform changes, improvements, product development is â platform development is something that really is something that I think we can â that can heavily influence our ability to grow. Recently, over the recent few years, we have really focused on things to make the platform easy to use. Itâs really moving it from a PC based platform over to a web-based platform. And then, more recently, itâs building out the global admin features for Universal. These global admin features really donât impact our ability to grow at least directly. But they were to grow within Universal, I would say. When we talked about our platform in the past and it can refer to you to Q4. The platform itself has really four main components. And I think I went into that to describe how the platform works and how we are going to grow. But itâs what I wanted to do this quarter is, is really talk about â talk about it from a very simplified way. And I think if you look at the things that will influence our ability to grow with Play MPE, you look at these three main things, releases, and if you want to draw a metaphor, it will think of us as like a FedEx or post office or something and releases are the package. So the more packages we send, the more revenue we will get. And then similarly, the more destinations you send that package to, you will drive up revenue. The third one, the value-added component is really where the metaphor might not be perfect or where it breaks down a little bit. But itâs really just things that enhance the overall effectiveness of the delivery. With FedEx, itâs either it gets there, it doesnât, maybe it has insurance or something like that or read receipts on the other end or something. But this is where Play MPE probably has a bigger impact when it comes to things that we can add there. So what I wanted to do is spend a little bit of time discussing how these components, what things we are working on, how these components can influence our revenue growth. The first â in the first section, there is really a bunch of things here. The self signup checkout, thatâs really an ability for a customer to sign in and select their list, prepare release and checkout and pay. We donât currently have that and itâs a bit of a bottleneck to sales right now. Lead conversion, lead automation, growth in new markets, Allan will talk about these a little bit more in depth. But these are things that are improving â helping us improve our growth recipient sourced content requests. Thatâs again more of a product in platform communication, where if you get a song from an artist and you want more from that artist or more similar things like that, then you can generate the recipient request â recipient-sourced content request. We do get those, but they are â right now, they are word of mouth where a programmer or something like that will tell the artists to send it through Play MPE. Thatâs our â actually our best source of leads. But we want to do that in a more technical manner. There is other things here, archived releases, thatâs really a feature that we added not this current year like this â but we added it last year and itâs really a way to send more content that you donât want to spend the same amount of money on, you do bulk distributions. And then a reporting, there is certain things that I think we can do without getting into a tremendous amount of detail here. The reporting, we can structure it in a way that reinforces the sale. So, that improves client retention and or resending content or resending more from that same artist that sort of thing. In the second leg of this stool, we will talk about destinations. Now, the biggest parts here are expand our list offering and recipients, we provide the most expensive recipient lists in the world by any competitor that we have by far, but we also have a lot of recipients that are using Play MPE that we donât know who they are and they are not on our list. And we think that if there is certain things we can work on within the platform, technical solutions that will expand our recipient base at least the ones we facilitate distributions for. This is really something that I want to spend just a bit more time on, because itâs important. Recipient lists, providing recipient list is critical to our â much of our independent sales. And I mentioned this at the year end, where the majority of our distributions use our lists. And thatâs because a lot of times customers donât know who to send to. And quite frankly, our lists are great. They are current. They are updated. They are accurate. But it is a bottleneck to growth. The faster we can expand our recipient list base we can grow revenue. And thatâs â we think thatâs a technical solution within the platform. Also in there is list selection improvements. So, there is a few things that we have already been working on descriptions of our lists. They tell you who we are sending to making those lists easier to select in the platform. Right now, itâs not particularly easy. Itâs not easy to select an international list. If you have a country distribution, for example, you got to hunt and search through it. We are in â we have just designed an improvement there. We have got to build it out yet. Last quarter, we mentioned international lists. We have started providing those international lists for certain genres of music. We think we can keep building those out. Recipient feedback things, I am â there is like you can use feedback within the platform to generate larger distributions. Thatâs like people requesting content that sort of thing. Automated list expansion reports. Thatâs something where if a release is doing well, maybe you want to consider sending it more broadly around the world. We have already generated those reports. Itâs once that report is generated it then becomes a manual process for sales to follow-up, but we can automate that. And then list management efficiencies thatâs really just doing things that help our list management services department manage more lists. Value-added services, this is â when we talk about the global administration functions for Universal, this is really where they would lie. For the most part, thatâs a little bit oversimplification, but there is lots of things we can do here that will enhance the distributions for smaller clients as well. International e-mails what I mean by that is languages. Right now, the player and the distribution software is translated, but the e-mails arenât. And I think I will mention only Quick Share here. Quick Share is a kind of exactly what it sounds like. Itâs an ability to share a piece of content really quickly. And we see that itâs more for one-off sending like if you are standing next to somebody and they want to receive a piece of content, you just can quickly share it. We have â we are in beta starting well, probably next week for that. We are just testing it internally right now. We think thatâs going to provide some incremental revenue for people who want to do that and then re-enhance the platform as it is. I will leave it there, because itâs a little bit longwinded, but there is just a tremendous amount of things that you can see that we are working on. And I think whatâs probably obvious is that a lot of these things are within platform improvements. And thatâs why we are spending up more and more on product development. We have â we are kind of focusing in on the self-signup, self-checkout. So thatâs getting more customers with an easier ability to signup and then sending, making it easier for that those customers to send to more recipients. So this is sort of the two main thrusts there. And to deliver faster we have made a change in our product development group to restructure it. So we think we are going to be able to deliver updates faster and in the right priority. Basically, we are focusing in on the quickest way to cash basically focusing on revenue generating things. Thanks, Fred. Good afternoon, everyone. Happy New Year. Before I get into wider updates and similar territory strategies for things like the Latin market in Canada, I wanted to expand a bit on the independent revenue that Fred touched on earlier. So generally, we look at independent revenue is any client that isnât a part of one of these three major label systems. So, this covers everyone from independent artists up to labels of essentially any size that arenât affiliated with either Universal, Sony or Warner. Due to this classification, there is some extra contents or context â excuse me on the revenue thatâs really helpful to understand. Going through the revenue at a very granular level shows that, as Fred mentioned, this quarters decline has almost exclusively been from independent artists and very small operations, such as management firms with one client or clinical labels that have one or very, very few artists on their rosters. And this decline is not seen with our label and promotion agency clients how they consistently put through releases on a weekly or biweekly or sometimes monthly level. The reason for the change with artists in these very small operations is somewhat an after-effect of the pandemic and the hit that the music industry took during it. Over the last year, year and a half, there has been a large amount of federal relief funding through things such as PPP loans in the U.S. some grants in other territories as well. And all of that funding has been available to artists for the first time in some situations. So while they werenât able to tour much of their spend and this budget that they had was reallocated from going out on the road to either creating new contents or marketing past contents that they hadnât sent out wide before. Essentially artists had to pivot to any avenue that could generate revenue for them, which was often radio or press or music supervision or something like that. So these artists essentially had more to spend than ever in the past. We have seen quite a few examples of this. For instance, one management company who I call it a management company itâs really one artists team. They took their federal funding and decided to put out all of that artists pass content globally in September, October of last year and that resulted in a single spend of nearly $10,000. Similarly, many other artists had the sudden budget to send the release internationally as opposed to keeping it in within their usual territory, their home territory and this past fall, without additional federal funding coming in and some of those programs kind of dwindling, many artists and small operations needed to become a bit more budget conscious and their total spend per release declined from the year prior. And I am sure the next logical question as well as the funding slowed, but touring began to open up as the world kind of opened up, then that revenue would have replaced the funding. Thatâs not exactly the case with these smaller artists. So with touring shutdown for so long, many of the opportunities coming out of the pandemic when venues and tour agencies reopened, they were given to the larger artists with more support behind them either as a following or just the team behind them. So independence ran into almost a bit of a catch-22, where they didnât have the additional funding that they did during the pandemic, but also couldnât book the tours that they are hoping for. For instance, we have been speaking to our partners in Australia and this hit there almost more than any other territory. Many of the opportunities when Australia began to open the borders were given to international touring acts that had to cancel tours in 2020 or early 2021 and the independents had trouble securing these routings. Another after effect of COVID was just a general kind of lighter release schedule for some labels, even labels with larger rosters and larger teams, they saw fewer releases this past fall as much of their roster had released that new content in early 2022. And we are now essentially off album cycle while they record new content for this year and next. We discussed with numerous of our clients and we are very confident that we will see return to the norm very shortly. We have also made advances internally that we believe will improve revenue from individual artists as well as those label clients. One of these advances is on our new marketing website that we launched publicly on November 1st. We basically stripped everything away from the old site and redesigned it from the ground up with the key point of making sure as we optimized, making sure the flow from getting to the website to requesting that demo and requesting more information was easier and smoother for the artists. And we also gave more detail to the value prop that that Plan B offers. Lead flow through the website has never been greater, we saw a roughly 20%, 22% increase already in this quarter compared to last fiscal with still obviously a month and a half to go. Lag time in lead conversion and the sales process sometimes appears due to the onboarding process, and things like artists planning ahead for at least itâs actually coming out a month or two months down the line, or maybe they are just kind of getting their head around the process and trying to plan it with their team. But with these new generated leads and some of the other optimization we have done, we have seen conversions begin to increase and pick up itâs just in so far in January alone, itâs up nearly 30% compared to last January. And towards the end of October, we did have a team member depart the business development team, which put us in a bit of a short staffed situation over the holidays, which also contributed slightly to the prolonged onboarding process. We have since made sure that we have the right team in place for our goals and our priorities moving forward that Fred will touch on. And as of this week, we are again fully staffed and we donât see â foresee this as an issue moving forward for a number of reasons. One of them being the new lead response automation that I think we have touched on in past calls as well. So, that automation, we fully launched it this past December, and it was designed to really try to dig in and optimize our onboarding process. We know that Plan B is somewhat complicated business for some independent artists and small teams to understand, so we took a magnifying glass to the process and the information to make sure that everything they need is delivered very clearly and concisely from their initial contact and hopefully that kind of advances the conversion conversation as it goes. This has been a collaboration between both our business development teams and our operations team. And we are very excited for what even further synergy there can mean for the future. Digging into some specific territories in the Latin sector, as you know from previous quarters and previous versions of this call, we spent the last year or so growing our presence and list offerings in Central and South America and the greater Latin market. The majority of our efforts have been around growing recipient lists and providing a distribution outlet to clients looking to target those territories. Now, we have built operational lists in 19 territories as of late last year. We are going to be focusing our efforts on growing the business in key territories in much of the same way that we have expanded into new territories in the past. I know Fred has gone through this process on past calls. But in short, we look at finding strategic content partners to grow our release catalogue and thus encourage increased activity from these new recipients. Itâs a little bit of a chicken and the egg of how do we get activity numbers without content and vice versa. So, we always start with making sure content is there when new users login if you compare it for the first time. This strategy also adds value to the list and higher activity rates we can achieve, the more value areas for artists and labels trying to get into the market. We believe focusing on Mexico is the best path forward not only due to its size and slightly more sophisticated music industry compared to some other territories in the region, but also there is a connection and a bit of a crossover between the Mexican industry and the U.S. Latin market. Given the size of Mexico as well, we are confident that success here will encourage greater use in other territories as well. Kind of having the stable tent-pole user in Mexico and then expand that to other countries like Argentina and Colombia and then such like that. I also wanted to review progress we have seen in Canada. As you know, we began commercially charging in Canada in mid to late last year. And we have seen progress there. Prior to commercially charging our Canadian revenue was mainly artists within the country, exporting their releases to our other global lists. These artists and small labels were hit by many of the same hurdles that I discussed earlier, whether it would be touring, diminishing funding, the same things that any other artists in any other territory we are going into. So, these specific hurdles in that independent artists sector has contributed to the decline we saw in Canada this quarter. However, digging deeper paints a much more positive outlook. Similarly, to how we are approaching Mexico moving forward, we focused on key partnerships with large independent labels and promotion agencies. And through these efforts, this past quarter, we saw substantial increases in both releases and revenue from some now consistent clients, such as longstanding Canadian independent labels, such as arts and crafts and flying colors as well as one of the most well-respected independent Canadian promoters company [indiscernible]. We are also having â continuing ongoing discussions with some other additional key partners. And we expect to have some more successes to talk about on future calls there as well. Speaking the future, with that, I will hand it back over to Fred to discuss the path moving forward. Thank you. Looking forward, so as I have said earlier, product development, I think is a really important way for us to accelerate revenue growth. We have talked about the growth in users, both in terms of growing customers, and then growing recipients on those. Those are really the two main drivers that we are going to be focusing our product around. We did where we are expecting to see a few press releases in the short-term on things that we are developing and starting to deliver. The first being Quick Share, and then the second is really a new product. We have talked about a little bit before and thatâs radio monitoring. We have â we are working through a couple of technical challenges, contextually detections are high and then in some areas where they are â we are missing something, we are just working through a technical challenge there. But thatâs moving forward. And we are just working on our business plan on how to launch that. To do all of these things, we again, we have made a change internally, that department and I expect things to be producing at a quicker cadence. Thanks Fred and Allan. So, yes, now we will begin our questions-and-answer session. [Operator Instructions] It looks like we do have one that was written into the Q&A chat if you guys want to touch on that one. Sure. I would prefer if people actually put their hand up and ask a question verbally, itâs easier for us to keep on top of those rather than reading them, so everyone else can see the question. The first question we have received is global revenue from Universal Group grew by 8.7%. How much of that is just price increase? Well, I donât know what that means by just price increase, the Universalâs agreement is flat global agreement that covers all of their use. We think we approach that in that way for specific reasons, but essentially covers all of their global use. And with growing use, growing platform capabilities, we negotiate increases. We agreed on 10% increase, effective April 1st, I think it was of last year. And the 8.7% is really just a revenue recognition issue. They are at â their monthly fees are 10% higher than they were last year. And thatâs really a function of all the custom development that we have done, and their growing use of the platform. The second year of that agreement starts, I think April 1, 2023. The second question is about activity metrics and I assume that means within the platform. Activity metrics are which activity metrics would you disclose there is all sorts of things as we track releases and distributions, active recipients, activities by recipients. And I think if you start producing those and we look at them internally, it has to come with a narrative about explaining how they relate to revenue. And it gets overly complex I think to do that.
|
EarningCall_1171
|
Ladies and gentlemen, good morning, and welcome to the Webster Financial Corporation Fourth Quarter 2022 Earnings Call. Please note that this event is being recorded. I would now like to introduce Webster's Director of Investor Relations, Emlen Harmon to introduce the call. Mr. Harmon, please go ahead. Good morning. Before we begin our remarks, I want to remind you that the comments made by management may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to the Safe Harbor rules. Please review the forward-looking disclaimer and Safe Harbor language in today's press release and presentation for more information about risks and uncertainties which may affect us. The presentation accompanying management's remarks can be found on the company's investor relations site at investors.websterbank.com. Thanks, Emlen. Good morning, and welcome to Webster Financial Corporation's Fourth Quarter 2022 Earnings Call. I am going to provide remarks on our strategic execution, high-level results, merger integration and strategic actions before turning it over to Glenn to review our financials in more detail. Opportunistic and prudent growth in targeted areas where we have competitive differentiation while continually see enhancing a diverse and advantageous funding profile. We continue to deploy capital and expense dollars into business activities that maximize shareholder returns and economic profit. We are delivering on this strategy as a unified Webster while at the same time executing on the integarion of our merger with Sterling. We continue to exhibit solid credit performance, and we are conservatively positioned in our capital levels and loan loss allowance. The net results of executing on this strategic plan are evident in our performance this quarter. On an adjusted basis, we generated EPS of $1.60 versus $1.46 last quarter and our PPNR grew 9% quarter-over quarter or by $35 million. Both our GAAP and adjusted EPS numbers are a quarterly record for Webster. Underpinning our performance, our net interest margin expanded 20 basis points and loans grew over 4% in the quarter with further moderate NIM expansion and solid loan growth in our 2023 forecast. With respect to our 4Q loan growth, we again focused our origination activities in asset classes with stronger credit profiles, such as public sector finance and fund banking. For the fourth consecutive quarter, the weighted average risk rating of our commercial originations were significantly stronger than that of the existing portfolio, which is intentional when operating in a more uncertain macro environment. We also enhanced our liquidity profile with the acquisition of interLINK, and we continue to have a solid capital position. These results produced an adjusted ROA of 1.61%, a return on tangible common equity of nearly 23% and an efficiency ratio of 40%. All of these figures meet or exceed the pro forma metric targets we detailed at the time of our merger announcement. While aided by a beneficial interest rate environment, we are also delivering on our operational efficiencies, growing loans in excess of our original targets and realizing new business opportunities from the merger. We believe that our business can drive solid operating leverage and PPNR growth through a variety of macroeconomic operating environments and interest rate backdrops and our goal is to generate consistent earnings and revenue growth throughout operating cycles. We also feel confident that we can operate with an efficiency ratio in the low 40s without sacrificing our ability to continue to invest in franchise enhancing and differentiated businesses. In fact, in Q4, we invested several million dollars in expanding our commercial banking activities, which should result in future growth over the coming years. The strength of our franchise is also evident in our annual results, which you can see on Slide 3. On a full year basis, we grew our adjusted EPS to $5.62 from $4.85 in the year prior and our return on tangible equity increased to 19.8%. We accomplished these results with a full year efficiency ratio of 43% and post-merger loan growth of 15%, ahead of our 8% to 10% expectations. We are certainly proud of the financial metrics achieved in the first year since merger closing, but we may be even prouder of what we've accomplished from a culture and talent perspective. We have an incredibly aligned and talented management team and a clearly defined values-based culture that is coming together ahead of our initial expectations. One of the keys to our performance, culture building and client retention as a company has been the consistency, continuity and execution of our client-facing colleagues, among whom we have experienced virtually no loss of talent over the last two calendar years since deal announcement. Before turning it over to Glenn, I want to provide a brief overview of our acquisition of interLINK, which closed earlier this month and provides us with tremendous core funding optionality adding to what we believe is an already differentiated deposit funding profile. Deposits we access via interLINK are considered core from a regulatory perspective, have an extremely low cost of acquisition and thereby an attractive all-in cost profile, which works well in all rate scenarios. And most importantly, it can be scaled up or down relatively quickly according to our funding needs. Operationally, interLINK administers FDIC insured deposit suite programs between broker-dealers and banks, such that broker-dealersâ customers receive FDIC insurance on idle cash balances in their account. We currently administer around $9 billion in deposit balances in the program, a substantial portion of which Webster could access over time. There is a small portion of the deposits we would not access to ensure that customers in the program receive maximum FDIC insurance coverage on their balances. We collect a small fee on deposits that we do not hold on our balance sheet. Itâs only been two weeks since closing and weâve already had great success with the program. Weâve begun utilizing deposits on our balance sheet as a replacement for wholesale funding without changing our risk tolerances in terms of asset generation. And weâve signed up a brand new broker-dealer contract just last week. We are also excited about potential other revenue synergies with our broker-dealer partners. We are pleased with our performance in the quarter, excited about how we are positioning the company for the future and confident in our ability to consistently deliver top-tier financial performance as we take care of our clients, our colleagues and our communities. Thanks, John, and good morning, everyone. I will start with a reconciliation of core earnings on Slide 6. We reported GAAP net income to common shareholders of $241 million with EPS of $1.38. On an adjusted basis, we reported net income to common shareholders of $278 million and EPS of $1.60, each of which exclude onetime after-tax expenses of $37 million. Merger expenses were related to real estate consolidation, severance and professional fees. The strategic initiative expense is primarily repositioning of our securities portfolio. . Next, I'll review balance sheet trends before moving on to the income statement. On Slide 7, at period end, total assets were $71.3 billion, with total loans of $49.8 billion and total deposits of $54 billion. Loan growth of $1.9 billion was primarily driven by Commercial Banking, which increased $1.6 billion. Deposits were essentially flat quarter-over-quarter. I will provide additional detail for both on the next two slides. Slide 8 highlights the diversity of our loan growth by category, a great illustration of the breadth of our business lines. In total, we grew loans $1.9 billion or 4.1% on a linked-quarter basis. Growth for the quarter was in the following verticals: commercial real estate, $756 million; fund banking, $520 million; sponsor $428 million and residential mortgage, $345 million. This was partially offset by lower mortgage warehouse lending of $252 million. Quarter-over-quarter, the yield on the portfolio increased 73 basis points and excluding accretion increased by 80 basis points. Switching to deposits on Slide 9, total deposit balances were essentially flat from prior quarter. This was the net result of a reduction in public funds, which were down seasonally by $1.1 billion and offset by wholesale deposits as we used a greater number of sweeps and other alternate sources of funds. The total cost of deposits increased 60 basis points â to 60 basis points from 28 basis points prior quarter. Our effective beta was 22% in the quarter and 15% for the year. Beginning on Slide 10, I'll review the details of our income statement. We provided our reported to adjusted income statement by line item and compare our adjusted earnings to the third quarter. Net interest income grew by $51.4 million or 9.3% linked quarter, driven by our origination volume and a higher rate environment. The growth in net interest income drove meaningful improvement in PPNR, net income and EPS. On an adjusted basis, PPNR was up $35 million or 9.5%. Net income was up $21 million or 8% and EPS was up $0.14 or 10%. I will cover the individual line items in more detail on subsequent slides. The net interest margin was 3.74%, up 20 basis points on a reported basis and our efficiency ratio was 40%, down 90 basis points from prior quarter. On Slide 11, net interest income grew $51.4 million relative to prior quarter. Adjusted for accretion in both periods, net interest income was up $58.3 million. This was our third quarter of strong results driven by both loan growth and the asset sensitivity of our balance sheet. Excluding accretions, the net interest margin increased 24 basis points to 3.68% and the earning asset yield was up 70 basis points in the quarter. As illustrated on the earlier slide, the cost of deposits increased 32 basis points quarter-over-quarter. We anticipate further deposit rate increases in the coming quarters and through the cycle cumulative beta of roughly 25% excluding mix shift effect â the mix shift effects from wholesale funding into interlinked â from interlink deposits. On Slide 12, we highlight our fee income for the quarter. On an adjusted basis, fees were down $7 million linked quarter. The linked quarter decrease was driven primarily by the outsourcing of our consumer investment services platform, as well as a number of smaller items and other fees. The year-over-year decline was a result of lower income in direct investment and mortgage banking fees, as well as the outsourcing of our investment services. Slide 13 summarizes non-interest expense. We reported adjusted expense of $302 million relative to prior quarter of $293 million. We continue to make progress on cost efficiencies related to the merger. However, this quarter included increased levels of performance-based compensation, benefits expense and a strategic investment in Commercial Banking. The year-over-year increase of $2 million is a combination of our cost save efforts to-date, offset by the increase in intangible amortization, the Bend acquisition and performance-based compensation. Slide 14 highlights our allowance for credit losses, which was up $21 million over prior quarter. After recording $20 million in net charge-offs, we recorded $41 million in provision expense with loan growth representing $20 million of the increase and macro factors adding $21 million. Slide 15 highlights our key asset quality metrics. On the upper left, nonperforming assets declined $6 million from prior quarter and represented 41 basis points of loans. Likewise, commercial classified loans declined $4 million and represents 150 basis points of total commercial loans. Net charge-offs on the upper right totaled $20 million or 17 basis points of average loans on an annualized basis and the allowance coverage ratio remained flat period-over-period at 120 basis points. The allowance to non-performing loan ratio increased to 2.9 times, up from 2.7 times last quarter. Coverage as a percent of commercial classified loans increased to 99% from 95% prior quarter. Our capital levels remain strong as illustrated on Slide 16. All capital ratios remain well in excess of regulatory and internal targets. Our common equity Tier 1 ratio was 10.71% above the medium-term operating target of 10.5% and tangible common equity ratio was 7.38%. Tangible book value per share increased $1.38 to $29.07 a share, driven by our strong earnings growth. I'll wrap up my comments with our outlook on Slide 17, where we provide our full year projections. Our expectation for the rate curve is that the Fed funds peak at 5% in Q2 and end the year 50 basis points lower. We expect loans to grow in the range of 6% to 8% with diverse growth across all business lines. We expect deposits to grow 4% to 5% excluding the impact of interLINK. The acquisition of interLINK provides flexibility in funding our forecasted loan growth. Given that in the structure of our balance sheet, our full year outlook for net interest income, excluding accretion is around $2.5 billion. On the slide, you see the range of expected results. We expect $25 million in accretion that would be added to the net interest income outlook. For those modeling net interest income on an FTE basis, I would add roughly $65 million to the outlook. Fee income should be in a range of $415 million to $430 million, which incorporates the full year impact of lower net fees from the outsourcing of our consumer investment services platform, as well as lower derivative income. As the range in our outlook illustrates, core expenses are expected to be around $1.2 billion to $1.225 billion, which will continue to result in an efficiency ratio in the 40% range. On capital, our overall philosophy is unchanged. As we approach our medium-term operating target, organic growth opportunities will likely occupy a greater share of capital deployment and we are forecasting an effective tax rate of 22% to 23%. Thanks, a lot Glenn. We are systematically executing on our merger integrations and our core conversion timeline remains unchanged with final conversion targeted for the middle of this year. We continue to consolidate systems sitting on top of our core technology, which enhances our colleaguesâ capabilities and simplifies the conversion process, as well as our operating processes. We've also wrapped up our previously detailed corporate real estate consolidation. While a tremendous amount of effort, as you can imagine, is going into ensuring a smooth systems conversion, all of the business lines have turned the page and are functioning as a unified Webster from an operating relationship management and client service perspective. Our strategic vision and values are integrated, our operating structure is established and performing at a high level and across the bank, we are focused on delivering for our clients. 2022 overall was a terrific year for the Bank. Our commercial loans grew 17% for the full year. We maintained a relatively low cost of funding as our transactional deposit balances, including HSA deposits positioned us well for a higher rate environment and we should continue to benefit from a relatively lower cost of deposits in 2023. We added to our technology-enabled businesses with the acquisition of Bend at HSA Bank and the announcement and subsequent close of the interLINK transaction, while also investing in digital enablement across the Bank, all of which enhances our differentiated funding profile. During the year, we repurchased $320 million in stock enabled by our strong capital position and capital generation capability. As we look forward for the rest of this year, we understand that the macroeconomic environment remains uncertain. However, we are confident in our ability to generate solid operating results regardless of how the year plays out with respect to the economy. Our ability to operate a highly profitable company starts with our competitively differentiated business lines and our diversity of funding channels, our efficient operating structure at 40% efficiency, an agile approach to our business and importantly, very importantly, prudent enterprise and credit risk management across our organization. As we wrap up, I am sure most of you saw our announcement, but I just want to highlight that we'll be holding our 2023 Investor Day on March 2 in New York City, where our talented management team will provide an extensive view of our disciplined approach to managing our business, our go-forward strategies and the significant opportunities for growth we have in front of us. We'll also have an opportunity to do a deep dive on our loan portfolios, enterprise and credit risk management frameworks and how we view our role importantly as a responsible community-focused corporate citizen. I look forward to seeing many of you there. Finally, I want to thank all of our colleagues at Webster. The outstanding results we announced today are a direct result of their hard work and commitment to the culture and the focus on our clients. Hey, John. Hey, John. I guess, maybe a question on the InterLINK deal, your stock has traded heavy over the past few weeks I think because of some concerns about liquidity and I think the quarter was very strong. Could you help us with just how you plan on using InterLINK and maybe it feels like arbitrage on the deposits just from a classification but what are the rates that are on these versus the borrowings in the quarter and just how much growth do you expect to put on the balance sheet? Thanks. Yes. Glenn can give you some more detail on the cost of the deposits? Look, it is interesting, right? We've gotten a lot of feedback, some saying, boy! they had a liquidity issue. They needed to beef up their liquidity. On the other side, concerns that we were going to take $9 billion and generate and accelerate loan growth into an uncertain macro environment. Neither of those are the case, Chris. We looked at this as a long-term opportunity from a position of strength to further enhance our optionality on funding sources. So, if you look at us, even in a quarter like this quarter where we had seasonally low government deposits and we haven't yet seen the first quarter inflow of HSA deposits, our loan-to-deposit ratio, even after $2 billion of loan growth still comfortably in the low 90s. And in the first quarter, we're going to be $300 million or $400 million of HSA deposits flow in. We'll have government seasonality work to our advantage. So, we're not constrained at all from a growth perspective and a funding perspective. But we looked at this as an opportunity to give us in terms of our three to five year plan, optionality around how we can fund our growth with core deposits and it can replace wholesale funding. It can help us if we do have acceleration of loan growth when we get the all clear from the economic environment, it can help us there, as well. So we looked at this as a really opportunistic acquisition for us and we think when you add it to BRIO, our direct bank and you add it to HSA and you add it to our sticky core retail deposits and our commercial deposits and our government deposits, we are in a position now where we continue to build out this really diversified and broad funding source and we think this is a really good addition. Yes, Chris, I would just add, if you think about it from a cost standpoint, FHLB but use it as a proxy, we are paying about â I think for the quarter, we're like 438 all in on FHLB and this is probably a product that has -- it's priced at like Fed funds plus 10 to 15. So really, it's just moving the geography of our funding and actually increasing our core funding ability. Okay. That's helpful. Thank you. And maybe on credit, last quarter, you moved off roughly $0.5 billion, which I don't know got enough attention of riskier credits. Can you just, John, make a comment or two on how you are feeling about certain portfolios? Obviously, the sponsor book is a lot of attention. And also remind us, your ACL is 1.2, but do you have that stat with the marks? Thanks. Yes, no, I think all really good points. Obviously, thatâs right the focus of everyone following the industry is what we are going to see here from an economic perspective and what the impact is going to be on credit. So far, again, obviously, we're pretty pleased with where we are. We, interestingly, write NPAs come down and classified has come down both on a real dollar basis and on a percentage of portfolio basis, I did make the comment around the quality of our originations. We're being very thoughtful around trying to avoid cyclical businesses and stick to our knitting in areas where we think there's a lot of resiliency. From a â we did shed about $0.5 billion strategically and I think that was a really good call just in terms of the way the markets continued to move in the third quarter. Chris, we didn't have any material moves like that in terms of portfolio sales in the fourth quarter. Our charge-offs, which are lower than prior quarter do include some losses taken on sale of loans, not loans that have gone through a foreclosure process, but again, being proactive. A couple of office deals are in the four or five commercial charges that we took that make up the $20 million. So we are still being really proactive from a balance sheet management perspective. And as we mentioned last quarter, when we â as we look into 2023, we are kind of right now currently evaluating all of our commercial niche businesses to see whether we've got some businesses that are subscale or are there portfolios that we're concerned about. We didn't take any material actions in the fourth quarter and right now, quite frankly, we don't see any urgency in terms of deteriorating credit performance. More broadly and I don't want to ramble on forever. But more broadly, we're still focused on office because we think not only does the economic environment impact it, but as you probably talk to all the companies you cover, people are just concerned about the paradigm shift there. And so, we still are in a pretty good position in terms of risk ratings there, rent rolls, classified. So, we're not at all panicked. We're focused on it a lot, but also really focused on all of our risk selection moving forward. So, pleased with where we are now. We haven't really seen the deterioration. I think that people across the industry would have anticipated. I think the whole industry is feeling that way, but we're certainly being more proactive in how we manage our balance sheet, how we select onboarding credits, making sure we're doing more frequent and deep portfolio dives on what we have in our book right now. Just, if I could. You mentioned office. Can you provide the updated exposure, anything on watch, classified non-accrual, any trends there? Thanks. Sure. Our classifieds are down a little bit. Let me pull it up. I think we are about $1.5 billion in total office exposure now. And when I say total office exposure, it's kind of traditional white collar, it's not including the medical office, which, as you know, is performing really well across the board anyway. And so, I think our --let's see. Yes, we've had a slight decline in classified. Some of that probably have to do with the fact that we've been lightening up on the portfolio. But again, we haven't seen any material deterioration in the portfolio and what weâve been doing is kind of selecting those Class-B and Class-C office loans which representa about half of that $1.5 billion. Weâve been kind of looking at them and trying to think about whether or not there is particular vulnerability and then seeing whether or not we can exit those credits kind of before maturity. And so, I think I would characterize it as we come down from $1.7 billion through actions. We are at $1.5 billion. Itâs about 50:50 Class A and Class B, C and weâve seen sort of stabilization in the general credit characteristics of that portfolio, but we still are, like everyone else, concerned about the long-term nature of that asset class. Good, thanks. Just a quick follow-up on the office portfolio stuff. Of the $1.5 billion, is most of that in Metro Boston, Metro New York? It is not â I would say, yes, there is probably about half, Mark. Actually, that's not true. Hang on. Latest data, I have about 25% of our office exposure is five boroughs. Yes. The weighted average LTV, the last time we updated this at the end of the third quarter, we were about 53% weighted average LTV. And I am actually reading this as we go through it right. Our criticized and classifieds have gone down from about 8.7%, 6.6%, and that improvement is probably also because weâve lowered the overall amount of the portfolio. So, pretty decent stability, Mark, right now. But as I said, we continue to watch that like the rest of the industry does. Okay. Great. And then, I wondered if you could share with us how the renewal season in the HSA business is shaping up. I thought I heard you say $300 million or $400 million of new HSA deposits coming in. Did I hear that right? Yes, sure. You did and I know we historically have always answered this question in this earnings call by saying we'll be able to provide you more confident and detailed information when the first quarter is done. But I can tell you this, it looks like we're a couple of percentage points higher than the last enrollment season's growth. I think we expect about 325,000 new accounts to come in the first quarter and we're maybe 65% of the way there, which is kind of slightly ahead of where we were last year. And as I mentioned, the expectation is for $300 million or $400 million. It's always harder to predict the deposits because of initial deposits into the new accounts, how the funding works and whether or not there is any attrition in those numbers. But I think that's good enough to give you a comfort level as to what we feel we're going to achieve and then obviously, in the first quarter and at Investor Day, we'll give you a deep dive, and we'll tell you exactly where we are. Okay. Great. And then lastly, Glenn, I wondered if you could share any thoughts on the outlook for the provision over the next quarter or two? Yes. So we're at 120, as we reported in the quarter, it's been basically flat. We're at the top quartile of our peer group. So we feel really good about that. I think it will be impacted by loan growth as we go over the next couple of quarters, but more importantly, the macro environment and that's where the challenge is. And so we did build in the quarter and there was about $20 million of build that was related to the macro environment. So it's hard for me to handicap, but I think our coverage ratio could drift up if we do see us going into a light or a slowdown in the economy. But that's all I can tell you right now. I wanted to touch on the NII outlook, the core NII outlook. It looks like it averages about $600 million for the quarter, but as you alluded to, there is going to be some, the Fed fund is going to go higher and then potentially get some cuts towards the back half of the year. So I was hoping to get an idea of cadence and where we might see kind of the year-end NII. Yes. Good. I'll take that. So Matt, I think, look, if we look at it, these numbers are ex accretion, right? So if you think about our fourth quarter, 368 ex accretion. And I would probably say that by year-end, we end in the range of like the mid-370s. So, going into the first quarter, it sort of tapered by two less days, but then we start getting a little bit of expansion over the next couple quarters. And that's a sum of a lot of factors. Obviously, it's â it is â we do think this is based on a forecast where Fed funds peaks in the second quarter, 5% and then comes down by the end of the year, like I said, 50 basis points. So there is that â there is the loan origination volume. There is an assumption on data, but that's where we ended up. Understood. Okay. Going back to HAS, so a couple days ago, we received the pricing on a $380 million book of HSA deposits sold in November. It looked like it's sold for a near 25% deposit premium. Given the size of your book and the current valuation of the overall company, it certainly doesn't feel like you're getting that kind of valuation recognition. With that in mind, I would love your thoughts on the underlying value of HSA and how to either better showcase it within Webster or get your thoughts on potentially achieving it elsewhere? Thatâs a great question, Matt and it brings back the days when we answered this question more frequently. Look, I would agree with you right now that just in terms of the overhang in the banking industry and valuations of bank stocks, right, itâs hard to kind of do with some of the parts valuation and see that you are getting full value for differentiated assets. No matter who you are and what you own right now, just given concerns about credit and interest rates. We have said, over and over again, we continuously evaluate the HSA business and we continue to come from a pure economic profit perspective to the conclusion that our advantage of owning and wholly owning that business and our ability to deploy low-cost, long-duration deposits into the growth of our business and holistic relationships creates the most value over the long term. And what you've seen here is, throughout interest rate cycles, you have seen us start to get recognition for having that business because of its unique growth trajectory, the fees it generates and importantly, the long duration, sticky, low-cost deposits. The deposit costs in that business went from 7 basis points to something like 15 this quarter, that's still below our 10-year average rate of what those cost of deposits are. So we do believe that as we get more clarity just in terms of the economy and people realize the differentiation and it should grow faster than our other deposit channels just by its general nature and again, become more of a contributor to the overall funding profile that people will start once again to recognize the power of that business, both from a funding perspective and a growth perspective. So I think your observation is correct. I think we â obviously, we have a duty as stewards of capital in all our businesses to constantly look at the value and where are our assets and where the things we own are most valuable. We continue to be determined that it will continue to provide value to Bank shareholders, the shareholders of Webster Bank and that owning it wholly right now is absolutely the best creation of value that we could have with HSA. Thank you. I appreciate that. Two other ones from me. The first one was just past dues, there was a bit of a pickup in commercial real estate and ABL loans. Curious what was going on there? And if there is any sort of progress towards NPA or maybe pay offs? Yes, it's a great question and actually, I can â I always am transparent. I am frustrated that that was the case. They went up basically about $30 million in reported delinquencies. We have since the end of the year, resolved more than the increase in delinquencies. So if you looked at it, those were all administrative delinquencies, meaning we couldn't get the documents together and get the extensions or the payoffs or the restructurings or whatever they were off the books. They were all paying and current and at the end of the day, we're now down to $45 million, $44 million in delinquencies. So, that entire spike was really due to administrative delinquencies that since year-end have been resolved. Great. I appreciate that. And then the last one. On the Sponsor & Specialty and leveraged loan portfolio, I frequently go back to the first quarter of 2020, your presentation there where you laid out some really laid out some really fantastic metrics across the entire book. I was hoping for an update on a couple of them including leverage ratios, cumulative charge-offs, non-performers at this point in time and then loan-to-value ratios if you have them handy? Matt, I am going to defer that to our Investor Day. We are putting together all of our current numbers as of year-end to provide a really deep dive. What I can tell you is that you have not â we have not seen the significant risk rating migration. We have certainly not seen a material loss in that portfolio. We have, again, our â I think to give you the answer that I can best give you right now is we're seeing the same thing that we've seen in periods of uncertainty, which is, we're in industries that seem to be more recession resilient with more predictable and contractual cash flows. That's a general characteristic of the portfolio. We deal with sponsors that we know and love and have spent a lot of time with and even if revenues have been challenged or even if valuations and enterprise valuations have been sort of revisited, we're in a position where the capital structure and our position in that capital structure is such that no one is close to wanting to hand us the keys and both us and the sponsors that we work with, just make sure that we continue to evaluate opportunities and we continue to support each other going through. So, we have not seen significant migration. We have not seen people deciding that the operating environment is too challenging and we've been pleased that in areas like healthcare and areas like technology and the places where we focus our Sponsor & Specialty activities, we've seen pretty good resiliency from the portfolio so far. That doesn't mean, right, that higher interest rates don't matter on debt service, particularly if revenues are getting squeezed. So, we're on top of the portfolio, working closely with our sponsors and you can rest assured that on March 2nd, we will update all the information and give you a really good deep dive on what that portfolio looks like as of year-end 2022. Yes. Thanks. Good morning, everyone. Apologies if I missed this. Glenn, any thoughts on what deposit beta, cumulative deposit beta expectation is underlying this NII? Yes, sure. So I did say, Casey, if you missed it, our legal â since Legal Day one, our cumulative deposit beta is 15%, and quarter over â that means quarter-over-quarter our deposit beta was 22%. We think given our rate outlook, meaning Fed funds peak at 5% and dropped by 50 basis points by the end of the year that are cumulative through-the-cycle beta will be around 25%. I should point out that HSA to benefit that by about 5%. So the low cost long duration nature of existing deposits certainly benefits us. Excellent. Thank you. And then another follow-up on InterLINK, first off, can you disclose how much you have used since the deal closed over this month? And then two, one of the applications this â that you guys have spoken to is like, your forecast calls for Fed cuts and using this funding vehicle to build the bond book would be a very nice way to kind of increased liability sensitivity ahead of a Fed pivot. So just wondering how you're thinking about that as an application. Yes. So let me hit a few and then I'll flip it over to John. So, first off, the betas that I gave you are on our â they exclude interLINK because we're at the beginning of this and so there'll be some puts and takes to that as we decide whether to leverage the optionality that interLINK provides or not. To-date, I mean, and this is â as of two weeks closed, we have about $300 million in deposits and paying off things is the first tranche paying off some of our FHLB and I talked about the pricing dynamics of that to basically just a wash from a standpoint, but it does provide us with core deposits. And then, going forward, to your point, we do have the optionality to pay off some future FHLB borrowings or to investments in securities. So, that's an option that we're looking at going forward. But I don't know if you want to... Yes. I mean, Casey, I think the last point you made, thank you for making it. I agree. I mean we were traditionally, right, you heard me in my comments, our committed desire to have more consistency in earnings given our asset sensitivity, right? And so we've been spending a lot of time on that. This does provide different optionality. Yes, on its face, the cost of these deposits is Fed funds and â but obviously, in a lower interest rate environment, it does give us some opportunity to take advantages as the cost of those funds come down, and we can deploy them into securities or deploy them into loans. . As I said in the very beginning, we looked at this and said, given the opportunity, given our position of strength and where we are and the fact that we really love our funding profile already, wouldn't this be great to have another tool in the toolkit to deploy in various interest rate scenarios, in various asset growth scenarios, in terms of seasonality and inflows of outflows of other deposits and potential other business opportunities with the broker-dealers. So, I think your point is a very, very good one and the answer would be yes. Got it. Great. And then, just one more on the expense side of things. So, the guide, if I look at your run rate here in the fourth quarter, you are kind of in the middle point of your guide and you got that conversion coming midyear. So there could be some leverage in the back half as you recognize some of the cost saves. Just where are we in terms of realization of those cost saves? And I guess, what can the expense run rate exit the year at in the fourth quarter? Casey, I am going to let Glenn give you the specifics. I do want to make a strategic comment on expenses. Right, I mean, obviously, what weâve been able to do and again, we can go into more depth, obviously there are significant synergies related to this merger, some of which we have already realized, others that we still have to come, including, as you said, $30 million to $40 million related to ultimate end state after technology conversion. We also have said and I've said all along in terms of managing the businesses that this allows us to invest. We're operating at a 40% efficiency ratio. If you look at the guidance, the efficiency ratio could go have a three handle on it at some point and our goal is to operate a really robust and resilient bank that has franchise value and the ability to continue to invest in differentiated businesses and drive high ROATC and ROA and I think we're demonstrating that. So, just from a top-of-the-house perspective, we also look at the synergies not only to get to our lowest core run rate in expenses, but to offset our ability and to not have increase in expenses while we're continuing to invest. Glenn talked about $25 million in commercial banking and HSA investments related to Bend, teams and some other initiatives that we'll talk about again more at Investor Day. We're able to do that without increasing our efficiency ratio significantly because we continue to look at the synergies that come out of the merger. I would also comment that we've been very deliberate in terms of things like reducing square footage in the banking centers. I think we were one of the only MOEs not to have a bunch of the economics predicated on taking out branches. We haven't closed any branches since the â except for at a lease expiration, maybe a one-off or two off, but we've had no reduction square footage in our branch footprint. Obviously, as we've talked about over time, and the industry knows, there'll be opportunities to reduce square footage. We want to make sure we get through the conversion, take care of our customers. But we have levers like that to pull as well to accelerate expense reductions over the longer term. So, I wanted to give you just kind of my thoughts about the fact that we're not managing quarter-by-quarter that we think we've got a unique opportunity to continue to invest in key businesses and that the synergies underlying that will allow us not to have significant growth in expenses where many of our peers are seeing inflationary pressures and growth in expenses. And then over time, we do have more levers to pull should the revenue tailwinds kind of slow. We look at our branch footprint and look at other potential cost saves we have and levers to pull. Yes. Casey, I would just add. Look, our core expenses on a pro forma basis, I think, are about $1.19 billion for 2022 and our guidance would suggest that we have an increase of 1% to 3%. So that's anywhere from $12 million to $37 million. As John indicated, whether it's FDIC cost going up $15 million or whether it's the investment in end, the investment in commercial business, we're pretty much offsetting the bulk of those through vendor FTE redundancy, all tied to the merger of equals. So, we feel really good about our expense projections at this point. Will do. My first question is on DDA deposits. Can you talk about your expectations for DDA deposit outflows? What are you hearing from your customers? And what do you think is considered a more normal operating level? And maybe as a reference point, pre-pandemic, you were about 20% of total deposits. This is excluding Sterling. Do you expect to go back to that level or what is a more realistic mix going forward? So I think we are running about 25% of total deposits on DDA, right? And I think on an average quarter-over-quarter basis, there wasn't that much deterioration, a couple â maybe a couple of hundred million. On a spot basis, it was probably down, I think, about 6%. Some of that is the municipal deposits that I talked about. So you'll see some seasonality come back into that as well. So I think as we looked out on a full year forecast, we think it's going to be in that range, say, 23% to 25% of total deposits, which given our deposit outlook would indicate some growth. Thank you. And then, just a follow-up question, On NIM, what are your spot loan yields as of 12/31 relative to that 525 for the average for the quarter? Okay. Thanks. And then, maybe just a little detail on the securities repositioning, how much you sold, what you sort of picked up in terms of duration, are you extending duration there and if you have AOC at the end of the year? So, it was relatively small, Jared. We sold about $125 million of securities and I think the earn back on that is probably â it s less than a year and it was primarily munis sort of -- and we've repurchased the Ginnie Mae project. So, the yield on that, so we've gone from like a 1.5% rate to like a 6.5%, somewhere around there on that. So, and the duration was about 3.7 years in it. So, it was a small amount of $123 million. As we think about asset sensitivity, we're looking more at that. We're looking â we've done some collars. We're also looking at loan swaps and stuff like that. And so there is â we think it's probably the right time given the asset sensitivity in our view on rates that we begin to take and protect on the downside a little bit more. So, these are some of the actions that we're taking. So the AOCI actually came back to us a little bit. On a capital basis, I think we had an improvement of about $57 million after tax. So it actually we went from an after-tax of 688 million to an after tax is 631. So that's starting to accrete back into our capital. It's kind of tied to the five years and think about it that way. Okay. Okay. And then, just looking at loan growth in your comments that with the - more broadly on uncertain economic backdrop thatâs tampering it a little bit, 6% to 8% is still pretty good. Where do you think it would be if you weren't holding yourself back based on economic uncertainty? And I guess, where do you think that could go in a better backdrop? Yes, Jared, that's a great question, right? And I always have a tough time answering it, because I feel like we've said, again, and I've been pretty proud of this for seven or eight years, right, that we can grow commercial loans, 8% to 10%. And we've done that throughout different cycles and throughout different general circumstances, loan demand, economic environments. And we've also said that we're never going to try and grow loans at all if there is no safe loans that have the right risk return characteristics or that we feel comfortable about from a risk perspective. And I think over time, we had outsized loan growth to our original forecast. There was, I think, market concern about whether or not as a bigger organization, we could generate that. And then obviously, we did, we talked about higher hold levels, being able to take better risk with higher quality credits and higher hold levels. I think everything we talked about in getting to our 17% commercial loan growth in the year, kind of played out and came true and we were disciplined. We were going for loan growth for loan growth's sake, where you can see areas like mortgage warehouse that are less relationship-driven, didn't really drive loan growth, where we have loan growth, we're getting deposits. We're doing it in commercial real estate, in multifamily and mixed-use industrial, right? We're not doing office. We're being careful about the asset classes we're in. We're taking care of our geographic middle market clients. We're being careful and sponsor and we're moving forward. So, I think the 6% to 8%, if I could make it sort of as plain as possible is probably our general assumption that it's 8% to 10% but understanding that this is a choppier year, right. And understanding that there may be less loan demand given economic growth characteristics and we want to be really careful. So, when you asked and said, what would it be if we weren't in this environment, again, I think we can safely and predictably as a bank grow loans 8% to 10% year in and year out. I think you're seeing a little discount to that general guidance just because it would be prudent to put that out there given the economic uncertainty and concerns about risk return characteristics and quality of credit. Hey, good morning. I wanted to ask on repricing expectations on the loan book. Can you talk about how spreads are holding up in the commercial portfolios just general competitive dynamics and what runway you have for loan repricing if the Fed pauses later this quarter? Great. Are you asking more about the competitive landscape on loan spreads? Or the impact of our floating rate portfolio and asset sensitivity and what happens when rates fall? The former. Yes. So from a competitive perspective, it's interesting, I actually read a couple of other â our peers and big bank transcripts. I think everybody is seeing the same thing, which is there is slightly less competition just given the macro environment, the non-bank lenders that have been competing with the banks are less aggressive and active given cost of funding and other elements. So I would say spreads that had been continuing to narrow over time during periods of high growth have kind of stabilized. So from a competitive perspective, I do feel that the regulated banking industry has a little bit more leverage in making sure they are getting paid for risk. So I think we've seen rates kind of stabilize to slightly expand given the credit environment. And then obviously, the fact that we have a large floating rate book allows us in this interest rate environment to have higher yields on our loans. But the underlying credit spreads, I think, I would say, are stable to slightly improving. Got it. That's helpful. And then, just a follow-up on interLINK. I think you mentioned that there are other revenue synergies you have with your broker partners. Can you talk about what those synergies are and what the timing of those synergies would be? Yes. Again, nothing is factored into our forward forecast, but we have opportunities with respect to banking services and cross-sell with the broker-dealers. We have opportunities potentially with HSA Bank and investment platforms with the BDs, securities lending activities. So, there are a number of things that we're exploring. Nothing is in our guidance. So it would all be kind of upside to kind of the revenue and fee guidance that we provided. And again, I think one of the focuses we're going to have on March 2 and I hope you can be there will be a look at a number of revenue synergies coming from the merger and from some of these acquisitions like Bend and interLINK. So, we'll provide a little bit more meat on the bone there. But there are significant opportunities, and we've already engaged with our partners there in discussing some of the potential opportunities we have. Three unrelated questions here. Number one, just going back to interLINK. If I am looking at Slide 17, your forward guide, how much are you assuming in interLINK deposits that you actually pulled down this year in 2023? So like I said, right now, we have about $300 million in the first quarter and I think you could expect $2 billion to $3 billion in the first quarter and then to grow a couple of billion each quarter. Again, that will depend on the optionality. So, I think that the highest we would assume in our outlook right there is $5 billion to $6 billion by year-end. But again, we will monitor that and have optionality . Got you. Okay. Thanks. And your drop in wealth management revenues this quarter, can you talk a little bit about how we should think about that? Yes. So we announced in, I think, on the third quarter call that we had outsourced our Webster Investment Services, which is our retail platform to LPL. And so, what you see there, Laurie, is a netting of the fees with the expenses and so it's generally around $4 million to $4.5 million reduction in fees as a result of lower expenses. So Laurie, when we own that, right, we used to recognize gross revenue and we used to recognize all expenses. The Sterling model was an outsourced where there is a net fee of those two. We did a lot of examination in terms of client satisfaction and where we are from an economic perspective and it made sense for us to adopt the legacy Sterling model. And so now we happily report lower overall fee revenue, but significantly overall lower expenses there as well. The actual net is slightly better from an economic perspective than where we are. But that does not indicate any change in kind of the trajectory of the underlying business. Got it. Perefect. Thanks for the refresh there. And then last question, office, did you have any office sales this quarter? And then, your $21 million or so of net commercial charge-offs, how much of that if any was office? Thanks. Yes. So again, we're â what was wonderful is our net charge-off number on an annualized basis is kind of consistent with our pre-pandemic four year running average rate and in that, to your point, there are some â as I mentioned on an earlier question, there were a couple of proactive note sales that contributed. So we had in our consumer business, we had net neutral to net recovery. All the charge-offs were basically driven by four or five commercial credits, two or three of which Laurie were office related. Aggregating somewhere in the $10 million range and two of those three office credits were proactive note sales. And so, that's about as granular as I'll get there. And again, I think we feel pretty good about the way we're proactively managing that book within and the sort of ultimate results from some of the asset sales we've gotten there are going to benefit us going forward. Yes, just a few cleanups. Glenn, anything else to call out on the fee expectations guidance. Anything new there? Is it just a simple as pull out the losses and continue the path that you had in the fourth quarter? No. I mean, I think we just talked about part of that is part of a decline year-over-year. $25 million or whatever is â about half of that is the netting of the consumer investment platform. We don't think that will get the swap income that we got last year, obviously, because of higher rates. And then, we did â we have factored in lower deposit fees due to consumer behavior, industry pricing and things like on HSA. I am sorry, on a GAAP basis, for fourth quarter, obviously, you have that securities loss of $4.5 million as well. So, that will be, as we review the securities portfolio, we'll spike that out, obviously. But if we take more actions, that could influence that number on a GAAP basis. Okay. Good. And then, on interLINK, is there a size limit you are thinking about in terms of deposits on your balance sheet? And do you plan to report it separately like you're doing on Slide 5? Yes. we'll absolutely provide that. Again, the great thing about it is accordion feature where there is an automatic distribution valve in terms of whether we need the liquidity and it's optimal for us. I think just like we had the questions over years around HSA, what's the right number? We always got questions about whether the regulators care that HSA was becoming 20% to 25% of our deposits. I think we'll use the same prudent risk management and we have so many different deposit channels when you think about retail, commercial, small business, BRIO Direct, which is our direct channel, HSA Bank and now interLINK that I think will just be prudent to make sure that there is not too much of a concentration. But if you look at what Glenn just said about what we mentioned earlier, the opportunity, even if $9 billion or $10 billion could be available to us, it doesn't really represent a concentration going given the overall core funding deposit profile. So, I think itâs going to be less about us sending an artificial limit and more about do we have used an opportunity to deploy those deposits. Yes. And John, we have about $5.5 billion in FHLB funding at quarter end and we are basically at 438 and so the pricing is pretty much very similar to InterLINK. And so, if you think about on that perspective you can pay a bulk of that down and gain the core deposits at the same time, right? And then, you have further optionality, whether it's the securities portfolio or things like that. So it provides a significant amount of optionality for us. We don't have to take â I think I answered 1 of the questions say we could have up to $5 billion or somewhere around there by year-end. But that's an option for us, right? Okay. Great. And then, on expenses, you may not answer this, you may have answered it already, but you mentioned some expenses on expanding commercial activities. And is that what you talked about sharing on Investor Day? Is there something more that you can talk about now in terms of that? Yes. I mean, there is nothing hidden, right? It's new verticals, it's hiring teams and people. There are a couple of new potential business initiatives that we're viewing right now. So it's what you'd expect and what you've actually quite frankly, seen Webster entirely and both of the legacy organizations that form this new bank do over time, which is to continue to take advantage of opportunities in areas where we can get full relationships with deposits, capital markets fees, cash management and look at geographies, asset classes and verticals and invest in those. And I think I'd like to say that we've done it with success over time and I think we will share more at Investor Day, but it's not a top secret. It's about building out and kind of replicating what we've done in the past with respect to expanding activities. And with no further questions, I will now turn the call back to Mr. John Ciulla for closing remarks. Thank you very much. Really appreciate everybody joining us for this great discussion this morning and thank you for your continued interest in Webster. Have a great day.
|
EarningCall_1172
|
Good morning, and welcome to the Pacific Premier Bancorp Fourth Quarter 2022 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After todayâs presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. Thank you, MJ. Good morning, everyone. I appreciate you joining us today. As you are all aware, we released our earnings report for the fourth quarter of 2022 earlier this morning. We have also published an updated investor presentation, with additional information and disclosures on our financial performance. If you've not done so already, we encourage you to visit our Investor Relations website to download a copy of the presentation. In terms of our call today, I'll walk through some of the notable items related to our performance. Ron Nicolas, our CFO will also review a few of the details on our financial results, and then we'll open up the call to questions. I note that, our earnings release and investor presentation, include a Safe Harbor statement relative to the forward-looking comments. I encourage each of you to carefully read that statement. We delivered another quarter of solid financial performance, while maintaining a conservative approach to managing our balance sheet to drive long-term shareholder value. We generated a record level of quarterly total revenue of $201.9 million, and our net income increased from the prior quarter to $73.7 million, while earnings per share of $0.77 was consistent with the prior quarter. We generated an increase in pre-provision net revenue and realized a return on average tangible common equity of nearly 17%. Tangible book value per share grew 3.7% to $19.38 per share, and we ended the year with a TCE ratio of 8.88%, while all of our regulatory capital ratios further strengthened. Our ability to generate strong financial performance in a challenging environment is attributable to the deep client relationships we have built over several years, as well as our proactive and strategic approach to balance sheet management. I want to thank every one of my Pacific Premier colleagues for the outstanding work that they do every day to positively impact our clients, the organization, and the communities we serve. We enter 2023 with high levels of liquidity and capital, which will provide us with optionality and flexibility in a number of areas as we move through the year. Many of the trends of the fourth quarter were similar with what we observed in the third quarter. During this period of rising interest rates, we have maintained a disciplined approach to our loan to deposit production and pricing. By leveraging, our robust treasury management solutions and innovative technology platforms, our bankers are successfully developing new commercial banking relationships. We saw a slight reduction in total loans from the prior quarter due to both a lower level of loan demand in connection with higher interest rates, particularly in the areas of commercial real estate and multifamily, and the prudent underwriting standards we maintain in light of the ongoing economic uncertainty. In the fourth quarter, nearly half of our loan production was business-related loans, which reflects our ability to add quality banking relationships to the franchise. Our fourth quarter loan production continues to be attractive as the average yield on new loan commitments increased 79 basis points over the prior quarter. Although, we experienced a decline in core deposits, the strength of our client relationships coupled with disciplined pricing resulted in a relatively low cost of core deposits of 31 basis points. Our commercial escrow and exchange business experienced another quarter of deposit outflows declining by $396.7 million, which is a result of decreasing commercial real estate transactions. Additionally, we have seen clients utilizing excess cash to pay down or pay off loans, as well as some deposit mix shift. During the quarter, we added broker time deposits of varying maturities, which kept our loan-to-deposit ratio in the mid-80% range. These actions resulted in relatively low deposit betas for 2022, which Ron will discuss in more detail. Beginning in the fourth quarter of last year, our teams began executing on a number of new initiatives and marketing efforts to expand the products and services we are offering to existing clients and to enhance new client acquisitions, which we expect will benefit growth in future periods. Our asset quality remains solid. As always our teams are proactive in terms of portfolio management and credit monitoring. We receive frequent updates on our clients' financial performance, liquidity and collateral values, which informs our approach to managing individual credits. Our nonperforming assets totaled 14 basis points at year-end. And although we did see some migration of a few credits, we are not seeing an overall degradation in our borrowers' cash flows or their ability to service their obligations. With that, I'll turn the call over to Ron to provide a few more details on our fourth quarter financial results. Let's start with the quarter's financial highlights. Fourth quarter earnings increased to $73.7 million, driven by slightly higher revenues and lower operating expense. As a result, our efficiency ratio improved to 47.4% from 48.3% and our pre-provision net revenue totaled $102.7 million, an increase of $2.3 million from the prior quarter and as a percentage of average assets rose to 1.89% from 1.85%. Our return metrics were solid as return on average assets and average tangible common equity increased to 1.36% and 16.99%, respectively. Taking a closer look at the income statement. Non-interest income increased to $181.4 million, driven primarily by higher yields on interest earning assets and $3.8 million of additional swap income benefit compared to the prior quarter. The higher yields were partially offset by higher cost of funds and lower loan-related fees and accretion income as a result of decreased prepayment activity. On the funding side, our core deposit cost was well controlled at 31 basis points, with a spot rate of 43 basis points at year-end. Average total deposit costs came in at 58 basis points, reflecting an increase in broker deposits of $418 million. On a full year basis, our cumulative period-end total deposit beta was 18%. Our low-cost deposits supported the fourth quarter net interest margin of 3.61%, which was flat to the third quarter. As reported, loan yields rose 33 basis points to 4.94% inclusive of the fixed to floating rate swaps. Our core net interest margin narrowed six basis points to 3.38% with the decline being predominantly attributable to lower prepayment activity compared to the third quarter. Non-interest income increased $333,000 from the prior quarter driven mostly by a $582,000 increase in other income principally due to loan recoveries. These increases were partially offset by a $306,000 decrease in net gain from loan sales. We also saw slightly lower fee revenues in our escrow and exchange and trust business lines. In the escrow and exchange business, as we noted earlier, the decrease in fee revenue is attributable to the lower transaction activity in the commercial real estate market. We also anticipate an increase in trust income for the first quarter for annual tax service fees. As a result, for the first quarter of 2023, we expect our total non-interest income to be in the range of $21 million to $22 million, excluding any security sales. Non-interest expense decreased $1.7 million to $99.2 million, primarily due to a $2 million decrease in compensation and benefits reflecting lower performance-based variable comp, as well as reduced staffing levels, which decreased to 1,430 employees. Commensurate with higher interest rates as anticipated deposit expense increased $1.9 million from the prior quarter. Looking at our expectations for the first quarter, we anticipate our non-interest expense to approximate $102 million to $103 million due to increases in deposit expense, FDIC insurance costs, as well as the timing of certain seasonal items, such as payroll taxes and annual staff merit increases. Our provision for credit losses of $2.8 million increased compared to the prior quarter's $1.1 million impacted by changes to the overall size, composition, asset quality and unfunded commitments of the loan portfolio. While we have not seen a meaningful deterioration in our asset quality, we are closely monitoring the systemic issues impacting our borrowers such as supply chains, inflationary pressures and higher interest rates. Turning to the balance sheet. We saw a slight decline in loans of $239 million, driven by lower loan fundings. Given the higher interest rates, we also saw the continued trend of slower prepayments and payoffs. Deposits ended the year at $17.4 billion, which represented a linked-quarter decrease of $394 million attributable mostly to the escrow and exchange business as well as lower deposits in both commercial and consumer businesses as we continue to defend our deposit costs. To help mitigate the cyclicality of deposit flows, we added another $418 million in term broker deposits and $214 million of retail CDs, which provided additional liquidity as well as interest rate protection. We saw a slight reduction in our securities portfolio, as we did not purchase or sell any securities during the fourth quarter. Our overall securities portfolio yield increased to 2.35%. Additionally, we realized an incremental benefit with the fair value mark-to-market loss reduction of $20.6 million on the available-for-sale portfolio compared to September 30. Our tangible common equity increased 29 basis points to 8.88%. Additionally, we further strengthened our other risk-based capital ratios this quarter with Tier 1 risk-based, Tier 1 leverage and total risk-based capital ratios all increasing meaningfully from September 30. And finally from an asset quality standpoint, asset quality remains stable as both non-performing assets and delinquent loans totaled 0.14% and 0.30% respectively. Although classified assets did increase from September 30, they remain relatively low. Our allowance for credit loss was effectively flat in terms of dollars and our coverage ratio increased 2 basis points to 1.33%. And our total loss absorption, which includes the fair value discount on loans acquired through acquisition finished the quarter at 1.70%. We would not anticipate any decreases in our coverage ratio given the uncertain economic environment and could see an increase if a potential downturn materializes. Great. Thanks, Ron. I'll wrap up with a few comments about our outlook. We have always managed the company in a conservative manner, balancing growth with prudent risk management while maintaining strong levels of capital, ample liquidity and reserves. This has enabled us to effectively manage through a variety of economic cycles and consistently deliver strong financial results for our shareholders and this will remain our approach. At this point, it's difficult to forecast, how the economic environment will evolve and to project its impact on our clients' businesses. For the near-term, pressure on deposit costs likely will remain. But given our strong liquidity levels, we are well positioned to mitigate some of those pressures. And as previously noted, during the fourth quarter, our teams began executing on a number of targeted business development initiatives that we expect will enhance our loan and deposit production in coming periods. Our disciplined approach to expense management will not change. We believe our history of investing in employees and innovative technology platforms position us to enhance both efficiencies and business development activities while generating profitable long-term growth. As we've grown the company, we have maintained a proactive approach to credit risk management, which has helped us to achieve consistently strong credit metrics. Given the strength of our balance sheet and strong capital position combined with our results-oriented culture, we believe we will navigate this period of economic uncertainty from a position of strength and remain positioned to deliver long-term value for our shareholders. That concludes our prepared remarks and we would be happy to answer any questions. MJ, please open up the call for questions. Thank you, Steve. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from David Feaster with Raymond James. Please go ahead. I want to start out on the deposit side. And just if you could help us think about flows going forward. It kind of feels like we're kind of nearing a trough or at least the level of stability in the escrow business. I guess, where do you think we are in terms of some of the surge deposits and some of those more price-sensitive deposits? Would you expect to see maybe some more outflows in the near-term? And how do you think about funding those future outflows whether brokered funding borrowings and the securities of the -- cash flows off the securities book? Right. I mean there's a lot of questions wrapped up there David. David, I was going to ask you if you could give me insight on deposit flows. I think it's -- we're in a little bit of an unusual period. I don't know, if we're in the early middle or late innings. I think in many respects it has to do with some of the decisions that the Federal Reserve ultimately makes on both where the terminal Fed funds rate is how quickly we get there and how long do we remain there. And then coupled with quantitative tightening and the shrinking of their balance sheet at $95 billion a quarter or a month rather how that impacts the entire industry and we've clearly seen some level of disintermediation. I think it's right that the commercial escrow and exchange business maybe is at a trough. We'll see. We ended the quarter at I don't know $680 million roughly. And we do have some new business development initiatives going on there, but we'll see how that plays out over time. If you strip that out and the volatility we saw in the third and fourth quarter there really owing to the pretty substantial decline in commercial real estate transactions the deposit base has been pretty stable, which we're pleased with. And so with some of the initiatives that were deployed and began to execute on in the fourth quarter and really are in their infancy stages we believe those will -- some of those activities will offset the pressures that we're seeing around the deposit side. Okay. That makes sense. And maybe just touching on the loan side. I was hoping you could maybe elaborate on some of the initiatives you talked about to improve production. And you also talked about weaker demand and I know your appetite for credit is somewhat muted here just given your conservatism and the economic backdrop. What segments from your standpoint are still providing good risk-adjusted returns? And if we maintain, maybe the slower pace of production, how do you think about loan balances as we look forward? Yes. I think that, there's always some things we can do around the margin on the pricing standpoint to -- that will benefit production. Where we're seeing it is naturally in the business segments owner-occupied commercial real estate C&I as far as opportunities go to grow the business. And that goes part and parcel with the fact that those loans we have always done with full banking relationships. And given the pressures on the deposit side, that's what we're going to continue to focus on. There's also the fact that we do have excess liquidity that we can deploy, so we'll look to do that incrementally, depending upon deposit flows here. But again, I think that some of the initiatives that we began again in the fourth quarter and tweaks that we've made are going to benefit us as we move forward. Okay. Makes sense. And then last one just maybe touching on the margin side. I just want to make sure that I understand some of the dynamics within that, especially on the core front. It seems like you guys are -- the swap benefits are being accounted for in that accretion line. I was hoping, you could help us just think about given the loan and deposit dynamics that we just kind of talked about exclusive of the four basis points of loan fees, the margin actually would have expanded if we include the swap. So, just help us think about the core margin as we look forward and then some of the dynamics of how the swap will play out and play into that? Yes, David. As Steve indicated, as you highlighted, when you include the swaps which were taken out in the second half of 2021, we're actually -- our core margin actually expanded a couple of basis points. So we're getting very good lift from there and you saw the -- we're looking at a loan beta that's running somewhere in the 25% to 30% with the inclusive of those swaps. The deposit beta has been running, the core deposit's closer to 10, the total deposit closer to 18 and that obviously is somewhat a function of the additional broker deposits. But we continue to defend on the deposit side to Steve's earlier comments, where hopefully we've hit that inflection point on escrow. And we continue to -- the loans that we are putting on the books, we are getting very attractive loan yields on that, on an incremental basis. So, we'll continue to see lift here, if the Fed moves in the first quarter as is the market believes it will. We'll get additional lift on the swaps on that and an additional lift on our floating rate loan portfolio. So, we'll see where it goes, although we've -- we're not providing margin guidance at this point in time. Yes. The loan beta, which we include the fees, the fees came down about 4 basis points. So the loan beta was about 27% for this particular quarter. But if you were to normalize that, it would be right where we anticipate, right in that 30%, 31% level on the loan beta. So we're marching right along as anticipated on that loan beta. Hopefully, that helps, David. But it is a good point on just the way that we happen to characterize things, one would include maybe or some do the swap income in your core margin. We want to be fully transparent with everyone and break all of these different components out so they can see it. So for some people, the reported margin is consistent across the board with other institutions, but you can peel the onion back and see the core for us. Yes. For every 25 basis point, David, we see about $0.75 million of benefit on that. So, again, if the Fed does move in this first quarter, whatever they move, we'll see that benefit on an incremental go-forward basis in that. I might also add, as you think about the margin in that, I think that both accretion and in this environment, fees, prepayment, deferred fees that amortize, we're seeing high single digit in terms of basis points, net 7, 8 basis point, 9 basis point range in that margin, which is down, obviously, from where we were running last year, when we saw higher prepayments. Maybe just drilling down a little more on the margin. If we can get the spot rate on the cost of deposits or interest-bearing deposits at the end of the year and then the average NIM for the month of December. Yes. The core deposit spot rate was about 44 basis points, so up from the average that we saw in the fourth quarter of 31, Matt. So if you want to think about it, probably, across the board, you're looking at, right now, on a spot basis, probably around 8 or so, 8 to 12 basis points increasing on the spot rates, over the average rates that we saw in the quarter. But that's just on the core right? I mean, you've done some other stuff, so we might be underestimating kind of the lift in deposit costs in total. Is that not fair? I'm just trying to get a kind of all-inclusive deposit costs. Great. That's helpful. Thank you. Okay. And then in terms of the uptick in classified, I mean, I know these balances can bounce around, but everybody is pretty hyper-focused on credit these days. So just want to get a sense for what drove the uptick and what your outlook is for that increase. Yeah. It's â they are one-off credits or three or four. There's a couple on the Ag sector, where folks were impacted on some labor costs and also fuel cost, gas, petroleum, diesel and the like. There were a couple on the franchise side, where it were poultry costs, and labor costs. But they seem to be â as we go through these, they are specific to these individual borrowers, and most of our other businesses are working through various challenges, whether it's on the supply chain side inflation, labor and the like. Okay. And then just last one for me around your comment in the release, and I think also on the call here about executing on new initiatives and marketing efforts to expand the products and services, you're offering to existing clients and enhancing new client acquisitions. I guess, knowing that, you're a relationship bank to begin with I assume you've been doing a lot of this already. I guess, what's different? No. There's just â you're right we have. These are just some refinements in various areas and things that we've been doing where we can expand on some of our efforts in particular in maybe some of the specialty areas where â whether it's IOTLA deposits, gaining greater deeper relationships with existing clients where it's â and so just in a number of areas there, and I'm not going to go into any other specifics. And then, it's coupled too with some of the marketing efforts that we're doing to support these initiatives as well. Good morning. So on your capital priorities just a couple of questions. Your capital levels are obviously really healthy right now. Is there any thoughts on using the buyback at this point or is the environment still a little too uncertain? It's something that we regularly consider and discuss internally and with the Board, so it's always an option. I think as we gain greater visibility on the outlook is again something that we very well may deploy. But we will consider to think about it. Okay. Thank you. And just sticking on capital is M&A still a possibility right now? Are you having conversations or have those sort of slowed due to credit uncertainty and potential rate marks? I think, it's slowed pretty materially. We're very focused on protecting tangible book. And just given the volatility in the equity markets, in the rate markets and the uncertainty around the outlook that makes M&A as hard as it is. Throw in those additional factors and it really limits most folks' appetite. Okay. Thank you. And then last one just on credit. I appreciate all the detail in the slide deck on the different portfolios. But can you maybe just provide a little more color and statistics on the office and retail portfolios? Yeah. To shorten up the deck, we didn't include it this quarter. No real change, but I think it's in there from in Q3. Anything in particular around the office? Anything in particular you're looking for? They're pretty consistent with the overall investor owned CRE, which the debt coverages are pretty strong as you could see in the one slide on page 30, 1.90 DCR coverage. The loan to values are relatively low at 50%. These are mostly all stabilized properties, but something that we're monitoring closely. Maybe just to start on the margin for Ron. I know you did I think a really good job in preparing the balance sheet ahead of rate hikes at the swaps. And then I think you locked in maybe some funding at a certain point in time. Just with the curve projecting rate cuts later this year, I'd be curious to your thoughts on just how you're thinking about managing the balance sheet ahead of that point in time. And any specific actions you're looking to take throughout the year in preparation for the potential of rate cuts? Maybe before you give any specifics there Ron, I'll just give you broadly Andrew. The way that we have always thought about it is that we've generally managed the balance sheet to be close to neutral, slightly asset sensitive and really not looking to take a position one way or another that generate pretty consistent good earnings in a variety of environments and to be able to provide the deposit and loan products that our clients need and are competitive in the market. So that has been our approach and that will continue to be an approach. We certainly did take some actions in 2021 and 2022 that are benefiting us. And we'll continue to look at various options as we move through the year. Go ahead. And Andrew just to add to what Steve has said, if we've reached what we believe to be or hope to be believe that we've reached an inflection point on the deposit side and we've seen some stabilization there. We do have some excess cash. As Steve indicated earlier that we've got some reinvestment opportunities. But as it relates specifically to the swaps, I think we've been pretty -- well pretty fortunate. We have a good chunk of those swaps by year-end that will be coming off the books. So, if you believe right now what the market is telling us where we could see a reversal in monetary policy by the Fed by year-end, we've got a good chunk of those swaps that will be coming off. And as a result that will position us better for the -- for what we could see is again a reversal in that direction by the Fed. So, we feel pretty good about where we are and how they're positioned right now. And as you said we've benefited very nicely. We did it knowing full well that we were putting on some hybrid type loans that we needed to protect for this eventuality. Yes. About 50% of those swaps will be matured by the end of the year and they don't start until that fourth quarter. Okay, awesome. Thank you. And maybe just sticking on the margin so the 47% of loans on the balance sheet that are adjustable rate, can you just remind us how much of those have resets occurring throughout 2023 and just what the average kind of spread is between the back book to the front book where those would reprice that? Just trying to get a sense of some of the repricing dynamics on the asset side. Well, here's what I can tell you that I've got ready, ready if you will. The loan book has about a 22% just the loan book of floating rate currently. We also have probably another, call it, 8% to 10% of fixed rate maturing during the year over the next 12 months. And then we've got of course the benefit of the swaps. So, when you kind of total that all up we're looking at a beta as I mentioned earlier, a loan beta that -- a repricing beta that would be somewhere in the low 30% levels. Okay, understood. And then last one for me. I appreciate the expense commentary; I think it was $102 million to $103 million in the first quarter. I guess I'd be curious to hear your thoughts on kind of the expense progression throughout the year. I know there's maybe some seasonality in 1Q, but I think I called in your prepared remarks you mentioned maybe some reduced staffing levels. Just would be curious to hear the puts and takes on the expenses in 2023 and how we should think about the progression throughout the year? When we get to the first quarter earnings, we'll give you some idea of what we think about the second quarter at that point. How is that? Not very helpful. I mean right. Here's what I would say is obviously, as we have seen in years past, the first quarter we do get â like the industry, we get hit with payroll taxes right upfront. It's always a little bit outsized. You have some resetting of some of the performance incentives and compensation on that front merit increases, all the things that we've talked about as well. In addition, of course we saw the FDIC premium. I would not anticipate the same delta if you will from the fourth quarter to the first quarter that we're projecting today to be â to carry forward â incremental to carry throughout the year. That would not be the case. And I mean from the staffing levels, we don't see any material change in one way or another on the staffing side, which of course, the comp and benefits is the biggest component of the expense base. And we will though see continued pressure on some of the deposit costs that are there. So as I said, as we get better visibility into it here, we're happy to share with our thoughts as we get through the end of the first quarter how things are playing out. Thanks. Good morning. A lot of my questions were already asked but just one more in terms of just kind of balance sheet management thoughts for the year. In terms of securities, cash flows or cash flows coming off the investment portfolio, could the expectation be that you continue to reinvest those execution duration on the balance sheet for a potential Fed reversal, or how are you thinking about that broadly? I think that Gary, it depends on deposit flows, loan growth, loan activities, what is the magnitude there and how those different dynamics play out. But certainly, we could look to invest some of that excess liquidity and the cash flows from those securities back in to securities at more attractive yields today. Yes. It's a little north of $400 million, but it's a little lighter in the first half of the year call it about $80 million on average per quarter for the first half and closer to $120 million, $125 million on the back half per quarter. Great. Appreciate it. And then just one other question just kind of big picture. I think your kind of sales or calling effort has always been pretty aggressive and separate from kind of the credit side of the house. So in an environment where your risk appetite and credit appetite maybe is a little lower than it's been, do you repurpose some of those folks on that side of the business, or is it just really continuing to turn rocks over for opportunities that might fit within kind of the current appetite? I think it's a combination of the two, Gary. And as we've said, we've had some staff reductions here during the second half of 2022. Where we are at this point, we think is pretty stable, but you're always assessing that. But we've got a lot of activity going on here beginning with some of the initiatives in the fourth quarter. I think there was a pretty big adjustment that our team had to go through in the level of activity that we were running through the bank with a pipeline of $2 billion, $2.5 billion, and closings on new commitments well in excess of $1 billion. And as that adjustment occurred throughout last year, there's no question that that was a big impact on folks. And I think the team has done an outstanding job of adjusting to the current environment, and really got to sort of switch gears in the fourth quarter here to start playing a bit more offense if you will. This concludes our question-and-answer session. I would like to turn the conference back over to Steve Gardner for any closing remarks.
|
EarningCall_1173
|
Good morning. My name is Devin and I will be your conference operator today. At this time I would like to welcome everyone to the Super Micro Computer, Inc. Fiscal Q2 2023 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakersâ remarks there will be a question-and-answer session. [Operator Instructions] Thank you for your patience. Good afternoon and thank you for attending Supermicroâs call to discuss financial results for the second quarter, which ended December 31, 2022. By now, you should have received a copy of the news release from the Company that was distributed at the close of regular trading and is available on the Companyâs website. As a reminder, during todayâs call, the Company will refer to a presentation that is available to participants in the Investor Relations section of the Companyâs website under the Events & Presentations tab. Weâve also published managementâs scripted commentary on our website. Please note that some of the information youâll hear during our discussion today will consist of forward-looking statements, including without limitation those regarding revenue, gross margin, operating expenses, other income and expenses, taxes, capital allocation, and future business outlook, including guidance for the third quarter of fiscal 2023 and the full fiscal year 2023. There are a number of risk factors that could cause Supermicroâs future results to differ materially from our expectations. You can learn more about these risks in the press release we issued earlier this afternoon, our most recent 10-K filing for fiscal 2022, and other SEC filings. All of these documents are available on the Investor Relations page of Supermicroâs website. We assume no obligation to update any forward-looking statements. Most of todayâs presentation will refer to non-GAAP financial results and business outlook. For an explanation of our non-GAAP financial measures, please refer to the accompanying presentation or to our press release published earlier today. In addition, a reconciliation of GAAP to non-GAAP results is contained in todayâs press release and in the supplemental information attached to todayâs presentation. At the end of todayâs prepared remarks, we will have a Q&A session for sell-side analysts to ask questions. Today, I am pleased to announce another outstanding quarterly result for Supermicro, driven by contributions across our diversified customers, end markets and strong products. No single customer contributed more than 10% of our revenue. This is the eighth consecutive quarter of outstanding growth that effectively doubled our annual revenue. Let me share some key highlights for the quarter. First, revenue for the second quarter of fiscal year 2023 totaled $1.803 billion, up 54% year-on-year, above our guidance range of $1.7 billion to $1.8 billion. Our fiscal second quarter non-GAAP earnings per share grew over 271% year-on-year at $3.26 compared to $0.88 a year ago, far exceeding the high end of our guidance range of $2.64 to $2.90. This great achievement is made possible by our much-improved operational and financial discipline, including our Taiwan campus that contributed lower operation and production cost. With the increase of AI applications, our Plug-n-Play Rack-Scale Total IT solutions and GPU based systems continue to be strong contributors with more than 100% year-on year growth. Storage products are also gaining significant traction with 41% year-over-year growth as we continued to grow market share. We are mindful that many of our partners and customers have become increasingly more cautious with respect to macroeconomic headwind, and we are prepared to deal with these uncertainties as we always have in the past. The strength of our products and business fundamentals keeps us confident in our ability to continue gaining market share from competition given in the traditionally soft Q3 quarter. We expect the headwind may persist in the first half of calendar 2023, but we believe our business will recover quickly in the second half of the year as our new Sapphire Rapids, Genoa product and H100 product lines start to ramp in high volume. Having said that, our fiscal year 2023 revenue year-over-year growth should be in the middle 30% compared with last year without changing our business plan for strong growth in the coming years. For fiscal year 2024, we are targeting year-over-year revenue growth of at least 20%. We continue to see new customers, increase demands for energy efficient rack-scale plug-n-play solutions across the tier-1, tier-2 datacenter ecosystems as well as other enterprise customers. Some of them are highly interested in our liquid cooling at the rack and system level for their green computing HPC, datacenter and cloud installations. In addition, our continuous investment in software, switch and service are paying dividends to our Total IT strategy as they grow. Our Silicon Valley and Taiwan campuses continue to optimize their rack-scale production processes, ready to deliver L10, L11 and L12 systems in volume with software, networking and services. Our U.S. facility still has 40% capacity while Taiwan still has 50% capacity headroom to grow for the next one to two years. To accommodate stronger growth in the near and midterm future, our recently broken-ground Malaysia new campus will start to contribute even better profit margin through economy of scale with our more and more new high-volume customers. I am very glad that the lower operation and production cost from our new Malaysia campus will be ready in just 4 to 5 quarters away. When the time gets tough, customers are looking for tangible value from their IT investment. With the power requirements rising with each new generation of technology, now up to 400 watts on the CPUs and 700 watts on the GPUs, we are seeing the true value of our Green Computing effort. We have added both high ambient temperature operation and liquid cooling support for the new portfolio to reduce environmental impact, cooling-related infrastructure costs and OpEx. We are happy to see many more cloud total solutions customers speeding up their deployments with our Green Computing methodology. Many of them have already saved tens of millions of dollars in electricity cost as a direct result. We expect them to grow even faster by the coming quarters and years as we deliver superior performance, performance per watt and per dollar through new generations of products. As I have shared in the past, when the IT industry adopts our Green Computing solutions or develop green solutions like ours, itâs possible to save close up to $10 billion in electricity costs per year, which is equivalent of eliminating about 30 fossil fueled power plants and equating to the preservation of up to 8 billion trees for our planet. As we approach the second half of our fiscal 2023, we see opportunities for diversified growth across more Large Datacenters, Enterprise, AI, Machine Learning, Storage, Cloud, 5G/Telco and IOT markets. Our online B2C and B2B programs have finally started to ramp up and offers the convenience and quicker service of direct support from Supermicro to many customers around the world. With all the online automation and intelligent database-driven tools, we see many new customers that are really happy to order from our new platform. 24-hour around-the-clock services, real time responses, precise communication, cost efficiencies are just some of the advantages this program offers. With our industryâs most extensive product portfolio supporting the recently launched Intel 4th Gen Scalable Xeon processors, Sapphire Rapids; 4th Gen AMD EPYC, Genoa processors; and NVIDIA H100, Hopper, GPUs, we are confident to maintain and enhance our market-leading growth momentum in the coming quarters and years. Unlike last few generationâs steady product ramp up, we currently see many more customers taking samples and seeding units of these new solutions. This demonstrates our customer base is strongly expanding now. We expect them to become a significant revenue stream by the June quarter and more so in the September quarter and beyond. With market excited for the latest innovations from Intel, AMD, NVIDIA and Supermicro, we remain optimistic that the demand will expand as new architectures developed for AI, Metaverse, Omniverse and IoT/Edge applications will be strong in the foreseeable future. We had a better than expected December quarter. With new generation of products in a strong position now, it will generate more demand, especially with our rack-scale solutions. Along with our getting stronger software, switch and service offerings, our potential to gain market share has never been stronger than today despite the macroeconomic headwind. With our strong cash position today, and especially total PE, [ph] we have allocated $200 million for stock buyback program. We continue to emerge as one of the largest global suppliers of Total IT Solutions with market share gains. We are a Silicon Valley company focusing on green innovation and system technology. Our efforts have saved our customersâ OpEx tremendously. With our 50% still available capacity in Taiwan and the soon coming more cost-efficient campuses in Malaysia, we continue to expect a 20% to more than 50% year-over-year growth for the coming years, and we remain on track to reach our long-term growth objectives of $20 billion annual revenues in the long run. Now, I will pass the call to David Weigand, our Chief Financial Officer, to provide additional details on the quarter. David? I am pleased to report Q2 fiscal 2023 revenues of $1.8 billion, up 54% year-on-year and down 3% sequentially. Revenues were at the high end of our initial guidance range of $1.7 billion to $1.8 billion and our recently updated range of $1.77 billion to $1.8 billion. Our year-over-year revenue growth continued to be driven by new and existing customers widely adopting our GPU/AI systems and rack-scale Total IT Solutions which contributed to solid gross margins and record operating margins. In fiscal Q2, we had good growth in our two largest verticals: enterprise/channel and OEM vertical -- Iâm sorry, the enterprise/channel vertical and the OEM appliance/large datacenter vertical, which demonstrated the resilience of our business model. AI/GPU accelerated computing solutions represented more than 20% of our revenues over the past four quarters and is a significant growth opportunity based on our wide range of AI/GPU platforms. We achieved Q2 revenues of $1.8 billion with no customer representing more than 10% of revenues. We recorded $970 million in our Enterprise and Channel vertical, representing 54% of Q2 revenues versus 45% last quarter, up 29% year-over-year and up 15% quarter-over-quarter. The OEM appliance and large datacenter vertical achieved $766 million in revenues, representing 42% of Q2 revenues versus 50% last quarter, this was up 172% year-over-year and down 17% quarter-over-quarter. Our emerging 5G/Telco/Edge/IoT segment achieved $67 million in revenues, representing 4% of Q2 revenues versus 5% last quarter. Systems comprised 92% of total revenue and was up 68% year-over-year and down 3% quarter-over-quarter. Subsystems/accessories represented 8% of Q2 revenues and were down 24% year-over-year and up 2% quarter-over-quarter. On a year-over-year basis, the volume of systems and nodes shipped as well as System node ASPs increased due to product and customer mix, while on a quarter-over-quarter basis, the volume of systems shipped increased while nodes shipped and System node ASPs decreased, again, due to product and customer mix. Taking a look geographically in fiscal Q2 the U.S. market represented 61% of revenues, Asia 18%, Europe 17% and Rest of World 4%. On a year-on-year basis, U.S. revenues increased 71%, Asia increased 16%, Europe increased 45% and Rest of World increased 98%. On a quarter-over-quarter basis, U.S. revenues decreased 15%, Asia increased 23%, Europe increased 33% and Rest of World increased 33%. The Q2 non-GAAP gross margin was 18.8%, that was unchanged quarter-over-quarter and was up 480 basis points year-over-year due to price discipline, lower freight costs and leverage from higher factory utilization. Taking a look at operating expenses, Q2 OpEx on a GAAP basis decreased by 4% quarter-over-quarter and increased 8% year-over-year to $122 million. On a non-GAAP basis, operating expenses decreased 7% quarter-over-quarter and increased 5% year-on-year to $109 million. OpEx decreased sequentially due to higher NRE and marketing credits that we received from the new platform launches. The non-GAAP operating margin was 12.8% for the quarter versus 12.5% last quarter and 5.2% a year ago as we benefited from lower operating expenses. Other income & expense was approximately $8 million in expense primarily consisting of $6 million in foreign-exchange losses as the dollar weakened during Q2 and interest expense of $2 million as compared to an $8 million in FX gain and $4 million of interest expense last quarter. Interest expense decreased sequentially as we reduced short-term credit lines, this was partially offset by increased interest rates. The tax provision for Q2 was $30 million on a GAAP basis and $34 million on a non-GAAP basis. The GAAP tax rate for Q2 was 14.3% and non-GAAP tax rate was 15.3%. Our tax rates were lower sequentially as we benefited from favorable discrete tax benefits. Lastly, our share of income from our joint venture was a loss of $1.4 million this quarter as compared to a loss of $0.9 million last quarter. We delivered strong Q2 non-GAAP diluted EPS of $3.26 which was up 271% year-over-year and down 5% quarter-over-quarter and exceeded the high end of the original guidance range of $2.64 to $2.90 and our recently updated guidance of $3.07 to $3.22. Our EPS outperformance was attributed to our ability to maintain gross margins, manufacturing efficiencies and higher NRE and marketing credits. Turning to the balance sheet and working capital metrics compared to last quarter, our Q2 cash conversion cycle was unchanged at 95 days versus Q1. Days of Inventory was 99, which is down by one day sequentially due to a more stable supply-chain. Accounts receivable increased sequentially by $32 million while accounts payable decreased sequentially by $225 million. Days sales outstanding was down by 1 day quarter-over-quarter to 38 days while days In fiscal Q2, we generated positive cash flow from operations of $161 million versus $314 million in Q1. Our operating cash flow continued to benefit from strong revenues and margins and an improved supply chain. We note that Q1 operating cash flow benefited from $70 million in customer pre-payments recorded as deferred revenues. CapEx was $10 million for Q2 resulting in positive free cash flow of $151 million versus positive free cash flow of $303 million last quarter. The closing balance sheet cash position was $305 million, while bank debt was reduced to $170 million as we paid down $80 million in short-term debt during the quarter. We did not buy back any shares during the quarter and have $200 million in share repurchase authorization until January 31, 2024. Our Board will determine the timing and amount of share repurchases. Now turning to the outlook for our business, we continue to watch the global macroeconomic situation. Additionally, as the supply chain disruptions have eased and the industry transitions to new platforms from Intel, AMD, NVIDIA during 2023, we anticipate normal -- return to normal seasonal patterns. For the third quarter of fiscal 2023 ending March 2023, we expect net sales in the range of $1.42 billion to $1.52 billion, GAAP diluted net income per share of $1.75 to $2.02 and non-GAAP diluted net income per share of $1.88 to $2.14. We expect gross margins to be down 30 to 40 basis points due to macroeconomic conditions. GAAP operating expenses are expected to be $139 million, which includes approximately $12 million in expected stock-based compensation and other expenses that are excluded from non-GAAP diluted net income per common share. GAAP and non-GAAP operating expenses are expected to increase in Q3 due to lower R&D NRE credits and higher personnel costs. We expect other income and expenses, including interest expense, to be a net expense of approximately $3 million and expect a nominal loss from our joint venture. The Companyâs projections for GAAP and non-GAAP diluted net income per common share assume a GAAP tax rate of 15.9%, a non-GAAP tax rate of 16.9%, and a fully diluted share count of 57 million for GAAP and 58 million shares for non-GAAP. We expect CapEx for the fiscal third quarter of 2023 to be in the range of $11 million to $14 million. For the fiscal year 2023 ending June 30, 2023, weâre maintaining our guidance for revenues from a range of $6.5 billion to $7.5 billion, GAAP diluted net income per share from a range of $8.50 to $11.00 and non-GAAP diluted net income per share from a range of $9 to $11.30. The Companyâs projections for GAAP annual net income assume a tax rate of 19.2% and a rate of 19.8% for non-GAAP net income. For fiscal year â23, we are assuming a fully diluted share count of 57 million shares for GAAP and 58 million shares for non-GAAP. The outlook for fiscal year 2023 fully diluted GAAP EPS excludes (sic) [includes] approximately $33 million in expected stock-based compensation and other expenses, net of tax effects that are excluded from non-GAAP diluted net income per common share. We remain confident in our long-term outlook for robust revenue growth and profitability driven by our leading-edge new platforms, design wins, market share gains, and engagement with significant new global customers. Yes. Thank you. And congratulations on the strong results, especially gross margin, and the guidance that implies very resilient gross margin. Dave, you did mention that youâre expecting 30 basis points of the Q-over-Q downtick due to macro pressures. I mean, thatâs a de minimis amount. Can you discuss why only that amount? Well, Nehal, our margins are holding up. We expected a downtick last -- in this Q2, but it didnât happen. Weâre still allowing for a downtick just in case we have to sharpen our pencil on some particular deals. But otherwise our prices and margins are holding up. So then, can you talk about why you think your margins are indeed holding up in what appears to be pretty quickly deteriorating macro environment? Well, we have customers that are -- that have pushed out orders, certainly Nehal, but that we still bring value to our customers. And that value is -- has not diminished. And, in fact, with all of the new designs that are coming out, we believe itâs increased. Got it. Thatâs great. And then, youâre maintaining your fiscal year â23 guidance despite outperformance in the December quarter and youâre providing at least March guidance thatâs above my expectations. So, how should we be reading that implied June Q guidance, basically? Should we be -- if we take at the low end of the fiscal year â23 guidance, you could be looking at a pretty dire gross margin situation within June Q, is that the correct interpretation? No, I would say Nehal that really we are -- we donât want to update our guidance. Weâre confident in our guidance and in the ranges that weâve given. And so really weâre just -- weâre watching the macroeconomic situation. But we remain confident in our basic business fundamentals and in our values -- the values that our products bring. Okay. So just to be clear, there is no reasonable basis for believing that gross margin would drop to the low-end of your whatâs arguably a sale target model of 14% to 17% in the June quarter, or lower, is that correct? So we -- right now, we donât see any degradation of our gross margins, as I mentioned. And so -- but we feel like -- we remain confident in our in our ranges. And we donât believe this is a time to update them. And then, Charles made a comment that he expects fiscal year â23 revenue be taking at least 30% year-over-year growth or mid-30%. But your overall fiscal year â23 guidance range is still a pretty large bracket. So, how should we be reconciling these two things here? Yes, just a few if I could. So, maintaining -- actually, I think, slightly raising the midpoint of the fiscal year guide, March is below where Street is, the implication is June is above where Street is. And so, is it really just a matter of, kind of Street, like we are -- and I think Iâm part of this, sort of had miss-modeled March to the low side? And subsequently, weâre also miss-modeling June? Well, we miss-modeled March to the high side, and weâre miss-modeling June to the low side? Just a clarification. Just your thoughts on that and I have a couple of follow-ups. Thanks. Sure. So again, Iâll kind of go back and weâre -- because things have been changing economically and we had some -- weâve seen some push-outs, not cancellations, again, push-outs, we feel like, we shouldnât be adding more details on Q4 or annual guidance. And so, really, we feel like the guidance ranges that we gave allow for where we think performance will land. And so, to give more specificity to that, at a time when details are not easy to -- are not as clear to see, we think is the wrong way to go. And so instead, weâre giving good guidance on what we see in the quarter ahead. But again, weâre still comfortable with our annual guidance. And it sounded -- I think, I believe Charles mentioned, and actually just please clarify this for me if this is inaccurate, something about kind of macro software, but recovery in the second half of calendar year â23. And if I heard that accurately, is that to say, you guys envision the first half of the calendar year being sort of the softest part of macro for you? And you also made comments Dave about returning calendar â23 to seasonality. And so first half is the soft spot, second half, you guys think sort of normal seasonality plus quote unquote, recovery begins and that dovetails into your fiscal year â24 outlook? And so contextually, I just want to ask you, is that how you guys are thinking about it? Yes. Macroeconomic headwind issue is some concern to everyone now. So other than that, indeed, our demand is still pretty strong, especially as you know, Intel just announced Sapphire Rapids; AMD, Genoa; and NVIDIA, Hopper, H100. So we have very strong products available. And this time, we saw a customer very aggressively asking was simple for early seeding. So, we believe these were put in big growth. And -- however the very big growth in model should be in about summer or even after summer timeframe. So long-term, we have a very strong confidence, especially after summer. Before summer, depends on macroeconomic headwinds. We try to be more cautious. Very helpful, Charles. And, Charles, last for me, I believe you mentioned potential for more large data centers in the second half of calendar â23. Did I hear that accurately? And are those incremental data centers, if I heard it accurately? And any more context you could provide around that? Thanks. Yes. I mean, as you know, we start to approach large accounts since maybe one year ago. So, we continue to gain interest from those CSP and larger accounts. And thatâs why we increased having capacity for lower production cost to support those larger accounts. And we even started a big campus in Malaysia. So, the goal is to increase our production capacity and lower our operation and production costs, so that we are able to support those larger accounts with reasonable profitability. So, we continue to gain some engagement and interest from larger accounts around the world. And also at the same time, we also started to engage with lots of mini size accounts, especially those through B2B and B2C. So, we are engaging with much broader customer base now. Couple of follow-ups. It seems like the price decline in the December quarter has more to do with the mix. And I am assuming that the OEM and large data center mix went down from 15, September to 42% in December. And in that context, my question to you is how should I think of the mix in the March quarter, and how will that impact unit and ASP trends? In March quarter, because of the market headwind, so we still tried to be cautious. But after summer, our feeling become much stronger, because a lot of good products, lots of engagement from larger accounts, middle sized account and even small -- a lot of small accounts. So, Charles, I just want to understand, would the mix of revenue from OEM and large data center decline again in the March quarter? And then, I also want to understand how you see the ramp of these three different CPUs. You have always -- youâve historically been a close partner of Intel, AMD and NVIDIA. How long in advance do you actually procure those components in advance of building the boxes? How much of the inventory commitment or working capital commitment do you have to make before the actual high volume manufacturing takes place? Indeed we have a very close partnership with all of our vendors. So, in this area, I believe we are similar to the industry standard or slightly better. David, you may⦠Yes. Many things have improved recently, as you know, on the supply chain side. So, we used to procure further in advance. And so one of the reasons our inventories have come down, one of the reasons our cash flows have been -- have increased. And by the way, we had net income the last two quarters of $360 million, we had free cash flow of $454 million. And so, again, the reason for that is we had to invest less money in inventory. So, our ability to produce products is faster now, because we can buy later in the cycle. But to your point on the timing, some of itâs going to be dependent on when in the quarter our customers are taking the bulk of their products. So, if we have early quarter shipments versus late quarter shipments, that can affect the timing of our inventory and accounts payable. And then one last question for me on the balance sheet, especially with the Malaysia facility coming on line, are you still targeting, like a $45 million of CapEx for fiscal year â23, or more or less? Yes, so, fair question. So, weâre going to add in -- for Q3, weâre adding a $4 million of CapEx for Malaysia, and weâll add $9 million in our Q4, for Malaysia. So thatâll be $13 million for our fiscal second half. And then, this is going to be an investment over a couple -- over several years. And so, weâll make another $13 million in the first half of fiscal â24. So, thatâs not -- thatâs given you a little more insight on that investment. Should I assume that just the maintenance CapEx out to the Malaysia is what, $8 million to $10 million a quarter? Yes, thatâs correct. So, your question, yes, you can maintain the 45 and just add in the figures that I just gave you. Great, thanks. I get to leadoff and cleanup, awesome. So, relative to seasonal patterns, and excluding the 21.9% customer from the September quarter, how did the business actually perform in the December quarter then? So, the December quarter was an outstanding quarter on in every respect. And so from free cash flow, inventory, all the metrics were strong, cash position. So, as you mentioned, customer -- no customer concentration. And so, we feel we had a really good -- a really great quarter. I mean, my interpretation here is that the core business excluding that 120%-plus customer from the September quarter was up more than seasonal. Is that a correct interpretation? Well, we always have customers that will take -- when we have design wins, Nehal, weâll always -- from quarter-to-quarter, weâll always have shipments -- large shipments to customers. Sometimes itâs according -- sometimes they change their forecast, and we ship a little bit more in one quarter than another. So, we canât control that always. But as we said, as the supply chain has improved, that was -- that dynamic was felt a lot harder during the supply chain crunch. Now that weâve returned to a better supply chain, therefore, thatâs why we feel weâll return to more normal seasonality. But that can always be altered by a new design win that we get in one quarter or over two quarters. Yes. Basically, in â22, we had some larger accounts, but in fiscal year â23, now we are adding more larger accounts. So we are growing in more largely accounts and more midsize accounts, and also B2B, B2C. So, indeed, our customer mix is becoming much more diversified, much more healthier, and for sure the volume will be bigger. Thatâs why we extend to Malaysia for really lower cost operation and campus. Presumably, just diversification with the larger customers is coming on the higher margin plug and play rack-scale products. Is that correct? We hope so. So anyway, thatâs -- we feel we still have a lot of room to add more customers. And once we have a higher capacity in USA, Taiwan, Malaysia, our plan is to add a lot of more customers. And then, is there a particular vertical that you guys are seeing the pushups from that -- that you were talking about for the quarter? [Ph] Okay. All right. Very good. And then for the March quarter, youâre guiding to an 18% Q-over-Q decline in revenue. Thereâs clearly obviously some seasonality with March quarter. Then there might be, I guess, ongoing push outs from the large data center customers and then thereâs also a macro element. Are these the three major elements that are driving the 18% Q-over-Q decline? And then could you potentially help parse out what are rank order of these three drivers here? So Nehal, if you look back pre-COVID, our typical Q3 decline was 12%. Okay. So, that was during the time of normal seasonal patterns. During COVID, there was a different dynamic of course, because our supply was scarce. But we think as we return to normalized supply that we will have this kind of seasonality. Okay. And then, as far as the potential runoff of the large customer versus macro, any input as far as whatâs the driver there, as far as the above the 12% typical Q-over-Q decline? Well, weâre engaging with new customers all the time. And so, weâre not looking to be declining, and in fact, just the opposite. So, while we will have some seasonality as in a stable supply chain, we still have our growth plans that are intact and that we remain confident in. And then my last question here is, did I hear correctly that thereâs a new buyback that was implemented, something about $200 million buyback? Can you just clarify that? So, now that you guys have worked yourself back to a net cash position with the strong free cash flow that youâve highlighted over past two quarters, is it reasonable to expect that you guys are going to put that back to work now? Yes. So, just a quick follow-up, just a clarification. David, did you employ or did you say that the 10% plus customers that you had in September quarter of last year is going to come back or youâre going to have another 10% plus customer in the coming quarters? It was very confusing. Yes. So Mehdi, the 10% customer we had a year ago September is a different customer. Okay? The 22% customer that we had in the recent September quarter, again a different customer, was below was did not constitute 10% of our revenues in Q2. Okay, did I clarify that? Sure. Just as a follow-up, do you expect that particular customer to come back, is that what the confidence behind the June quarter is? Indeed with our new product, indeed very strong offering. So we expect any time we will have a more new larger customer or old customer coming back is always very high possibility. And we are working with them very closely there, the partnership would come stronger ever. There are no further questions at this time. With that said, concludes todayâs conference. Thank you for attending todayâs presentation. You may now disconnect.
|
EarningCall_1174
|
Good day and thank you for standing by. Welcome to the Fourth Quarter Ally Financial Inc. Earnings Conference Call. [Operator Instructions] Please be advised that todayâs conference is being recorded. I would now like to hand the conference over to Mr. Sean Leary, Head of Investor Relations. Please go ahead. Thank you, Carmen. Good morning and welcome to Ally Financialâs fourth quarter and full year 2022 earnings call. This morning, our CEO, Jeff Brown; and our Interim CFO, Brad Brown, will review Allyâs results before taking questions. The presentation we will reference can be found on the Investor Relations section of our website, ally.com. Forward-looking statements and risk factor language governing todayâs call are on Slide 2. GAAP and non-GAAP measures pertaining to our operating performance and capital results are on Slides 3 and 4. As a reminder, non-GAAP or core metrics are supplemental to and not a substitute for U.S. GAAP measures. Definitions and reconciliations can be found in the appendix. Thank you, Sean. Good morning. We appreciate you joining us to review our fourth quarter and full year results. I will start on Page #5. Full year adjusted EPS of $6.06, core ROTCE of 20.5%, and revenues of $8.7 billion reflected another year of solid financial results. ROTCE was approximately 16%, excluding the impact of OCI. We completed $1.7 billion of share repurchases over the course of the year, and this week, our Board approved a first quarter 2023 common dividend of $0.30 per share. We built businesses that are nimble and able to pivot against the fluid backdrop. We maintain healthy levels of capital, reserves and liquidity, which position us well for this dynamic environment. Within auto finance, consumer originations of $46 billion were sourced from 12.5 million applications across more than 23,000 dealer relationships. The average originated yield of 824 basis points expanded 114 basis points on a full year basis. In total, we put nearly 400 basis points of price into the market, largely in line with changes in the Fed Funds rate. Industry vehicle sales remain below pre-pandemic levels, but our ability to generate strong originations shows the benefits of our scale and depth of application flow. Net charge-offs in retail auto were 97 basis points for the year. In the fourth quarter, net charge-offs increased to 166 basis points as we saw accelerated normalization within the quarter. Brad will cover losses in more detail as well as our current thinking for this year. Within insurance, written premiums again exceeded $1 billion, driven by strong relationships with 4,600 dealers. Our insurance team remains focused on leveraging synergies with the auto finance sales team and we remain optimistic about the organic growth opportunities for this business going forward. Turning to Ally Bank, retail deposit balances increased $3 billion year-over-year, ending at nearly $138 billion. We generated $7 billion in retail deposit growth in the second half of the year while maintaining a very balanced approach to pricing. We continue to see strong momentum in retail deposit customer growth and ended the year with 2.7 million customers, up 8% year-over-year. We have seen increased consumer engagement and adoption trends across other Ally Bank product offerings. Ally Home originations of $3.3 billion were down year-over-year, reflecting broader mortgage market conditions. Equity market trends resulted in a decline in Ally Invest assets while active accounts increased to 518,000. Ally Lending generated origination volume of $2.1 billion as we added merchant relationships across home improvement and healthcare verticals. Ally Credit Card reached $1.6 billion of loan balances from more than 1 million active cardholders. The card team also reached a key milestone in the fourth quarter as we rolled out a lineup of Ally-branded credit cards. I am proud of what we have accomplished on the integration over the past 12 months and excited about the continued opportunities which lie ahead. Corporate Finance continues to generate steady loan growth with the held-for-investment portfolio reaching $10 billion with growth coming primarily from asset-based lending. Turning to Slide #6, our long-term strategic priorities remain unchanged, even as we navigate this dynamic environment. Our teammates are well prepared to handle near-term challenges while remaining focused on driving long-term value. Our culture is the driving force behind everything we do as a company and I will share more on that on the next page. Since the launch of Ally Bank, we have challenged ourselves to provide differentiated and frictionless products in the market. Consumer preferences have evolved over the past decade and we have always strived to deliver leading digital experiences allowing us to be an ally for our customers. Our dominant positions in auto and deposits continue to fuel consolidated earnings today and we see growth opportunities across the company which will drive continued asset and revenue diversification as we further scale our newer businesses. Central to all our lending products is a disciplined approach to credit risk and we view [Technical Difficulty] ability to underwrite and manage risk as our most critical core competency. And lastly, disciplined capital deployment is a foundational aspect of our strategy to deliver strong returns and add value for all stakeholders. Turning to Slide #7, the building, caring and nurturing of our culture is what has given me the greatest joy in leading our company over the past 8 years, and it remains a huge priority for me. Our culture is not about the CEOâs culture. Itâs a culture that harnesses the true power of over 11,500 teammates and empowers everyone to make a difference. I firmly believe a strong culture is essential to delivering for our customers, communities and stakeholders and that all starts with taking care of our employees. We have consistently prioritized investment in our people and culture and our actions in 2022 reflect that commitment. In the past 12 months, we have increased our minimum wage by 15% to $23 an hour, which makes a meaningful difference for thousands of our teammates. We recently announced another year of our OwnIt Grant Program, which provides every employee 100 shares of Allyâs stock and empowers them to act as owners of the company. We have expanded mental health benefits for employees and their families this year and expanded upon our benefits for new parents. The investments that we have made and our deliberate focus on culture has resulted in a highly engaged workforce. We are in the top 10% of companies when it comes to employee engagement and well above industry averages. Our employee resource groups, or ERGs, were launched 5 years ago as we expanded our DE&I initiatives and I am proud to say over 50% of our workforce volunteers and is active in at least one ERG. Creating an engaged workforce that embraces our Do It Right approach improves every aspect of our business as we serve our growing customer base now 11 million strong. Retention levels at Ally Bank remain industry leading, along with compelling customer satisfaction rates. We have consistently rallied around initiatives that help us better our customers and drive industry change and our teammates continue to invest in the communities we live and work in. We work hard to nurture this culture across the enterprise and I am confident it will be a differentiator for Ally now more than ever. Letâs turn to Slide #8. Before diving into the fourth quarter details, Iâd like to highlight Allyâs multiyear strategic and financial transformation which demonstrates the steady execution and strong performance over a longer lens than a quarter or two. In nearly 10 years as a publicly traded company, we have consistently worked to remain a disruptor and execute against our long-term priorities which has resulted in sustained improvements in operational and financial results. Within Auto & Insurance, we have transitioned from a captive auto finance company to a market-leading diversified lender with dealer relationships of 23,000, increasing roughly 50%, while application flow of nearly 13 million is up almost 40%. Ally Bank remains the largest all-digital bank in the U.S. While the direct banking industry was largely unproven when we launched Ally Bank, our steady growth to $138 billion of retail deposits and 4 million customers make it clear our model and our brand resonates with consumers. Our balance sheet has evolved through optimization within auto finance, along with expansion into other consumer lending verticals. Overall, earning assets are up $44 billion since our IPO, which includes $28 billion of non-auto loan growth. This growth has generated $3.7 billion of revenue expansion. This evolution has created a structurally more profitable company. NIM of 3.88% is up 134 basis points from where we were in 2014 and is driven by optimization on both sides of the balance sheet. Throughout this transformation, we have remained disciplined on capital allocation and ensured we are adequately reserved. Shares outstanding have declined 38%. Book value, excluding the temporary headwind from OCI, has effectively doubled and we maintain a $3.7 billion loan loss reserve. These metrics reflect years of consistent execution and give me confidence in our ability to deliver in the years ahead. Slide #9 reflects our focus on growing an engaged customer base. We now serve 11 million customers across our businesses, which represents a 58% increase since 2014. Ally Bank customers have more than quadrupled over this timeframe as we have evolved, expanded and enhanced our digital capabilities. Our consumer lending products are resonating and customers want to deepen their relationship with Ally evidenced by the significant growth in multi-product customers shown at the bottom of the page. Across Auto & Insurance, we have added 500,000 customers as we have leveraged our strength and scale in the market as the leading independent full spectrum lender. This product expansion and customer growth have translated into improved balance sheet composition and expanded earnings, which I will cover over the next few pages. Turning to Slide #10. Since 2014, we have significantly transformed our balance sheet as we have optimized auto and expanded additional consumer offerings. Loans and leases have increased $31 billion or 26% since 2014 through disciplined expansion across all our lending products. Auto assets have been relatively stable as growth in higher yielding retail assets has been offset by a decline in floor plan balances. While not reflected in the charts, the return profile of the auto finance business has dramatically improved as we strategically shifted into the intersection of prime and used. Allied Bank Consumer and Commercial Products have grown 6x since 2014 and now make up $33 billion of balances. And itâs important to keep in mind that while we have recently added point-of-sale lending and credit card capabilities, our balance sheet remains 95% secured. On Slide #11, you can see we have driven substantially higher net interest margin given the optimization across both sides of our balance sheet. NIM increased 134 basis points from 2014 given expanded earning asset yields and an improved liability construct. The optimization within auto has increased yields, while expanded consumer lending offerings have provided incremental tailwinds. Our liability stack shows equally meaningful progress. In 2014, we were only 41% deposit funded relative to 88% today. Market-based funding has declined by more than $50 billion. The transformation of our funding profile has driven cost of funds down nearly 30 basis points despite average Fed Funds being 160 basis points higher. While we face near-term pressure on margin, given our liability-sensitive position, this optimization on both sides of the balance sheet positions us with a much improved NIM despite the rapid rise in interest rates. Brad will share more on margin dynamics later. Turning to Slide #12, total revenue of $8.7 billion represents a 74% increase since 2014. Net financing revenue of $6.9 billion has nearly doubled through balance sheet transformation and the strategic positioning of the auto finance business. Other revenue has also expanded as we have grown fee-generating businesses like insurance and smart auction. Investment gains will fluctuate with market conditions, but we see a path to a $2 billion plus annual other revenue stream. The bottom of the page highlights the significant progress across our Ally Bank businesses. Revenue in 2022 of $1.2 billion has increased more than $1 billion since our IPO and is up 75% in just the last few years. Moving to Slide #13, we show the consistent credit performance of our largely secured balance sheet and significant reserve coverage relative to losses. On a consolidated basis, net charge-offs of 74 basis points compared to a coverage rate of 2.72%. Within retail auto, net charge-offs of 97 basis points reflect normalization of historical lows. The retail auto reserve of 3.6% remains elevated versus CECL day 1. We feel comfortable our reserves position us well for a variety of environments as we have consistently taken a conservative approach in our reserve methodology. Slide #14 adds additional perspective on absolute levels of our reserves and excess capital. The $3.7 billion allowance on our balance sheet is roughly $1.1 billion higher than CECL day 1 and positions us well to absorb expected lifetime losses based on the current economic outlook. And our capital position creates significant buffer against unexpected losses and volatility. While we have largely normalized excess capital relative to our internal targets, we continue to maintain $3.6 billion of CET1 above our regulatory minimum under the SCB framework. The ultimate path of the economy over the near-term remains fluid, but we feel very good about the reserve and capital position of the company. Moving to Slide #15, we have highlighted our steady growth in book value per share. At year end, book value per share, excluding the impact of OCI was $44, up 92% since 2014. We understand the magnitude of interest rate movements has heightened the focus on AOCI and the mark on our securities book, but we feel the $44 figure is a better representation of the true intrinsic value of our company. The existing mark will fully amortize back to par over time and declines in rates like we saw in the fourth quarter will accelerate book value generation. The bottom of the page shows the progress we have made in buying back shares at levels below the intrinsic value of the company. Since the inception of our repurchase program in 2016, shares outstanding are down 38% creating significant value for long-term holders. We recognize there is a lot of focus on our earnings trajectory over the next few quarters, but itâs important to consider the tailwinds that have been created by a fundamental transformation over the past several years. Thank you J.B. Good morning, everyone. Iâll begin on Slide 16. Net financing revenue, excluding OID, of $1.7 billion was up slightly year-over-year, driven by continued strength in origination volumes and auto pricing, higher funding costs given the rapid increase in short-term rates partially offset to our hedging position and growth in unsecured consumer products. Adjusted other revenue of $478 million reflected continued momentum across our insurance, smart auction and consumer banking businesses. Elevated investment gains in 2021 drove the year-over-year decline. Provision expense of $490 million reflected the continued normalization of credit and modest reserve build to support loan growth and to reflect the evolving macro environment. Non-interest expense of $1.2 billion reflects investments in our growing businesses and in technology. As we mentioned during our last call, the fourth quarter included a $57 million charge consisting of the final impact of the termination of our legacy pension plan. Results also reflect the tax impacts related to that termination, which drove $60 million of tax expense and increased the tax rate in the quarter by approximately 14 percentage points. GAAP and adjusted EPS for the quarter were $0.83 and $1.08 respectively. Moving to Slide 17, net interest margin, excluding OID, of 3.68% decreased 14 basis points year-over-year and 15 basis points quarter-over-quarter. The impact of rapid increases in short-term rates and the repricing dynamics of our balance sheet creates some near-term margin pressure. We still see NIM troughing around 3.5%, which I will cover in more detail shortly and remain confident in our ability to return to a 4% margin over time. Fourth quarter NIM benefited from continued increases in retail auto originated yields, declining retail auto prepayment activity and growth within our commercial and unsecured consumer lending segments. Total loans and leases are up nearly $16 billion versus prior year, while declines in cash and securities resulted in total earning asset growth of roughly $9 billion. Earning asset yield of 6.24% grew 65 basis points quarter-over-quarter and 149 basis points year-over-year reflecting the continuation of trends weâve highlighted previously, including strong originated yields within retail auto, growth in higher-yielding assets, and more than $40 billion of floating rate exposures across the loan and hedging portfolios. Retail auto portfolio yields expanded 33 basis points from the prior quarter due to continued increases in originated yields and a decline in prepayments, which have been pressuring yields since mid-2021. Including the hedge â impact of hedges, yields reached 7.98%, up 69 basis points quarter-over-quarter, and we expect yields to migrate towards 9% throughout 2023. Similar to the prior quarter, commercial portfolio yields expanded as their floating nature benefits from higher rates. Turning to liabilities. Cost of funds increased 84 basis points quarter-over-quarter and 170 basis points year-over-year. The increase in deposit costs was in line with what we shared last quarter and reflects higher benchmark rates and a competitive direct bank market for deposits. Slide 18 provides incremental detail on our outlook for margin. We continue to expect near-term compression and NIM to trough around 350 basis points, assuming the forward curve and a Fed funds peak of 5%. In retail auto, we added 395 basis points of price into the market in 2022 and are currently originating loans in the 10% range. On the deposit side, our OSA pricing has moved up 280 basis points as of year-end. So prices in retail auto were 115 basis points in excess of what we passed through on OSA. Despite that pricing momentum, the timing dynamics weâve highlighted previously will remain a margin headwind until we get through the Fed tightening cycle. So much of this last quarter, the bottom of the page highlights the two largest drivers of our NIM trajectory. Retail originated yields were 9.57% and given the portfolio yield, itâs still more than 150 basis points lower than originated yields, we see meaningful portfolio expansion ahead. By the fourth quarter of 2023, we expect portfolio yield will increase to roughly 9% without assuming any incremental pricing actions on new retail auto originations. The bottom right shows the evolution of retail deposit pricing. At year-end, our OSA was priced at 330 basis points, while average retail deposit costs in the quarter were just over 240 basis points. Deposit pricing has remained dynamic and competitive and incremental betas were a little higher in the fourth quarter. And while weâre not providing a specific outlook for OSA pricing, we continue to see a 3.5% NIM trough in a scenario where liquid deposits go to 375 basis points. Clearly, there is a range of possible outcomes but we feel very good about our overall NIM trajectory. Turning to Slide 19. Our CET1 ratio remained at 9.3% as earnings supported $2 billion in RWA growth. In 2022, we executed $1.7 billion of share repurchases as we continue to normalize excess capital. Additionally, we announced a dividend of $0.30 per share for the first quarter. We remain disciplined in our capital allocation and currently maintain $3.6 billion of CET1 in excess of our SCB requirements. Our priorities remain focused on maintaining prudent capital levels amid continued uncertainty while investing in our businesses and supporting our customers. Letâs turn to Slide 20 to review asset quality trends. Consolidated net charge-offs of 116 basis points reflected the combination of normalization and seasonality. Comparison to the prior year and three pandemic periods are influenced by the addition of unsecured lending, which added 11 basis points. Iâll provide more color on retail auto credit shortly, the trends remain generally in line with our expectations. We are closely monitoring performance trends across the portfolio to inform tactical actions and risk tolerance as we continue to manage through credit normalization. In the bottom right, 30-day delinquencies increased due to typical seasonality and have normalized back to 2019 levels. 60-day delinquencies are elevated versus 2019, given strategic shift in collection practices, but we continue to see favorable total loss rates. We expect continued increases in delinquencies and are closely monitoring consumer health and the impact of persistent inflation on spending and savings trends. The investments weâve made within servicing and collections over the past few years will enhance our ability to communicate with and support our customers. Slide 21 shows that consolidated coverage increased 1 basis point to 2.72%, primarily reflecting growth in our retail auto and unsecured lending portfolios. The total reserve increased to $3.7 billion or $1.1 billion higher than CECL day 1 levels as we accounted for modest loan growth and the current macroeconomic outlook which has the unemployment rate approaching 5% by year end. Retail auto coverage of 3.6% increased 4 basis points quarter-over-quarter and is 26 basis points higher than CECL day 1. Total retail auto reserves of $3 billion are up roughly $600 million or 25% versus CECL day 1. Slide 22 provides a detailed view of originations dating back to 2016 bucketed into our proprietary credit tiers. As a full spectrum lender with critical scale, we are able to opportunistically focus on market segments where we see the most value while supporting our dealer customers. Since 2016, originations from our top two tiers have remained consistent in the 75% range, while we slightly decreased our exposure to lower credit tiers. Our approach to risk-based pricing is evident on the right side of the page. In total, we added 395 basis points of price in 2022, which was intentionally added across the credit spectrum. Like some other lenders, we werenât able to add as much price into higher FICO segments, but we aggressively added price to higher risk tranches to buffer returns from losses that may exceed underwritten expectations. The bottom of the page highlights a few originated stats showing our strategic shift towards used, which has largely driven yield expansion despite stable credit origination trends over the past 7 years. On Slide 23, we show our forecast for used vehicle values, which has remained largely consistent for the past 12 months. In 2022, we saw a 19% decline from peak values most of which was realized during the second half of the year. We are projecting a further decline of 13% from current levels, which will result in a 30% total decline from 4Q â21 to the end of 2023 consistent with previous guidance. There are certainly other views on used values out there, most of which are projecting smaller declines in 2023. While we do see the possibility for a smaller decline in 2023 based on the supply and demand dynamics at play, we continue to maintain a conservative stance. Turning to Slide 24, we have added some details on what weâre seeing within the retail auto portfolio regarding vintage performance. We have continued to see strong performance from vintages originated through mid-2021. These loans have now passed their peak loss period, and we expect lifetime losses to be favorable to price expectations. We are seeing elevated delinquency and loss trends in the vintages originated from late 2021 through mid-2022, consistent with what others have observed in the industry. These vintages currently account for about 38% of the portfolio and are just entering peak losses. Although we expect that cohort to amortize to about 24% of the book by the end of this year, we do expect elevated losses in those vintages to impact our full year 2023 net charge-off rate. As we have discussed previously, we have been taking underwriting and pricing actions to reduce the risk content of new originations. By the end of this year, these latest originations will account for the majority of the portfolio and loss content heading into 2024. Slide 25 provides an update on retail auto net charge-off expectations. Our 2023 net charge-off outlook assumes a mild recession in 2023, along with a 13% further decline in used values just discussed. Loss performance in December was consistent with what we expect on a normalized basis, and we assume full normalization of the portfolio in first quarter of 2023. Peak losses on the late 2021 and early 2022 vintages and increasing unemployment drive elevated losses late in the year and a full year 2023 net charge-off rate of around 1.7%. The bottom of the slide provides a perspective on how we currently expect losses to materialize throughout 2023. Weâve also included historical references, which have shown similar seasonality. Overall, expected losses are up approximately 30 basis points from those periods and are slightly elevated relative to what weâd expect for the normalized risk profile of our originations. We expect 2023 to continue to be a very dynamic environment and we will continue to be transparent about what weâre seeing and our current expectations for the year. On Slide 26, we have laid out various actions weâve taken throughout 2022 to mitigate risk on new originations and how weâre prepared to manage credit through the cycle by focusing on what we can control. Front-end actions, including modifying decision strategy, implementing pricing increments and curtailing risk helps to ensure weâre originating loans at adequate risk-adjusted returns, maintaining appropriate staffing levels through the cycle and investing in digital capabilities proactively positions us to handle normalized credit conditions. Moving now to Ally Bank on Slide 27, retail deposits of $138 billion increased $3.8 billion quarter-over-quarter reflecting continued growth and solid inflows from traditional banks. Total deposit balances $152 billion increased $6 billion quarter-over-quarter, driven by incremental growth from broker deposits. Given the continued momentum across the deposit franchise, weâre currently 88% deposit funded. We delivered our strongest quarter of customer growth since the second quarter of 2020, adding 85,000 new customers in the fourth quarter, our 55th consecutive quarter of growth. Since we founded Ally Bank, balanced growth and retention have been foundational aspects of our retail deposit strategy. We continue to lead the industry with a 96% customer retention rate. Customer acquisition, especially within the younger generations is noteworthy. The customer demographics in the bottom right highlights the long-term opportunity we have to deepen relationships by being part of our customersâ financial journey from the other stages. Turning to Slide 28, we continue to drive scale and diversification across our digital bank platforms. Deposits continue to serve as the primary gateway to our other banking products, which enhanced brand loyalty, drive engagement and deepen customer relationships. The strength of our brand allows us to build on current momentum across our newer consumer lending products. Ally Invest continues to increase depth and strength of customer relationships at Ally Bank. The percentage of new accounts opened by existing customers remains above 70%. Card balances of $1.6 million are derived from 1 million active customers reflecting our strategy of low and grow credit lines. Ally lending balances of $2 billion highlights the momentum across healthcare and home improvement verticals. And we continue to see balanced opportunity for accretive growth in these portfolios as they currently comprise less than 5% of our earning assets. Letâs turn to Slide 29 to review auto segment highlights. Pre-tax income of $437 million was a result of continuing actions, pricing actions as well as balanced growth within the retail and commercial auto, offset by higher provision. The increase in provision expense versus the prior year reflects historically lost performance in 2021. Looking at the bottom left, originated retail auto yield of 9.57% and was up 82 basis points from the prior quarter, reflecting significant pricing actions. As mentioned previously, we put nearly 400 basis points of price into the market in 2022 and are continuing to see solid flows with originated yields above 10%. This drove further expansion of the portfolio yield, and we expect this to continue over the medium term, given the strength and scale of our franchise. The bottom right shows lease portfolio trends. Despite the decline in used values, gain per unit was up quarter-over-quarter given the decline in lessee and dealer buyouts. Turning to Slide 30, we continue to realize the benefits of our leading Agile platform underpinned by a high-tech and high-touch model. Consistent application flow shown in the top left, enables us to be selective in what we approve and ultimately originate. Applications and approvals have been relatively stable over the past couple of years, but we did target a tick down in approval rate as we proactively manage risk through detailed micro segment analysis. In the upper right, ending consumer assets of $94 billion are up 6% on a year-over-year basis. Commercial balances ended at $18.8 billion as new vehicle supply remains pressured, but has shown some signs of normalization. Turning to origination trends on the bottom half of the page, consumer auto volume of $9.2 billion demonstrates our ability to add price in the market and maintain solid origination volume. This culminated in full year originations of $46 billion. We remain nimble and are not tied to any target, but we would expect to generate originations in the low $40 billion range in 2023. Lastly, use accounted for 60% of originations in the quarter, while non-prime declined to 7% of volume given ongoing risk management and seasonal trends. Turning to insurance results on Slide 31, core pre-tax income of $52 million decreased year-over-year from the low â from the impact of lower investment gains, given the market backdrop. Total written premiums of $285 million increased year-over-year but still reflects headwinds from lower unit sales and inventory levels across the industry. Last quarter, we shared some context on how our proactive approach and dealer relationships were able to limit losses related to Hurricane Ian. We continue to see favorable results and expect minimal loss content as shown in the bottom left chart. Going forward, we remain focused on leveraging our significant dealer network and holistic offerings to drive further integration of insurance across auto finance. Turning to Corporate Finance on Slide 32, core income of $67 million reflected disciplined growth in the portfolio and stable credit trends. Net financing revenue was driven by higher asset balances as well as higher benchmarks as the entire portfolio is floating rate. The loan portfolio is diversified across industries with asset-based loans comprising 55% of the portfolio and a first lien position in virtually 100% of exposures. Our $10.1 billion HFI portfolio is up 31% year-over-year reflecting our expertise and disciplined growth within a highly competitive market. Mortgage details are on Slide 33. Mortgage generated pre-tax income of $19 million and $170 million of DTC originations, reflecting tighter margins on conforming production and effectively zero demand for refinancing activity. Mortgage is an important product for our customers who value a modern and seamless digital platform. Weâre focused on a great experience for our customers, but refrain from any specific volume targets. Before closing, Iâll share a few thoughts on the outlook for 2023. On Slide 34, we show key drivers of expected 2023 expense growth while headline expenses are projected to grow roughly 6%, itâs important to look a little closer at the details. Roughly half of the year-over-year growth is comprised of non-discretionary items including an industry-wide increase in FDIC fees and insurance expenses, primarily commissions, which have a direct offset in revenue and weather losses. Growth also includes increased costs to ensure we are able to provide leading service to our customers, support continued credit normalization and manage loss exposure. The remaining increases in expenses consist of variable costs directly tied to revenue growth, like servicing and acquisition costs in auto and card and long-term investments across the enterprise like cyber. So what you traditionally think of as discretionary expenses are driving approximately 1% to 2% of expense growth in 2023. We acknowledge the revenue headwinds present this year and remain very focused on efficient expense deployment. Slide 35 contains our financial outlook as we see it today. Clearly, the dynamic environment makes it harder than ever to provide granular guidance, but we remain committed to transparency. Based on what we know today, we see adjusted EPS of approximately $4 in 2023, the main drivers of which include NIM of 3.5%, which weâve covered previously, other revenue expanding to roughly $500 million per quarter, modest earning asset growth, mid-single-digit expense growth, retail auto net charge-offs of 1.6% to 1.8% and consolidated net charge-offs of 1.2% to 1.4%, and finally, a tax rate in the 21% to 22% range, slightly favorable versus our historic average given ongoing tax planning strategies. We have also provided our thoughts on earnings trajectory beyond 2023. We expect earnings expansion over the next several years as NIM moves past the trough and migrates path towards 4%. Based on what we know today, we can see a path to that $6 as early as 2024, but obviously, several variables will ultimately dictate the pace of EPS expansion. We continue to view mid-teens as a return profile of the company based on all the structural enhancements we have made over the past several years. We acknowledged 2023 will be a very dynamic year given macroeconomic headwinds and volatility, but we are confident in our ability to continue to execute and drive long-term profitability. Thank you, Brad. I thought I would close by highlighting several of my near-term priorities. First and foremost is credit risk, as I have said before, our ability to underwrite and manage credit risk is our core competency. I am confident the investments we have continued to make in risk management positioned us well to navigate this fluid environment. The bar on cybersecurity risk management continues to move higher, and we are committed to protecting our customers from external threats. I am thankful for the talent of our CIO and CSO and the broad cyber teams that exist at Ally. Taking care of our people and maintaining a purpose-driven culture is even more important during periods of heightened uncertainty. Our continued emphasis on essentialism will drive operating efficiencies over time. While we are focused on actively navigating this dynamic environment in the near-term, we are committed to continuing to execute on our long-term priorities. And finally, we must live our name and be an Ally now more than ever. We are going to support our dealer, corporate finance and consumer bank customers, staying true to our name and promise has driven our unique growth and retention of customers. I remain incredibly proud to lead our company. And over time, I am confident these priorities will serve us well and deliver value for all stakeholders. I know the deck today was longer than normal, but we thought it was important to really give that longer term view and focus on the trends that we have executed on since we went public and also hit the things that are top of mind for all of you and top of mind for investors, things like credit and margins. So, we tried to evolve the deck this time. We know we added several pages, but we thought that transparency was very important. Thank you, J.B. As we head into Q&A, we do ask that participants limit yourself to one question and one follow-up. Carmen, please begin the Q&A. [Operator Instructions] One moment for our first question, it comes from the line of Moshe Orenbuch with Credit Suisse. Please go ahead. Great. Thanks for that extra disclosure. To just drill in a little bit on the credit loss outlook and how we should think about it. Can you talk a little bit about the impact of frequency versus severity, the period that you saw from the middle of â21 to â22, those originations, what are you seeing thatâs driving that higher loss? And how does that inform us as to the path in â23 and â24 for the overall loss rate? Hey. Good morning Moshe. Itâs Brad. I will start on that one, and J.B. can certainly add in. As you mentioned, we did highlight that kind of late 2021, early 2022 vintage. From a frequency perspective, we did see that kind of normalization pace accelerate in the fourth quarter and a couple of variables to that are important. One, as customers really get to that stage earlier in the cycles alone, that is typically a higher balance charge-off was certainly impactful. And then as well, as noted, we did see some acceleration in used car values in the late part of the year, which were also impactful. As we think forward drilling into 2023 here, as I mentioned, that vintage was about almost 40% of the book at the end of the year. As that continues to normalize, we will work that through the system here in 2023. And I think that, that will, as we mentioned, be impactful to the 1.7 rate that we highlighted as well. But then at the same time, we have taken, as noted, significant actions tactically around risk management and trimming some of the risks that we see, particularly around micro segmentation which will also â which has really reduced the loss expectations on that more recent book. And then couple that with the really strong outperforming back book really kind of gives us comfort there in terms of that range. And then ultimately, the macro environment is certainly impactful. As mentioned, this does assume â we are assuming a mild recession in 2023. Thatâs really led by contraction in GDP for the first couple of quarters and then ultimately unemployment getting near 5% by the end of 2023. Great. Thanks. And the margin outlook is roughly consistent with where you had been, although rates have moved up a little bit more. What has countered that? Has it been the yield on auto? I mean I think the â your performance this quarter was a little better than we had been expecting. Talk a little bit about what drove what you â how we should think about whatâs happened on the yields side, I guess? Yes. Sure. Well, I would go back to all the enhancements that J.B. highlighted at the beginning, structurally, that is continuing to be a significant part of the expansion just generally from an overall company and balance sheet perspective. I would say that retail portfolio yield continues to expand. I think that â those levels, I think have been a little bit underestimated as well. And I think again, putting on good solid business at 10% yields, high-9s during the fourth quarter was also impactful. And then you think about things like the hedges that we have, which really do provide a nice bridge for us. As you think about the increase in Fed funds in the fourth quarter, 125 basis points was dramatic. So, that did re-price the OSA portfolio as we also highlighted. But the hedges really do kind of help us bridge the 4Q through really most of 2023 to kind of give time for the retail auto portfolio to really overwhelm the increase in liability costs. Yes. The only thing, Moshe, maybe I would add just a couple of things on â itâs really Slide 30. We didnât spend a ton of time drilling into what we did in the quarter, but you will see auto originations. We pared back fairly considerably in the fourth quarter from where we had been running. And I would say that was probably driven two-fold. One, just being ever more deliberate on credit management and as Brad talked about trimming some of those micro segments and things like that. But you also saw a decent pop in what we are doing in the new space. And part of this, we just think itâs a function, and I talked about it at one of the industry conferences in December as you get to kind of a 10% type of yield on new consumer originations, you hit a bit of a saturation point with the consumer. So, part of that â all those factors sort of drove into kind of lower volumes and maybe a little less risk appetite in the fourth quarter as well. Hey. Good morning guys and thanks for all the additional disclosure. Brad, to Mosheâs question, you outlined what you expect to drive credit losses in the near-term. Can you maybe just expand upon whatâs included in the allowance from a macro perspective? I know you said 5% unemployment by the end of the year. And just how are you thinking about future reserve build here given the fact that you are expecting a modest recession in the near-term? Thanks. Hi. Good morning Ryan. Sure. So, I guess I would start by saying we did mention the macroeconomic. It certainly has evolved since third quarter, right. And we pointed that out, you did as well, GDP contraction as well as higher unemployment by the end of the year, approaching 5%. I would start with by saying we â and J.B. pointed this out, right. We continue to be really generally conservative in our overall reserving methodology that includes the assumptions that we make in our CECL framework as well when you think about our 12-month supportable and then the 24-month reversion as well and the look back there, which includes the Great Recession, to kind of get into that kind of reversion mean of 6.3% in unemployment. So, when we kind of think about 3.6% coverage versus that range of 1.6% to 1.8%, and my kind of simple broad math when you think about even the high end of that range, if you allocate that annualized number over our weighted average life of auto, which is 22 months or so, you will see that we are really well covered even at the higher end of that range. Got it. Thanks for the color. And then J.B., maybe a question for you on capital, so, the slides note that you donât expect to repurchase any shares here. And given slower than last yearâs balance sheet growth, I think itâs pretty clear you are going to build capital this year. So, maybe you could just talk about, given the uncertainty in the environment where you would like to run capital ratios at? And then maybe what would it take for you to turn repurchases for the company back on? Thanks. Yes. Sure, Ryan. So, as kind of we alluded to, we are close to sort of running at our internal target, which is 9%-ish. And so we have been aggressive buyers of the shares. Got ourselves paying a reasonable dividend today. I think just in light of what a fluid environment, dynamic environment challenging, whatever you want to call it, we think the prudent thing right now is not to plan for incremental buybacks. But to the extent we get clarity, to the extent â whatever we head into and it becomes a mild recession, and we start generating incremental capital, I think we would look to restart the buyback program at some point in the future. And so that was using that word currently was very much by design. I mean I think what we see today, the prudent things do not plan for it. But look, we â I think we have shown we are aggressive buyers of our shares when we feel they are undervalued, and we certainly would say that today. And so to the extent we get more and better clarity, it would not be unreasonable to assume we begin again. Thank you. One moment for our next question please. And it comes from the line of Bill Carcache with Wolfe Research. Please proceed. Thanks. Good morning. Your presentation materials go a long way towards addressing some of the major debates on your stock. So, let me add my thanks. I wanted to follow-up on your credit comments. Based on what you see today, would you expect NCOs to peak in 2023, or could we see peak NCOs going on until 2024? And when should we expect the reserve rate to start to drift floor in relation to those peak losses? Yes. Hey. Good morning Bill. Sure. So, I think the slide that we added that shows sort of that expected trajectory in 2023 is a great reference point. And you will see kind of at most, the biggest delta and sort of our normalized view versus 2023 expectations really is in the fourth quarter. And so thatâs where the unemployment rate, as I have said, is peaking and cresting as well as working through some of the other dynamics we mentioned in terms of just when you think about the content of new originations as well, the vintage, the dynamic that I mentioned, which is really working through that late â21, early 2022 cohort where we expect that to be down to less than a quarter of the book by the fourth quarter. So, I think that, that â and also kind of continuing what we have guided to previously around our decline in used vehicle values, they will kind of get us to that high point of the 4Q 2023. Now, if things worsen or things change from here, I mean variables, as I mentioned, are moving quickly and certainly hard to predict. But we would see that there could be some of that elevation going into 2024, but really feel like given all of those dynamics that, that should be around the top... Got it. And separately, I did want to also ask if you could give some color on the decision to provide concrete expense guidance and speak to the concerns that 2024 is a long way away and you may be limiting your flexibility. Why not go with more of an efficiency ratio that gives you the ability to potentially manage expenses for the revenue environment? Just any kind of color on the thought process that you all went through there. Yes. I mean Bill, what I would say is look, we â across the enterprise, we embrace this essentialism mindset, which is disciplined pursuit of less. There is a number of the items let our sort of non-controllable, what I think Brad pointed out, FDIC piece being a big driver. The insurance line item creates a decent-sized pop and your headline expense number. But as Brad mentioned in his prepared remarks, thatâs the direct offset in revenues there. And so then when you get into kind of controllable space, you got a number of 1% to 2%, which we think in light of the environment is pretty reasonable. I mean as I talk to other CEOs in financial services, I think everyone is kind of grappling with higher people costs and human capital costs. And so we are trying to manage through that. What I would say is, as an enterprise in the end of the summer last year, we more or less hit the pause on hiring. You have seen other financials do that as well. I would say there are some special exceptions to that new talent, entry-level talent you want to continue to build a pipeline and allow those people to come into the company, that doesnât end up being a big driver of expenses, but we have added to the headcount there. And then with respect to the technology space and cyber space, things like that, we think these are areas that you have to constantly invest in. And we think itâs kind of interesting whatâs going on in the world of technology, more layoff announcements throughout this week more this morning, and that may provide us an opportunity to bring in incremental talent. So, all of these things kind of balance out the way we are thinking through. I mean we recognize revenues, as Brad talked about, are going to be pressured in the near-term. But I think our focus is trying to create that right balance for the long run. And I think what we have done in hiring has been very responsible and very disciplined in what I think our long-term holders would expect us to be doing. But I mean I would start with there is a big essentialism push to drive efficiencies wherever we can. Thank you. And one moment for our last question. And it comes from the line of Betsy Graseck with Morgan Stanley. Please proceed. Two questions. One, just wanted to dig in a little bit on the guide for how you are thinking about the OSA rate and the NIM and all that. And I know that you indicated there were several different scenarios in a range of potential outcomes. So, can you help us understand how you are thinking about working through the scenario where perhaps OSA rate becomes a little more competitive than what you are baking into the baseline that you have got here? Yes. Betsy, I will start and Brad, feel free to dive in. So, what I would say, certainly the direct bank market has been hypercompetitive as of late â I think there is a bigger thrust for deposits. So, we take the point. I think where we are priced at right now at 3.3 on OSA is in line with what I would say are other kind of top name direct banks and big banks. And so we are kind of right in line with the pack. There are certain names that are priced higher than us, and we are not seeing big outflows. And so all this ends up being kind of a â a balancing act on the competitive environment and the rate environment. I think the guide that Brad tried to point out is, I mean we â I think most of the universe is starting to think that the Fed is getting closer to being done, maybe there is another 50 basis points to go. And obviously, I mean we are at 3.3 today. Brad is showing you a scenario where you are going up 45 basis points against maybe a 50 basis point move. So, itâs kind of like a 90% beta. That feels pretty darn aggressive to me. So, it is a balancing act. Thatâs why we try to add the transparency about what you are assuming on the Fed funds rate. Everyone can kind of do their own math if they think it would go higher. But the nice thing, I would say, in talking to our deposit leader, Paula and our bank leader, [indiscernible], they would tell you things have kind of felt a little bit more stable here in the past three weeks, four weeks. So, we think there is more to go, but I donât think itâs another kind of 100 basis points from here. Okay. Got it. And then separately, same kind of theme, how should we think about the impact on loss rates if used car prices fall more sharply than what you have baked in? Yes. I mean obviously, they would go up to some degree. But I think there are a couple of dynamics at play. First, if you look at other industry experts and big names that are out there, they are more modest than the declines that they have projected. I think we have been pretty consistent saying end of â21 to the end of â23 would be this 30%-ish type decline. We saw a little more than that last year. But as Brad shown you, you have got probably 13 basis points of decline embedded here. I think that â the other factor thatâs out there is there were about 11 million less cars produced over the past sort of 3 years. And so we think that provides some structural support. We always try to take a more conservative view. But I mean the way I would think about the range of risk is maybe itâs another 5% decline in used car prices, and that would represent kind of a couple of basis points of incremental NCO. So, itâs fairly well in there. Yes, could it be worse, but we think thatâs probably a little bit unlikely from here. Great. Thank you everyone. Thatâs all the time we have for today. If you do have additional questions, as always, please feel free to reach out to Investor Relations. Thank you for joining us this morning. That concludes todayâs call. And thank you, ladies and gentlemen. This concludes todayâs conference and thank you for your participation. And you may now disconnect.
|
EarningCall_1175
|
Good afternoon, ladies and gentlemen, and welcome to the ServiceNow Q4 2022 Earnings Conference Call. [Operator Instructions]. At the time, I'll turn things over to Darren Yip, Vice President, Investor Relations. Darren, please go ahead. Good afternoon, and thank you for joining ServiceNow's Fourth Quarter and Full Year 2022 Earnings Conference Call. Joining me are Bill McDermott, our Chairman and Chief Executive Officer; Gina Mastantuono, our Chief Financial Officer; and CJ Desai, our President and Chief Operating Officer. During today's call, we will review our fourth quarter 2022 results and discuss our guidance for the first quarter and full year 2023. Before we get started, we want to emphasize that some of the information discussed on this call, such as our guidance is based on information as of today and contains forward-looking statements that involve risks, uncertainties and assumptions. We undertake no duty or obligation to update such statements as a result of new information or future events. Please refer to today's earnings press release and our SEC filings including the most recent 10-Q and 2021 10-K for factors that may cause actual results to differ materially from our forward-looking statements. We'd also like to point out that we present non-GAAP measures in addition to, and not as a substitute for, financial measures calculated in accordance with GAAP. Unless otherwise noted, all financial measures and related growth rates we discuss today are non-GAAP, except for revenue, remaining performance obligations, or RPO, current RPO and cash and investments. To see the reconciliation between these non-GAAP and GAAP measures, please refer to today's earnings press release and investor presentation, which are both posted on our website at servicenow.com. A replay of today's call will also be posted on our website. With that, I'll turn the call over to Bill. Bill? Thank you, Darren, and thank you, ladies and gentlemen, for joining us today. ServiceNow continues to perform as-the-beyond expectations company. For Q4, we beat guidance with subscription revenue growth of 27.5% in constant currency. Operating margin was 28%, 2 points above our guidance. Our free cash flow margin was 30%, 1 point above our guidance. We had 126 deals greater than $1 million in Q4, including our largest deals ever worldwide in EMEA and in Latin America. Our 98% renewal rate remains the industry benchmark. With 25.5% constant currency cRPO growth, we actually had better-than-expected new business in Q4 with less reliance on early renewals. Based on this new business surge, we are giving a very strong guidance for 2023. Our guidance reflects a disciplined forecast that appropriately balances our well-founded optimism for ServiceNow's business. We'll work hard to go beyond it, and we'll begin that march in Q1. Here is the main takeaway. Even in a complex operating environment, ServiceNow is executing at the rule of 58.5%. We are driving net new innovation, fast growth and operating leverage. ServiceNow is the proverbial safe harbor in all weather conditions. Let me unpack the current environment for you. The secular tailwinds of digital transformation aren't going anywhere. IDC's research makes a clear that technology budgets are growing. They forecast IT spend will grow 5% in 2023, software spend at 8% and Software-as-a-Service spend at 15%. So as businesses increase spend, the only question then is where will all that investment go? And this answer has everything to do with the great reprioritization. The theme in Davos this year was cooperation in a fragmented world. It all begins with a fragmented enterprise. C-level buyers don't want long-term road maps to clean up a siloed mess of point solutions. They want integration, speed, automation, great experiences and business impact. A CEO told me, "We can't afford 1,000 points of We need a cohesive plan with a trusted platform." So this is now without any doubt, a platform economy. And only a few platforms will be relevant in this shift, and none are as well positioned at ServiceNow. This begins with our business model. ServiceNow with born in the cloud, established itself in IT and expanded from that core. It accelerates with the realities of the multi-cloud world. Many enterprises are struggling to use public cloud capacity that they have already procured into ServiceNow, which directly enables cloud workload migration. We are the control tower for any architecture, public, hybrid or multi-cloud. And with open telemetry, we help business build and monitor cloud-native applications. This all extends to driving automation. ServiceNow has natively embedded the complete tool set from AI to RPA to process mining in our platform. Now professional developers and the rest of us, real people like you and me, can build mission-critical applications to automate the world of work. Everything culminates with real business outcomes. ServiceNow integrates the enterprise to deliver better customer service, employee experiences, security, risk management and next-generation business processes like Procure to Pay, technology foundation, hyper automation, process orchestration. With this completeness of vision, ServiceNow is the end-to-end platform for digital transformation. If all we did was help existing customers consume everything this platform can do, we would stay a fast-growth company. But of course, our strategy goes well beyond this as does our proven ability to execute. Right now, many technology companies are working to shift resources from bad businesses to good ones. ServiceNow only has good businesses. Our products and engineering team is building organic net new innovation with an unmatched level of speed and quality. When we started to sense noise in the macro early in 2022, we shifted immediately to a conservative cost management posture in running the company. This allowed us to focus on execution with our team rather than look to workforce actions to leverage. It also allowed us to continue hiring, especially in engineering and quota-carrying roles. The results tell the story. ITSM was in 14 of our top 20 deals, with 15 deals over $1 million. ITOM was in 16 of the top 20, with 14 deals over $1 million. Security and Risk Solutions were at 13 of the top 20, with 9 deals over $1 million. Customer workflows were in 13 of the top 20, with 13 deals over $1 million. Employee workflows were 13 of the top 20, with 11 deals over $1 million. And create workloads were in 19 of the top 20, with 11 deals over $1 million. We saw new business growth, new logos and major expansions with some of our existing customers. The United States Army expanded its ServiceNow road map well beyond IT. ServiceNow will improve the Army's ability to consolidate service management for its over 1 million active military contractor and civilian population. The Schwark Group, one of the world's top retailers will digitize its 11,000 stores from retail locations to logistics on ServiceNow as its digital business platform. This transition is a transformation and it will position the Schwartz Group at the forefront of the next-generation retail industry. From Banco do Brasil, to AT&T, to Sumitomo, we have countless stories that span ServiceNow's workflows, Lightstep, geographic regions and industries across the board, we're winning. And as you'll hear from Gina, we grew new business 100% year-over-year across retail, hospitality, transportation and logistics. That's only one example. And with the expansion of ServiceNow's impact, we are setting the standard for speed of deployment and business value for our customers. One of 3 years ago, I stated our ambition to be the defining enterprise software company in the 21st century. And this is an ambition I will see through to its full completion. Following my elevation of Chairman and CEO, I'm delighted to announce that CJ Desai has been promoted to President and Chief Operating Officer. CJ is the leader of consequence, well known in the industry. His track record and ServiceNow speaks for itself from strengthening our platform to driving our customer experience. This is exactly how we are orchestrating our company to perform on an end-to-end basis from innovation to execution with our customers. And I'd like to personally congratulate CJ for his latest well-deserved endorsement of his leadership. Congratulations, CJ. In other news, we proudly welcome Masatoshi Suzuki as the new President of ServiceNow Japan. He brings a long history of successful leadership with some of the industries most respected brands. We will elevate ServiceNow Japan to a fourth geographic region reporting directly to our proven Chief Commercial Officer, Paul Smith. And to add fuel to the growth buyer, we rolled out a new partner program to help our ecosystem drive full platform adoption of ServiceNow. We're also getting an enthusiastic reception for the company's premier global initiative rides up with ServiceNow. And under the thoughtful leadership [indiscernible] of we will continue to rise up. We offer the training and certification to help people build a lifelong career working on this platform. We have never seen so much interest in the ServiceNow franchise around the world as we are seeing right now. And from an ongoing operating perspective, we entered 2023 with much stronger sales coverage on a year-over-year basis. We have the feet on the street. We also see stronger pipeline coverage and the maturity of that pipeline, much more so than we did a year ago. The latest ratings feature ServiceNow as the 9th best place to work in the United States, 2nd best in the United Kingdom. The company is fully invested in all of our stated ESG objectives with our global impact report coming later this year. All this is a reflection of our proud culture built on Fred Luddy's founding vision for our company. I was just in Las Vegas last week for our sales kick-off of them. And I can tell you, our team is fired up and ready to go for the year ahead. Really fired up. I can only reiterate that we have said consistently, there is only one way forward, and that is innovation. IDC says that by 2027, the number of digital businesses on the S&P 500 would double. Every industry is being reframed by a new paradigm or several. The participants that lean in will lead, the others will fall behind and quickly. For ServiceNow, we are committed to make the world work better for everyone. Our fundamentals are operating at peak performance, net new innovation for our customers, business impact, driving long-term stickiness of our platform and network effects, giving us a competitive moat with multiple avenues for market expansion and profitable growth with a pristine balance sheet. All in all, when people talk about cloud economics, ServiceNow is the blue chip standard. Whatever the world lacks in stability, we will more than offset with relentless execution. Our customers need to automate for cost reduction and to innovate for growth. Yes, ServiceNow helps them do both. The world works with ServiceNow as the end-to-end platform for digital transformation. I'd like to personally thank our customers, partners and shareholders for their steadfast trust in ServiceNow. You can count on us. We're in your service, hungry and humble as ever. I'd like to now hand the call over to our CFO, Gina Mastantuono. Gina, over to you. Thank you, Bill, and happy New Year to all of you who are listening in. Q4 was another great quarter of execution. We exceeded our subscription revenue guidance and drove strong renewal and expansion rates. Our operating and free cash flow margins also exceeded our outlook as disciplined cost management drove tailwinds to profitability. In Q4, subscription revenues were $1.86 billion, growing 27.5% year-over-year in constant currency, exceeding the high end of our guidance range by 50 basis points. RPO ended the year at approximately $14 billion, representing 25% year-over-year constant currency growth. Current RPO was approximately $6.94 billion, representing 22% year-over-year growth and a versus our guidance, primarily driven by favorable FX movements in the quarter. On a constant currency basis, growth was 25.5%. While constant currency cRPO growth came in just shy of our guidance of 26%, we actually outperformed our target for net new ACV and renewal ACV for contracts expiring in the quarter. The delta came from fewer early 2023 renewals than is typical in the fourth quarter. Given our strong renewal rates, which remain the best-in-class 98% in Q4, this is only a timing issue. We expect these customers to ultimately renew upon contract expirations, providing opportunities to drive further expansion throughout 2020 rate. The timing of early renewals does not impact 2023 subscription revenue growth, only RPO. Net new ACV would drives incremental revenue growth, and there, we exceeded our forecast. Our larger-than-average Q4 customer cohort not only renewed at a very strong rate, net expansion also remained robust. What's more, the strength in net new ACV was added to existing customers. New customer net new ACV grew over 30%. We ended the quarter with 1,637 customers paying us over $1 million in ACV, up 20% year-over-year. From an industry perspective, retail and hospitality and transportation and logistics saw net new ACV growth of well over 100% year-over-year. Government remained strong, growing more than 50% year-over-year. Manufacturing and financial services also saw healthy double-digit growth. We closed 126 deals greater than $1 million in net new ACV in the quarter, including 2 of our top 5 largest ever. In addition, we saw 100% increases in the number of both $5 million plus and 10 million-plus net new ACV deals. More and more customers are seeing the true power of the ServiceNow portfolio as a unified platform. That's leading to more multiproduct deals in Q4, 5 of our top 10 deals contain 10 or more products. Turning to profitability. Operating margin was 28%, 200 basis points above our guidance, driven by disciplined spend management and less-than-expected FX headwinds. The cash flow margin was 53%, up 650 basis points year-over-year. For full year 2022, operating margin was 26%, 100 basis points above our guidance and free cash flow margin was 30%, also 100 basis points above our guidance. Total free cash flow for 2022 was a robust $2.2 billion. We ended the year with a healthy balance sheet, including $6.4 billion in cash and investments. Together, these results continue to demonstrate our ability to drive a strong balance of world-class growth and profitability. Before I move to guidance, I want to give a brief update on the trends we are seeing. Heading into 2023, we believe we have prudently factored in the evolving macro crosswinds into our guidance. Overall, the demand environment remains healthy, deals getting done, the market opportunity is growing, the ecosystem is expanding, our renewal and net expansion rates ended the year strong, our pipeline is robust. With that in mind, let's turn to our 2023 outlook. We expect subscription revenues between $8.44 billion and $8.5 billion, representing 22.5% to 23.5% year-over-year growth on both a reported and constant currency basis. We expect subscription gross margin of 84%, reflecting the expected diminishing impact of the change in useful life of our data center equipment as well as investments to accelerate customer time to value as part of our impact offering and higher inflation. We expect operating margin of 26% as sales and marketing efficiencies are offsetting headwinds from gross margins. We expect free cash flow margin of 30%. And we expect GAAP diluted weighted average outstanding shares of 206 million. For Q1, we expect subscription revenues between $1.99 billion and $2 billion, representing 25% to 25.5% year-over-year growth on a constant currency basis, excluding a 300 basis point FX headwind. We expect cRPO growth of 24% on a constant currency basis, excluding 300 basis points of FX headwind. We expect an operating margin of 24%, and we expect 204 million GAAP diluted weighted average outstanding shares for the quarter. In conclusion, we had a strong Q4, capping a resilient year. As we enter 2023, the macro challenges many enterprises face underscore a point we have made consistently. The technology strategy has become the business strategy. Digital technologies are growth-stimulating deflationary force. They power new business models, accelerating productivity while reducing costs. Our unique ability to drive business model transformation while delivering efficiency gains has created durable demand for the Now Platform. Our investment strategy is a laser focus on our customers' most pressing issues, and that continuous net new innovation translates into net new business for ServiceNow. We are well positioned for 2023 and remain on our way to becoming the defining enterprise software company of the 21st century. Finally, I'm extremely proud of our team's performance this year. Bill and I can't thank our employees enough for their continued hard work and dedication. With that, I'll open it up for Q&A. And congratulations, everybody. Bill, we continue to hear from some of your largest partners of the great opportunity ahead in the middle office for which ServiceNow platform just seems to be ideally suited. How are customers prioritizing these opportunities right now and into this year? And how do you position yourselves particularly with partners and vertical industry solutions to best capture it? And I've got a follow-up for Gina. Yes. Thank you very much, Brad. And before I answer the first question, ladies and gentlemen, I just wanted to officially welcome CJ Desai as our newly President and COO, who is joining me here today. and I will have him continue to join me on these calls. And I'd also like to acknowledge Gina for powering through while she's a bit under the weather, so please her voice might be a little scratchy, but her passion is on fire. So she's in good shape, but losing a voice a little bit. We've been all over the world from Davos to Vegas to here. So that's what happens when you travel a little bit. Brad, the partners and the largest partners are really doubling down on their investment with ServiceNow. And I look at it as a multifaceted situation. First, on this RiseUp with ServiceNow, we're going to train 1 million people in the ecosystem to be fully certified on the platform to ensure that we globally scale. Second, partners are teaming up with us on an industry domain basis also based on persona and mapping that back to our solution road map and naturally, everybody is all in on the platform. So the big ones are really doubling down on the platform. What's interesting, and you bring up a good point, this is for the front, the mid and the back office. And there's a next-generation ERP evolving here with things like procure-to-pay, optimizing supply chains and other things that definitely impact the middle office. But I would also say we have a great opportunity. And if you saw our new business surge in Q4, you're seeing it play out, where we're going to net new logos and drawing net new business. And I think that will be a big part of it. CJ, you may want to build on it from what you're seeing in the middle office. But is, I would say, when we look at the engagement layer, engagement layer has been around for a long time, say, for a customer service require. So for a large financial services organization, moving the workflow from the engagement layer on, say, customer complain to the mid office where we really shine because of our interoperability of the platform and our ability to integrate the systems and to different clouds all the way to the back office. And that's what is driving the middle office acceleration, whether that's for a financial services organization, telecommunications or a health care organization. And congrats. I was remiss in not congratulating you, CJ. For you Gina, I appreciate the additional disclosure on net new ACV. You guys clearly had a really strong quarter for new business, which is what matters most to investors. But as we think about cRPO and what you shared with us, I mean, we're all trying to understand the customer mindset during these uncertain times. Is it fair to conclude that perhaps there was less of a traditional Q4 IT budget flush in 2023? And if not, what else would be the rationale as to why you would see that phenomenon? Yes, of course, Brad. Thanks for the question and apologies for my throat. So I think what you're seeing is early renewals were always correlated and still always correlated to net new ACV. And when people really renew, it's really about co-terming multiple contracts. And certainly, in the current environment, when -- I don't know if you want to say it's just budget flush or just more tightening of budgets, the need or the desire to co-term the contract is a little bit less than what we've seen historically. Not altogether surprising given the current macro. It's why I wanted to be really clear about the fact that early renewals have no impact on future revenue, right? And in the quarter, our target forecast for net new ACV as well as renewal ACV within the quarter actually overachieved, which is why we were able to come out with a strong 2023 revenue guide and why we feel good about not only the Q4 results, but also the position that we stand in the market as well entering 2023. Congrats from me as well, and Gina, I hope you feel better soon. A quick question. If you think about the different pockets of growth, you saw this quarter that the HR and CRM part was a little bit stronger for Q4. Can you talk a little bit about the drivers? Because like ITSM, ITOM, you're kind of the #1 player. And the other ones you're expanding. So it's nice to see the expansion in them. And then I had one follow-up for Gina. Yes, I'll make the first point, Raimo. And then I think CJ can actually even give you some customer examples that might be helpful. We have become the platform for digital transformation, and that's an end-to-end platform for digital transformation. So what you're seeing now is a company that has evolved from IT to the employee experience to customer service management. And obviously, the low code platform and how the creative workflow is exploding is demonstrated in our outstanding results and our very strong guide. So we're really now a platform company with a multiproduct approach to helping every customer in the industry they operate in, based on the persona we're discussing business with and ultimately, it's that completeness of vision now that has made us one of -- about a handful of companies in the entire world that really matter in the enterprise. CJ, you've got some examples you want to talk about? Absolutely. So employee experience and employee productivity are two sides of the same coin. And with our HR service delivery product that is resonating really well, whether it's in commercial markets, including we had a very strong public sector performance that Gina outlined, where that product is resonating. And during this macroeconomic times, when you think about customer service, you want to hold on to your customers and you want to serve them profitability. That's what is driving business for our customer service management product. So we are seeing that despite the technology foundation where IT is the business, digital services other business which is what driving our ITSM and ITOM product lines and what we call service operations, picking the best of service management and operations management, but HR and our customer service management are also driving growth in very specific industries from telco to public sector and health care. Okay. That was very clear. And then the Gina one for you quickly, on the margin and cash flow outperformance. Can you talk a little bit about factors that we should consider in terms of timing, et cetera, that might have impacted this more, will we kind of don't want to extrapolate into next year, et cetera. Yes. It's a great question, Raimo. So I gave a good strong guide for operating margin as well as free cash flow margin for 2023. I think what you saw in Q4 from an operating margin perspective was continued discipline on the cost side, as you have seen us do and as you will consistently see us do. On the free cash flow side, obviously, that disciplined cost management flows through. But also, we did see some CapEx spend come through towards the tail end of Q4, which means that the payments are not due until Q1 of '23. So that does drive a little bit of headwind on the free cash flow margin in '23, which is why you see the guide that I gave. Hopefully, that's helpful. Just want to circle back on the cRPO. Given the constant currency was 25.5%, is more of the issue that you described more happening internationally than in the U.S.? And how should we think about kind of the appetite to do renewals? And is there any concern about expansions from some of those international customers here in the first part of '23? Yes. Surely, it has nothing to do with the renewal dynamics internationally versus domestic. The difference between the constant currency growth and nominal growth really just has to do with FX rates that moved within the quarter. So no real differences internationally versus the Americas on the renewal side of things. With respect to the early renewals, what I would point to is the strong net new ACV growth in Q4 tells you. And by the way, very strong expansion rate in Q4 tells you that customers are not changing their behaviors with respect to renewals, on-time renewals or with net new expansion. What you're just seeing is a little bit of the lack of meeting to do co-terms and bring things forward in the current macro. Again, with 98% renewal rates across the board, we remain as positive as ever that not only will we continue to expand in '23, as you've seen us do in '22, but also continue to renew those best-in-class renewal rates. Sorry for asking you use your voice again. But how are you feeling about the 2024 targets? I think the consensus to you is that the $11 billion might be a little bit of a stretch given that you've had to absorb a pretty heavy FX headwind. The operating margin target of 27% seems doable. But when I look at your free cash flow target of 33%, that would be a 300 bps improvement in calendar '25. So that one feels like a little bit of a push. Do you mind just commenting on those targets, much appreciated. Yes. Great question, Karl. What I would say is, overall, the underlying growth that we're seeing remains healthy. FX headwinds have eased slightly, but certainly are still material. And with the uncertain macro backdrop, we're going to continue to monitor the market and provide an update on our long-term targets at our Analyst Day in May. So I'd say, again, underlying demand, really strong; operating margin, well on the trajectory to hit 27%; with respect to top line and free cash flow, with the impact of FX, and that keeps moving along, we'll update those targets for you in May. But let's go back to what Bill talked about earlier. We remain very well positioned given the current macro environment. We are the platform of choice for digital transformation. And that opportunity is -- has not changed. If anything, it continues to grow. Bill, just given your comments on the pipeline coverage and also the maturity, would you say that the macro headwinds have actually dissipated somewhat if you compare it back to the summer? Or -- are those wins still blowing fairly steadily, but you're just able to kind of navigate through them through will power and execution rigor? Yes, Mark, thank you very much for the question. I did call it out. I think maybe we were the first ones to call it out that there were some clouds on the horizon back then with the macro, and we all know the forces that were blowing between Ukraine, inflation, tightening monetary policies and supply chain dislocation, and everyone sees that to a pulp so we don't need to go there. I think what happened back then is most businesses were not ready for that market. And we immediately revamped our go-to-market in the way we approached the customer because we knew the customer would have to do more with less, automate their business, take cost out and improve productivity per person. And the work wasn't going to go away. It still had to be done, and step ServiceNow's platform. And then we also knew at the same time that CEOs, 98% of them, this is a fact have a digital-first strategy. Worried about the other 2%, but I'm good with the 98% because that makes a lot of sense. And we also knew that they weren't going to give up on their digital business dreams and they would be investing to reorient business models, as Gina said and think differently about their enterprise, which CJ's example underscored and growth would still remain on the agenda. It's just a question of what equilibrium between growth and cost takeout would be necessary for them to achieve their goals. The good thing is, with ServiceNow's platform, you could say yes to both. And you don't have to make that choice. So what I see in the market, I see commodity tech that was at the peak of the hype cycle during the pandemic being dialed down or eliminated. And I see that investment freeing up to platforms that actually matter. So I do think our circumstances are actually improving because of this particular macro, because it's well known now that ServiceNow can take the cost down, if that's what you need immediately. And given the layoffs that we're seeing and the stories that we're reading, I clearly see that our company is rising accordingly. And I see that in the pipeline. I see that in the maturity of the pipeline which is a really important fact. And this year, we came in with sales productivity at least 20% better than I had at the start of last year based on the feet on the street and the readiness of those feets because they've been well trained and certified to do their job. All these forces are coming together in a way that gives me a feeling the market will be on our side, but our executional excellence will never have to rely on the weather conditions. We're ready. Very clear. And Gina, sorry again giving your voice. But just again, on the topic of the lower mix of early renewals from 2023, should we interpret it at all as customers may be a little hesitant to renew early just because of the cost of capital is higher. They want to hang on to cash a little longer? Or on the flip side, is there some element of maybe you actually enjoyed the luxury of not having to encourage as many early renewals because you did see so much strength on the new logo side? A great point, Mark. And certainly, I think you're seeing a little bit of both. And what I keep telling folks is the fact that we are not having to rely on early renewals as much as we've done in the past, shows the resilience and the strength and the power of the Now Platform. But yes, I also think that in this market, people are holding on to cash a little bit longer. And that's not altogether surprising either. And Mark, one thing I would just build on what Gina is saying, and for every investor out there, when you don't need to rely on early renewals, that means you have a competitive advantage with your technology. It also means that you're able to preserve your pricing power as you go into the renewal cycles on the normal terms. So this is actually a super healthy thing, and that's why the guide for 2023 was above all the consensus estimates that you guys have. I would think that in a time of inflationary environments that people would want to get rid of cash and preserve the purchasing power. But anyways, a little counterintuitive. That was not my question anyway. So congratulations, first of all, Bill, CJ and Gina. I will spare you. I'll give you some time off and not ask your questions, so you can test your voice. Bill, one thing that occurs to me is that you've scaled a very successful technology company before. So what are the patterns that you see at this point in the evolution of ServiceNow there on be so many things that you could be doing from differently, from a go-to-market perspective, verticalizing the product, expanded distribution partnerships with resellers potentially. There's so much innovation. I look at the number of products that you have, it's mind blowing. Almost complex. How do you ensure that this all does not get in the way of your mission to build the defining enterprise software company of the 21st century? How do you make these catalysts and tailwinds and make sure that nothing gets in the way since you've especially seen this pattern play out and you've successfully done this before? Yes, absolutely. Yes, Kash, as I said, we've been through this movie before, and I'd like to show. So here's the situation. We're keeping it real simple for 22,000 of our closest friends within ServiceNow and for our partners. We have the end-to-end platform for digital transformation. That platform is applicable to each industry and every persona within the enterprise. And we are going to expand that across the world. And you saw the move we made with Japan. Our ambitions are going to India, to the Middle East and many other places. So end-to-end platform, by industry, persona and geo, and we kept it very simple for our colleagues and also our partners. We focused on net new innovation. We will build the future. We have the best engineering leader and the best engineering team in the industry, hard stop. We have an incredible go-to-market machine, and we're betting on ourselves. So we're going to keep a real simple around net new innovation and net new ACV. That's it. And with a loyal customer base that will remain ever loyal with many upsells, cross-sells and same account revenue growth, if you get new business on top of that because you're building the best product in the world, you're going to have the defining enterprise software company in the 21st century. And congratulations on the performance, particularly on the net new ACV. In fact, that's what I'd love to help -- a little bit help unpacking that because obviously, it's including both new logos and expansion. And I think we heard last quarter and correct me if I'm wrong, that new customer acquisition had slowed relative to, say, Q2 where I think for new revenue, you had talked about maybe 10% of growth was coming from new customers. When you look forward now and looking forward to next year and the revenue growth, are you seeing most of that growth coming from existing customers relative to what you would have normally done with new customers, I guess, is part of the question. And then the other side of the question is it appears that NRR declined by about 300 basis points quarter-over-quarter and in your guide, it would anticipate continuing decline in NRR by probably another 300 basis points to hit your guide. What is really creating that weakness in the kind of the renewal NRR relative to recent quarters that have been pretty consistently at or above 130%? Peter, I'll take the first question. So clearly, we're thrilled with the net new ACV growth that we're seeing, and not only are our expansion rates strong within the quarter and for the full year in 2022, we were really, really pleased to see that new customer, net new ACV grew over 30% year-over-year despite the headwinds. And we've talked about this in the past. We've really evolved our focus away from the number and the volume of new customers to landing the right new customers that can land with us and expand with us over time. And so the fact that these new lands are growing is testament to the platform, a testament to the breadth of products on the platform. And so as we think about 2023 and beyond, we absolutely expect to continue to see very strong expansion rates as well as good new logo growth. But again, it's about not the volume of those new logos, but the quality. And really, you can see that in our results. With respect to your comment on NRR declining by 300 basis points, that's not what we're seeing. I'm not sure what math you're doing, but I'm sure that off-line, Darren can talk you through it. But our net retention rate and expansion rate remains very strong in Q4 and for the whole year in 2022. And very nice end to the year with that new business growth there. Gina, I wanted to dig in on gross margins a little bit. I'm still trying to wrap my head around a 200 basis point decline. We haven't seen 80% subscription gross margins in ServiceNow since 2016, if I'm looking on my model correctly, I believe. You told us last year at this time that there's still an incremental 50 basis points of tailwind that you can get from the accounting change on useful life. So there's somewhere a 250 basis point offset that's driving down gross margins. Can you help us understand what that is, a little bit better? What's that added expense that had such a weight on gross margin heading into FY '23? Yes. Great question, Keith. So first of all, your math is a little off, right? So we had in 2021, we had 85% gross margin, and then this year, 86%. And we talked about that 100 basis points being the change in depreciation life of our assets. And we've said that 100 basis points was going to come down to 50, right? So you take 86, you come off to 50, that gives you 85.5. And so what you're seeing, what I tried to call out in my script is, number one, we are seeing impacts of inflation, right, not surprising, and we've talked about. But also, we are also investing heavily in ensuring that our customers are getting to success in getting to implementation much faster with respect to our impact products. And so very conscious investment decisions being made there, offset by sales and marketing efficiencies that you've come to expect from us, which is why the operating margin guide remains absolutely where you would have expected to be because we're making investments in cost of sales to get our customers to implementation as a value faster, offset by the sales and marketing efficiencies. Congrats, CJ. Congrats guys on a solid quarter. I guess, we're all trying to unpack, I think, 2 metrics that would be very, very helpful from the quarter itself. So apologies for the more financial-oriented question. But Gina, can you quantify the renewal headwind from the -- from the smaller early renewals? And can you comment on the net retention rate itself? Was it still 125 for the full year? Because when you take a step back, it looks like the cRPO guide for Q1 is a lot stronger than where people thought it would be, which implies that maybe that renewal headwind becomes a tailwind if you get those renewals or maybe you've got them already in the quarter. And the guide for the full year, to your point, is I think, a lot stronger than what people realize. So we're all trying to kind of piece together that -- those 2 dynamics and questions. I won't quantify the exact renewal headwind. But what I would say is that if not for the early renewals, we would have beat our cRPO guide. And with respect to the NRR, while we don't comment on exact numbers, it was absolutely consistent and relatively close to the 125 that you quote. Perfect. Super helpful. And I guess maybe a technical one or a product-oriented one for you, Bill or CJ. With respect to some of the other new areas of innovation that you're bringing to bear, particularly in industries going forward. Can you maybe highlight some early anecdotes and examples of kind of some of the larger customer wins and verticals that give you confidence to kind of pour gas on the fire there? Absolutely. So great to hear from you, Alex. I would say one of the products that we verticalized pretty early on was in the telco media and tech. -- back in -- started building that in 2019, seeing very strong traction, everything from order management to mid office to back office in telcos. And that product line which was created for that industry is now at top 10 telcos and continue to win market share and displace multiple systems, whether it's a telco company or a media company. Similarly, the public sector, we created a product for public sector as well as health care that is seeing strong traction as well. And overall, between the new products, horizontal products like we have done in the world of ERP on procure to pay or supplier life cycle management, combined that with some of these new industry products, we are winning 7-figure deals, sometimes much larger and having massive traction in that specific where customers are actually going live in 3 to 4 months. Thank you, Alex. By the way, CJ had one go live yesterday with 50,000 agents, and we were in the board room together as we were watching the go live and it was flawless. So that's a customer service management example of one of the most prestigious brands in the world. So you can count on our customer service management business to continue to rock the house. So we're ready to go. And by the way, I don't get caught up in the cRPO thing because it's only a forecasting based on prior year assumptions, has nothing to do with what actually happened. The net new business was fantastic. And all those renewals are sitting for us in 2023. And obviously, because we're delivering business value and impact, it is sitting there for us at the right pricing structure. So it's actually a super good thing from a shareholder value creation perspective. Bill, last week, you spoke pretty adamantly about continuing to hire. Hiring net new downtick a little bit here in 4Q versus the previous few quarters. Maybe you can give us an idea of what the plan is for this year. Yes. Thank you very much, Brad. As Gina said, we're going to be very intentional about how we manage the headcount in the corporation. We are protecting this house as a primary objective. And we have invested very heavily now for the last 3.5 years, for sure, on headcount. And we have what we need. Where we are investing, and we'll continue to invest, primarily will be coders, people that actually write the code and also people that are actually responsible for the customer relationship and carry a coder. So we're going to be very, very intentional. And I'm really super because we're in great shape on our workforce. We are really happy workforce. Our retention rates are better than ever. The Glassdoor ranking speaks to some of that. So what we are finding is because of our intentionality, we're getting 9s and 10s in here, and the people we are choosing to hire come from a pool of thousands and thousands and only the best get to go to ServiceNow. And I think that's going to build an even stronger ServiceNow going forward. So no problem with the workforce. Everything is about driving innovation or net new ACV, net new innovation, net new ACV. That's the ball game. If I could just add, we're entering 2023, and Bill alluded to this earlier, we're entering 2023 with significantly more ramp reps than we entered into '22. So that growth. Yes, we might have had a little bit of a slowdown in hiring in Q4, but that was not on coder-bearing sales or engineering. We're entering 2023 from a ramp rep perspective, very strong, which gives us confidence not only with the pipeline we're seeing, but with the productivity that we'll get out of those ramp ups. Gina, I hope you feel better. Question and a clarification. First, a clarification. It was an impressive metric you provided on the net new customer ACV growth of 30%. Can you just for context, can you give us what that same number would have been last year in the December quarter or an average over the last 2 years in the December quarter? I'm just trying to see what the calibration point is. And then my question, it relates to the upsell. And in particular, on ITOMs and ITSM, in the past, you provided updates on kind of the SKU mix, in other words, going to Pro to Enterprise. If you could just give us an update on -- is that slowing up at all given the economy or are customers kind of forging ahead and just where are -- if you could give us an update on the transition. That's it for me. Yes, Keith, I'll tell you that 30% net new ACV -- net new customer ACV growth, we're really proud of in the quarter. We haven't given those metrics in prior quarters. Suffice it to say that we continue to see those net new customer ACVs growing as we are landing larger deals with new customers. And those new customers are able to expand with us more. So really strong growth in the quarter, but we've not consistently given that, but to say that we are continuing to see that grow. With respect to ITSM Pro, we've talked about penetration being at about 35%, and that continues to do well. And so does that continue to move higher Gina for the year? Or is that kind of -- is there any pressure on that stalling out at all in terms of customers willing to mix up? It has continued to grow. We don't give that percentage every single quarter. We'll give it every time it hits the next five if that makes sense. But we absolutely are seeing Pro penetration continuing. CJ, I don't know if you want to add any Absolutely, Keith. Here is what I can say. So the number continues to increase since we launched this -- and what was super encouraging in Q4 was that some of the new logos that we got with ITSM also landed with ITSM grow besides our existing cohort upgrading to ITSM Pro. So 35%, we are currently very, very optimistic. And at Financial Analyst Day, we will provide bigger updates on what's happening with ITSM Enterprise. Maybe for Bill or CJ, just given the widespread conversations around cloud optimizations as we heard from Microsoft last night, can you just talk about how you're approaching these conversations with your customers? Are there specific products that you're leading with? And then CJ, just I would love to get an update on your view on the ServiceNow observability strategy heading into 2023? Kind of what are your key milestones from a product perspective? And how is just the progress gone since the most recent acquisition? Absolutely. So let's first start with the cloud optimization question. Listen, our product line since day 1, whether you look at ITSM, ITOM or asset management, our ability to discover assets whether they are an on-prem cloud, private cloud, public cloud or multi-cloud has continued to be best-in-class. So we help our customers [indiscernible] line to optimize their power spend. That's great. If they're trying to move to public cloud and they want to accelerate that journey, that's great too. So our portfolio is best suited for meeting our customers where they are on that cloud journey and where they want to go. So I feel actually pretty good in terms of just our portfolio's relevance in this multi-cloud and how our different product lines can help them with their acceleration and optimization. And on observability, what was really encouraging for me in Q4 is that we had 3 of Fortune 100 companies decided to buy ServiceNow Observability solution and Lightstep at a meaningful scale. And these are real workloads that are really being monitored by our Lightstep solution. And as I think about 2023 milestones, as you know, that Tyler we bought company called Era, which provides large management solution. We will fully integrate that in our Observability platform. So we have not only primary observability solution, but also unified observability solutions that work across multi-states. So very optimistic going into '23. Congrats to CJ, wonderful to see. Really, I think just given that you're operating in this, what feels like rarefied air, let me sort of flip things over a little bit and ask if there were any verticals that you haven't called out or regions in particular where you saw any softness or perhaps extra layers of scrutiny on overall spending? So I will say, I'm going to take this, Sarah. Thank you very much. But overall, we feel very balanced performance. Gina called out certain verticals super proud of what we did in public sector. Typically, in Q3, we are expected to do well in public sector. But even in Q4, we did really well and as Gina called out 50% growth. So whether it's public sector, whether it's retail, whether it's health care and others, very balanced performance and strong growth, an amazing quarter. I would say, as Bill just touched on, we are really excited about our growth potential in Japan and India. And with new appointment in Japan and Japan being the 4 geographies reporting to us, Paul Smith, Chief Commercial Officer, is somewhere we really want to pay attention to, and we are very optimistic on the market side there. And again, ladies and gentlemen, I would like to thank you all for joining today's ServiceNow Q4 2022 earnings conference call. Again, that will bring us to end today's call. Thank you for joining us. Have a great afternoon. Goodbye.
|
EarningCall_1176
|
Good morning, everybody. Happy New Year to you all. Hope everyone's well and have a good rest of the holiday period. And thank you for taking the time to dial-in this morning to listen to this fourth quarter update. I am Martin Horgan, CEO of Centamin. I'm joined today by my colleagues Ross Jerrard, our CFO, who you know; and Alexandra Barter-Carse, Corporate Comms. I hope everyone had a chance to review this morning's announcement. I think it rather neatly encapsulates what I believe is another successful year for Centamin. We delivered against our stated plans, both operationally in terms of production and costs and also against project execution as well. Had some notable milestones in there, of course, one of the things that we're particularly proud of is that safety record. You will have maybe noted that we have achieved just over 8 million hours of LTI free at Sukari and that's significantly on the previous record of 5 million hour LTI free. So I'm delighted that the team has been able to achieve that. I honestly believe that a safe mine isn't indicative of a well done mine. And I think that those targets both leading and lagging targets that we beat be for 2022 are a testament to the quality of the team there as well. Maybe staying with the people, obviously they are key to our success. It's people that make the business and we've had some great progress across 2022. Delighted to see our Employee Development Pathway program coming through. We're looking to both identify, train and retain talent locally and also one of the things that we're particularly pleased about was our work around gender balance at the site. There is a change in Egyptian law and we reacted to that now and starting to have female employees at Sukari and across our exploration desert work in the EDX around the Eastern Desert. I'm delighted to say that we've gone from one professional female employee in 2021 to now a total of 34 across those two operations in Egypt as well. And I think that's absolutely fantastic result and a real sign of progress that we're making, but also important that Egypt is making as well. So delighted to see that. So I'd say operationally delivered into production just below the midpoint of guidance. I think the team did a fantastic job last year. It was a very big year for us. A number of challenges and sort of things that we faced not least of which the transition from underground contract mining to owner mining. The accelerated waste stripping program continued to move ahead at pace delivering us greater flexibility and consistency for the open pit and we've now got from multiple working areas from which to operate, which is fantastic. As I mentioned, that's a prudent planning around the underground transition and then despite sort of the interruption or potential interruption to the Q1, we navigated that and delighted that over the second half of the year, the underground team really hit their straps as well and deliver that 41,000 ounces of production, which is great to see. And despite the sort of global inflationary environment we find ourselves in, I'm delighted to say that the cost base is managed incredibly well. Obviously diesel price was a significant component of our cost base and a significant increase over the course of 2022. But in terms of prudent cost management, in terms of our planning, in terms of delivery of some of our longer term projects, we're able to manage those costs and keep those costs under control and deliver in line with the guidance as well. So I think that's a particularly pleasing result and the fact that we didn't have to re-guide during 2022. I think is a testament one to the prudent planning and to the execution capacity of the team there as well. And away from production and cost guidance, another great year in terms of our plans to reset Sukari and return that to a steady state at 500,000 ounces, which we're planning to do. The accelerated stripping program as I touched on continue to move forward. I'm delighted to say that that flexibility is returning now. Delivery of the solar project was a real notable high [0.4] (ph) in the second half of last year. Significant cost savings for us and also carbon emission reduction as well. So a real win-win for that project. And we're seeing sort of a current diesel prices annualized cost savings in the region of $20 million per year as we go forward. I think there's more potential to expand that, that's something we'll look at as our power generation in 2023 and beyond. But I think a real landmark and successful project for us and the sector more broadly as well. Paste-fill plant moves forward at pace. Great to see that coming through. Obviously looking to get that commission through the first half of this year now. And that means that we can look at and maximize the extraction of the underground orebody in a safe geotechnic controlled manner as well, so that's coming through quite nicely. As I touched on before, transition to owner mining, big cost and productivity gains to be seen there, we're starting to see those flow through in Q4 of last year and indeed the start of this year as well. And really that's going to be one of the key facets when we look to 2023 and improved guidance from there, what's going to drive that underground performance is a key element of that. And resource reserve growth, after a fantastic year in 2021 we added 1 million ounces to the reserve base, we have confidence in moving into 2022, the geological team framework we put in place and the processes we're going to be successful. I'm delighted to say that further reserve growth and 800,000 ounces of reserves added during the year pre-depletion is a fantastic result. So over the two years of '21 and '22 now, nearly 2 million ounces adequate reserves pre-depletion and I think that's absolutely superb and the value creation through that team has been phenomenal. And, of course, with that reserve growth really then it starts to support our plans for the future expansion of Sukari, not least of which is that underground expansion project which we highlighted in the fourth quarter last year as well. And with that sort of increased confidence reserve growth in the underground our ability to add up to 30% of additional production tons from the underground on a relatively low CapEx and low technical implementation basis, it's something that we'll look to sort of engineer through the first-half 2023 as well. So I think in terms of Sukari great delivery into production. Great cost control management in inflationary environment and fantastic sort of structural progress on a number of those projects that are really going to help to sort of maximize the value of Sukari. Moving away from Sukari quickly maybe, a fantastic results across the EDX project. We're delighted with the progress there in terms of the operations and field teams established and mobilized, they've moved immediate to priority areas that we've generated through the sort of pre-development sort of the pre-field worker program from the remote sensing and the teams have been very, very busy across both the Nugrus and Um Rus blocks which are closest to it. And lots of field work in terms of blake sampling, soil sampling and mapping and the aim is to work with a number of priority drill test targets that we can then start to put some holes in during 2023 as well. So super-excited around the potential for the EDX, the ability to make commercial discoveries that then could even feed into the Sukari complex or being potentially standalone opportunities as well. In parallel with that, steady and good progress around the negotiations with the government around the longer term exploitation terms for the mining sector in Egypt. The industry group has been formed. We've been engaged with governments, you may or may not picked up from the recent conference in Saudi Arabia that the Minister of Petroleum from Egypt, His Excellency Tarek El Molla had flight to an industry group from their perspective as well that he believes that we're very close to finalizing the terms and actually stated publicly that he'd like to have everything done and dusted to enabled us to announce the final terms as part of [Edalva] (ph) Conference coming up as well. So great and heartened to hear that the he shares our view that we're close now, very pleased with he's put that public timeline on the the table. Let's see if we can hold them to that book, but no great progress around that. And if we can get those terms finalized, I think that really just transforms the sort of prospects for the Egyptian mining sector, maybe just on that, just a slight pivot away to something that you may have picked up we announced on Monday at low 32, which prevents non-third parties from challenging legally binding contracts within Egypt with declared constitutional and of course the importance of that law 32 constitutionality ruling by the Supreme Court means that the case against the Sukari concession which was ongoing for over a decade now with that law 32 being provided as constitutional. We intend to use that ruling then to have the case against the Sukari Concession set aside as well. So something that we had a great deal of confidence around that it's a -- you win the case on its merits. But finally, with that legislative movement, we can now look to have this set aside and the legal team will be putting that motion to set aside in the immediate short-term and finally take that irritation off the table and move forward around Sukari as well that's superb. Pivoting to West Africa quickly. Good progress at Doropo, very happy with that. Obviously, resource updated in the fourth quarter and a complementary in terms of the overall global ounce content, delighted to see that, but I think importantly, a very nice pickup on grade of around about 20%. So that 1.5 grams average there or thereabouts. So I think that's great for us in terms of graded king and that pickup is it will make a nice difference to the economics of the project or a nice positive improvement to the economics of the project. And as we flagged, of course, we've seen an opportunity to reduce both CapEx and OpEx through the flowsheet and pursuing those down on the whole ore leach approach as well. So a slight delay to the PFS publication, but we think the opportunity around that flowsheet change is sufficiently sort of interesting that it [indiscernible] delay as well, but moving forward on Doropo and over the fourth quarter, some good work around the mine planning aspects of the newly updated resource model that we have received and obviously progressing those metallurgical opportunities that we mentioned as well. Corporately, very busy period. I'm delighted to say that we signed our inaugural sustainability linked loan RCF facility with the consortium of leading banks. This is the Centamin's first debt facility, it's a $150 million revolving credit facility. Pricing does linked to a series sustainability at targets that we've agreed with our lenders, which is a nice feature and put some real sort of teeth and commitment into our ESG targets, because it has a direct implication on cost of pricing of the debt that we're putting in place there as well. I'm delighted with the bank group leading international banks BMO, HSBC, ING and Netbank and lots of mining industry experience there. I'm delighted to say, of course, that they've been through an incredibly detailed due diligence process the call will over the company as you'd expect lenders do and we were sufficiently comfortable and confident in both the plants and our operating capacity that they were prepared to put facility [indiscernible] as well. So I think the addition of that facility really increases our operational, sort of -- sorry, our financial flexibility and capacity to look at both growth and shareholder returns and delighted that it's a bank -- consortium of leading banks that are sufficiently confident in our plans to go forward and they're prepared to lend against that as well. That's a great news. So as we look forward to 2023 now, I think we're entering with a real sense of momentum. And as I mentioned, step up in guidance again we're now targeting the 450,000 to 480,000 ounce range. I think the main thing to think about there is that, as I talked about the improving sort of underground performance to bring that machinery and capacity up to nameplate of about 1 million tons from the underground of ore pre-expansion that is the driver, [indiscernible] from the 430, 460 last year to the 450 to 480 I think the open pit and processing will remain largely consistent with 2022 with that underground performance and what will drive that step up as well. So well on our track getting back towards that 500,000 ounce mark targeted for 2024, another step up as well. I think within that 450 to 480 we're going to see a split first half versus second half, slightly lower in the first half, about 45% of those ounces will come into the first half of the year, about 55% at the second half of the year. And I think interestingly for us as well is that within that first half we are planning a lower first quarter, we will be looking or we are actually currently doing some plant maintenance around the processing facility. We also are mining through a slightly lower grade area in the underground compared to the balance of the year on the open pit. So we are planning, I'd say that 45-55 H1-H2 split and then within H1 a lower first quarter, our plans to get that scheduled maintenance done that way. And then that allows to pick up through Q2, Q3 and Q4 as well and target at midpoint about 450,000 to 480,000 ounce range. In terms of AISC, $1,250 to $1,400 per ounce range for next year. Obviously, the range there is that we're looking at both, obviously the top and the bottom end of the ounce range in terms of the denominator of that calculation. And also I think we've taken a prudent approach to forecasting and I think that worked well for us in 2022. We are required to re-guide like a lot of our peers. I think the same sort of thesis and approach has been taken for this year. Diesel a huge driver of our cost base, in 2021 we had a diesel price of about $0.52, we planned for a $0.60 diesel price in 2022, it actually average closer to $0.90 over the course of the year at the back of that sort of oil price increase around the Russia-Ukraine conflict as well. So rolling forward, we're assuming $0.90 again this year. And one of the big drivers of that is our [Technical Difficulty] And obviously looking to maintain that cost control with a number of cost initiatives that we brought in to try and manage that. But I think it's a -- a sense of prudent planning around the budgeting is important as we go forward from there. CapEx of $224 million, that obviously covers our sustaining CapEx as we normally -- we normally talk about $100 million a year, that's about $110. We've got some pretty interesting notwithstanding growth projects lined up for the year, gravity circuit for the processing plant, taking that forward as we look to improve gold recoveries and to maximize the value from those high grade material that we get, expansion of the dump leach and obviously looking to keep the TSF less moving so we can keep using that facility as well. And of course alongside of that is the continued acceleration of the waste stripping the open pit as we go forward. I think as we go and we look forward to 2023, some more catalysts to come, it was obviously a very catalyst heavy second half of last year. We're looking to maintain that momentum. We've got our life of mine plan update looking to now engineer that underground expansion case and look at optimization of the open pit versus underground trade off. Looking forward to bring that through the first half of this year. We are going to continue to look at the grid power connection, there's obviously some great both cost and carbon opportunities to look at. So we'll continue to push on with that as well. And of course we've got the Doropo PFS delivery as well. So look, I think it's a -- as we look back on both the quarter and the year, I think very pleased with the progress we've made. I think a step change in terms of the business, in terms of delivery, in terms of consistency, and in terms of excitement that we're generating within the team as well. I think I'd like to thank the team for all their efforts through what was another challenging year in 2022 on a global basis. I think the team has now created a fantastic platform for us. And at Centamin I'm really excited about how we're now going to take that platform and build on it into 2023 and beyond. I think just as a final note, I'd like to open up to questions, but I'd like everyone just to please bear in mind that our full-year 2022 financial results will be published on 16th of March. And so, well, we'll try to answer some of your cost questions. Please keep some of those financial questions for Ross maybe until that full-year results on the 16th of March as well. But with that, I'll now hand back to Seb and we'll open up the floor for questions from that for Ross and I. Thank you. Thank you, operator. Good morning and welcome, Martin and team. Look, I mean, '22 was a pretty strong year for the company in terms of the flexibility you developed in open pit, as well as the work you're doing in the underground. Now, looking forward, there was some expectation that 2023 cost would be lower, but I understand the inflation impact that you're getting at this point, I think it will be good too, if you can give some visibility. I know you're working on the updated mine plan. So what's the cost structure for the Sukari mine looks like? I mean, let's say 12 months ago, you would have had some expectation of what the long-term cost would be. Do you still attest to that expectation? And also if you can talk to some of the improvement initiatives that the company is undertaking with respect to reducing cost and improving production as well? Sure, Raj. No problem. So maybe I start off on that and maybe pass to Ross. So look, I think that's right, Raj. Look, I think each year we use the best available information we have at our hand to plan. So as I mentioned, '21, we had a fuel price of $0.52 diesel. So we use $0.60 for 2022 and it had been $0.90 obviously from that sort of global situation. So, obviously this year we're rolling forward with a $0.90 impact as well. So as best we can, we use the best available information, do some scenario planning around prudent on that -- prudently sort of scenario planning to look at sort of what range this might be and then look to sort of that obviously offset that against a cost saving initiatives as well. So I think we're always looking to make sure that we're using the best well information to give ourselves sort of the most confidence we have in terms of cost forecasting on a sort of annualized basis as we go. So I think that's the process and that's what's driven the numbers here. I think I'll leave Ross to talk about some of the details in that. I think more broadly on a longer term basis. Look, I think there's a couple of things to think about. Firstly, getting back to that 500,000 ounce, whether it's 475,000 to 510,000 type range, getting back to that sort of level is clearly key for us on that underground expansion study, as well as some of the other opportunities around that gravity and dump leach and so on, they are the drivers that are going to get us back to that sort of level as well. So when you think about sort of increasing the denominator on a unit rate basis by getting those ounces on the board. When we then think about cost savings, clearly, the accelerated waste stripping program, it's a necessary evil, we've got to get that flexibility back, it's coming back quite nicely now. But again, an extra in our own fleet does 90 million, 92 million tons a year and we're currently shifting sort of 120 million to 130 million, you can see there is an extra sort of 30 million to 40 million tons a year of waste stripping there, roundabout $2 a ton, you can see that there is a fair bit of additional sort of cost that has to go into rehabilitation about open pit as well. So when we see in the medium term or the next couple of three years that waste stripping returning back to sort of long run average around the life of mine average strip ratio, obviously that has a pretty substantial impact on cost as well. So as we see the pit coming back into compliance, we'll expect to see the cost trending down there. The additional things like the grid connection, again, some big dollars there to be saved in terms of connecting to the grid as well. So I think like met recovery, if we can get gravity and as 1% or 2% of additional net recoveries additional ounces and so on. So we look at sort of form where we sit today, Raj, the cost base at sort of $1,250 to $1,400, how do we get that back to where we want it to be? It's going to be increasing those ounces to get back towards that 500,000 ounce level through the underground expansion dump leach and gravity circuit at this stage. And then on top of that cost control waste stripping coming back to more normalized sustainable life of mine or back into this in line with the longer term sustainable strip ratio and initiatives like the grid connection to chase down this year. Put those two things together and that's where we start to see on a longer term basis that 500,000 ounces at the $1,100 to $1,200 AISC that we want to be at on a sustainable basis going forward. Now, of course, if diesel price fit to these levels, that's fine. If diesel price doubles, clearly we'll have to revise that. If diesel price comes off 20%, 30%, 40% as we settle down again, then obviously we can go lower. So we will do everything we can in terms of our control. We're clearly a diesel price taker in Egypt as the government sets the price. [indiscernible] most or quite a few African jurisdictions. We can't hedge that, we don't hedge that. So we are a price taker. So where we can control those inputs, where we can look at the mine plan our cost out initiatives will drive that. But note that we are diesel price taker, but moving to grid with solar and potential solar expansion being careful around how we use power. The other things that we can sort of do operations control out, but we do end up with a mobile fleet's being a diesel price taker from there. So that's kind of bit of an overview, I mean, Ross, from your perspective anything to add around that to Raj in terms of, sort of the cost planning and then cost control? Thanks, Martin. Certainly, that's quite a comprehensive coverage on that. I think, Raj, we're really pleased in terms of the initiatives that have been rolled out. We're well on target on that cost reduction stretch program with $100 million of the $150 million target. Some of those key initiatives have been delivered and we will look to see that those are actually hit the cost base as we go forward. But as Martin said, it's ounces up and costs down. I think the key one for us is around that grid power. We've made great strides on the solar side, but tying into the power line, I think makes it a huge difference. And then we -- in our final year of this sort of peak stripping program, as that drops off and these other initiatives flow through, I think, we're optimistic in terms of how that profile looks. I'll be honest with you, we've been very prudent in terms of looking at those costs. Martin spoken to that fuel price and where we sit, but we can only, I guess, plan with what we know today and that's what we view as we exit '22 and we use that for '23 and will sort of continue to keep the focus on the cost base and bring that down, but we are confident that we'll get that all in sustaining down to that $1,100, $1,200 range, which is what we're targeting. The one thing that hasn't been mentioned is probably the exchange rate and we're really watching that, you would have all seen the EGP this time last year, it was 15 to 1, this time [indiscernible] 30 to 1, and that makes a big difference in terms of the -- I guess, the cost base and the local inflation versus the US-denominated numbers. So we've factored that all in and we believe that we've addressed the forecast prudently and weâll keep the focus. Thanks, Martin and Ross. Those are pretty detailed answer. Just one follow-up on that. So the grid power, is there an update in terms of the progress, because as I understand that could have a massive impact, itâs almost 90 million liters of your 190 million annual consumption. Is that correct? Grid power and solar included. Yes. So, I was going to say, Raj. So solar has removed roundabout about 20 million, 22 million liters a year from previous consumption and, of course, on the table is the balance of that, so it the -- sold contributes about two-thirds of our power for about a third to date Eagle Pass and attractions. But, yes, so the opportunity there of course is to bring grid in, so it would be joined daylight hours, a combination of potentially solar and grid and then during the darkness then entirely grid. So that's the price forward effectively. So look, yes, we've been -- in terms of process, obviously, with us having the government as our partner, obviously, we have to go through a quite correctly a tender process for all of our major contract. And that's something that we always do. One, it's good practice; and two, it's a requirement with our government partners that we tend to thing. So we now are in the process of putting together a tender document, we've been out with just spoken to a number of potential providers that can actually do the work for us. The difference in there in terms of whether it's a third-party that sort of does everything and sort of we bypass then through to some one performing sort of connection to grid and then we sort of self-performance in there as well. So we've got a range of options, but we do have to go through a tender process because of the nature of the concession required to do that. So we're ongoing with that. Yes, great appetite needed to support on this basis and normal recruiting stepped up to say that they can do that. I think importantly for us access to equipment and the components of the connection, switchgear and transformers and so on, that's going to be one of the key aspects for us and then the ability to just Egyptian regulatory environment of connecting to the grid and having that permitted as well. So we're deep in that sort of process of developing and getting tenders out there. I think itâs a fairly short process and once we've done that, then we can lock-in and move for that basis. So still hopeful that we can get something done this year. I believe that is entirely possible, but just going through that sort of admin stroke concession requirements process around tendering to make sure that we can demonstrate best execution best price for that. Yeah. Thanks, Martin and team and thanks for the call. Just a couple of questions. Firstly, can you just give us a bit of kind of granularity and guidance just on the grade progression of the open pit and the underground. So open pit grade sort of nudge down a little bit quarter-on-quarter, can you just give us a bit of a steer as to what you're kind of expecting there? And then just on the underground as well, just sort of a modest ramp up in mine, can you just talk to us about what you're seeing just in terms of grade progression there? And then just also on the waste movement within the open pit. I mean, it seems like that's running ahead of plan. If that's the case, are there any other projects there that you kind of identified that can give you more flexibility or do you think as you sort of put it out in the previous question, once this particular slice of waste is addressed and then you can dial that back and stick to the mine plan and reduce your cash and spending on waste and turn that into free cash flow for whatever else decide to do with it? Thanks. Yeah. Perfect. Thanks, Richard. No problem at all. So, look, I think, as I touched on very briefly before as my I sort of -- my rambling preamble. Look, I think when I think about 2023 I would say that that's sort of open pit and processing broadly consistent with 2022. So what does that mean? So I would say that sort of open pit also ROM grade, it's going to be sitting around that -- around about that gram and I think that's pretty consistent across the piece as well. As mine grade have been a bit lower than that because obviously we mine some of the lower grade material that goes to stockpiles or the dump leach. But when you think about sort of the tones delivered to the ROM pad from the open pit, consistent with last year, it's going to be around about that gram level as well. So no change there. And in terms of volumes of feeding to the processing plant, that's pretty consistent. Similarly, with the jumping around slightly in terms of the sort of the mill feed, again, that's sort of consistent with last year, it's going to be just that sort of 12.25 million tones that sort of flowing through, again slightly, as I mentioned before, slightly lower in the first quarter because of that planned maintenance work that we're looking to do around that as well, but again in terms of the total amount of the same. And in terms of net recoveries, again, consistent with last year. So I think if you think about -- sort of you think about this year versus last year, yes, you can assume that this sort of open pit in terms of tones and grade delivered to the ROM are going to be consistent with last year. So that sort of 10 million, 11 million tones at roundabout a gram and that sort of 12.25 million tones at roundabout 0.88 and 0.885 sort of type net recovery as well. So I think that the delta this year on last year versus this year is around the underground, that comes in two things. So firstly, that sort of last year weâre about 800,000 tones from the underground in terms of total ore development and stopping to surface. We want to get that back to that million tons that we know nameplate for us, so that ability to step up from 430 to 460 guidance this year to 450 to 480, the delta there is the additional underground sort of tonnage == ore tonnage to surface, there is a volume implication there that we can hit those productivity rates get to that million tons. And then from a grade perspective, you can do the math there effectively to get that where we need it to be, we're going to be sort of north of a sort of 5 grams for the underground is where we're targeting for that sort of 5 grams to 5.5 grams at that million tons in the underground is what we're planning for the underground from there. I would say that, again, I flagged a little bit earlier around that first quarter grade in the first quarter from the underground is going to be sort of slightly lower. But then we sort of pickup and get into that range that I've talked about their through to Q3 and Q4 from that basis as well. So I think, that without sort of getting into too much granular detail on this call, yes, consistency '22 to '23 in open pit and processing, leg up from '22, '23 goes from underground. A volume consideration as we hit the 1 million tons of ore to surface and targeting that 5 gram to 5.5 gram type material over the year a softer Q1 sub five and then a stronger Q2. Well as planned as scheduled, that's just where we are in the orebody and then bringing those grades back for Q2, Q3 and Q4 to bring it into the year as well. So hopefully that gives you a bit of shape as to how we see the 2023 numbers versus the 2022 performance. On the waste stripping particularly, look, it's a fixed volume contract with Capital, they are contracted to move a certain number of VCM stroke terms. They have a fixed period. Well, they have a period to do that in and, of course, they have been performing very well for us. I think working very well with our team. Some good optimization around planning and haulage and so on and they performed well in 2022. And [indiscernible] the operator there is always the kind of tension -- not tension, but the balance of the trade-off between we need to move those tons to get the open pit back in compliance where we want it to be. So those tons need to be shifted and it gives us more working areas, better operational flexibility and so on and so forth, that's an imperative to do. Of course, that comes with a cost if you move more BCNs than you planned in the period, i.e., the calendar year, it cost you more cash. So you've got a trade-off, you need to move the tons to the operational mine plan, but it does come at a cost. Having said that, the short-term cost is then somewhat set off, because obviously we pay a monthly fixed fee as you do with contract process. So we've been able to move those tons in a shorter timeframe. It actually cost less than the overall contractual basis, because you're doing over a short period and not paying 60 months fee. So we're always constantly sort of trading of the sort of -- having to get the work done in a shorter time as possible to basically get the operational flexibility and reduce the contract value on a fixed monthly fee basis versus compliance to plan and not burning up all the cash in the quarter, because obviously we need that cash to pay the bills effectively. So that's where we are. I think once we get through that work, this new life of mine sort of revision update that we do the first half of this year. It's mainly focused on the underground expansion. But we will have a look at the open pit as well and then we'll see where we go from there. There may be opportunities to dial back some of the stripping outside of the contract that contracted about the capital. We're not going to touch that, but there's opportunities there. We might find that the satellite material comes in from the concession area that helps us to level through our plans and we might sort of change how we think about sort of the geotech angles as well. So there's lots of work to come in. We'll do that work over the first half of this year, but I think you can assume that once that the Capital contract is [indiscernible], that will run through. We need to do that work to get us back in compliance. Beyond that, then we'll do some trade off work to close off this year and see where we go with the open pit. Yes. Thank you for the call. Hi, Martin and Ross. So just a question on CapEx and the increased guidance. Don't you think it's quite sizable 30%, almost 30% increase? Honestly, I was expecting normalizing CapEx to some extent in 2023. So can you give us some color if anything was added to the non-sustaining CapEx and how would you generally look at free cash flow picture into 2023? Yeah. So maybe Iâll take the first bit around the CapEx and the plans and then Ross you can maybe talk about sort of the planning for that free cash. So look, to my mind itâs sort of three buckets within that CapEx is our, ongoing sustaining CapEx, the midlife rebuilds, underground development, all those usual cost, and we normally historically said between $90 million to $100 million. I think it's more like $110 million this year, simply because of inflationary impact on some of those inputs to that as well. So our sort of ongoing sustaining CapEx, that's pretty flat and I think that's consistent with previous year. So we can kind of bank that as being sort of consistent, no significant change. In terms of projects, obviously last year we did some pretty heavy-lifting, solar, paste-fill, a number of the previous years, we've looked at TSF 2 combination and so on. So this year, that sort of that [indiscernible] of growth projects or sustaining projects that's markedly down now to that sort of in the order of about $40 million there, that's focusing on gravity TSF further lift for continued use of the TSF and obviously the dump leach extension. We continue to mine sort of above cut off low to medium grade material and we can access that through the dump leach pads as well. So that's obviously going to add ounces to the production profile and early monetize some of that stockpile material as well. So again, when I think about that, thatâs kind of those two buckets sort of we're seeing those major sort of CapEx, non-sustaining development projects, whatever you call them, we are seeing a pretty big step down in those. Of course, the main difference is around that waste stripping as we touched on there and how that reports too to how we report CapEx and of course, within that element of the waste stripping a significant component of that is fuel. We've got to move an extra sort of 30 million to 40 million tons a year to meet our stripping requirements with the security program, that's call it plus, minus a couple of bucks. It's coming, round numbers. And with that diesel obviously the large component of that, you do moving within the pit as well. So I think the sort of the -- a portion of that has come from that waste stripping program, we're significantly through now, but still got to finish off and then the diesel component of that. So I think when we think about the project spend year-on-year, we are going to reduce spend now in terms of those projects, but still some projects that we believe will have medium to long term value to our sustaining CapEx. And then of course that element of the waste stripping as well physically. But Ross do you maybe want to sort of just touch on that and maybe and sort of how that flows through to how we think about that this year? Yeah. Thanks, Martin. No, that's exactly right. In terms of our sustaining number, it has gone up from the traditional 100 million. So there's a 10 million number in there. That's again reflecting current prices. The cost of mid-life and a full life rebuild has moved up significantly this last year and we've used our exit point for '22 again. So we're consistent with that. So that profile has slightly increased. As Martin mentioned, the non-sustaining side, there's basically three discrete projects there that remain, that's TSF, paste and the dump leach that make up those numbers. And then it's the waste stripping that sits within those numbers. So, yes, those numbers are higher than previously flagged, but they're not unreasonable in terms of where we sit. And with regards to free cash flow, I think, we're coming back into the stage where that profile is reducing. It's obviously all subject to gold price in terms of where we sit, but we are optimistic that we are on track in terms of being able to generate those returns. I think we've also got to highlight and we will have a more fulsome discussion with the full-year financials. But in terms of free cash flow, we've continued to pay profit share out of Sukari as we've gone through. So we've been able to finance and I guess go through this CapEx profile. But we also distributing to both partners as we go through this reset. So I don't think from a free cash flow perspective and now that we've got our sort of corporate facilities in place. I don't think we feel overly harassed that I think we've been cautious with our approach and with the gold price, where we are, we're going to generate some good returns. Good morning. Thanks for the call. I have a couple of questions. The first one is on your CapEx guidance. It seems that you are including some CapEx for the development of the gravity circuit that would -- could potentially increase the recoveries at the processing plant. Can you give us bit more details about this project? Why is the total project -- the total period CapEx to be? What are the timelines and what are the internal rates of return that you will get from this project with the current gold prices? Perfect. Hi, Marina. Yes, sure. No problem at all. So where we are right now is in the sort of test work at paste-fill and so we did quite a bit of test work second half of last year, sorry. And we're now moving through sort of some more refined and detailed testing. There is some work actually going on in the Perth Australia right now around that. So off the back of that test work, we would hope that by the middle of this year to have a, if you like, a sort of a finalize design for -- well, one proof of the sort of the applicability of gravity thatâs out there, that it actually makes sense and then it is a project that has its correct sort of rate return and NPV whatever you want to call it, whichever metric you want to use. But we have a viable project that makes sense. So we'll have that work sort of finalized through middle of this year. And off the back of that sort of feasibility work around that, then obviously we look to then have an engineering design basis and obviously associated capital cost estimate for that. So I think by heading into sort of mid-year into Q3, we'll be at the point whereby we've got effectively like a mini internal feasibility on it and an accurate CapEx and sort of execution count for that. Gravity circuit arenât particularly complicated pieces of equipment. So then, in terms of securing the underlying concentrators and then the various parts of steel work and concrete and tying into the existing processing facility that obviously that's something we'll execute over second half of '23 and I would hope that assuming that everything lines up is the background circuit would come in during 2024. So that's a bit of an overview. In terms of CapEx, as you can probably see that we're in the process of doing that. We've done some internal work at this stage, you might consider it to be a scoping study PEI type level fairly broad ranges of CapEx within that. So what I'd like to probably do, Marina, is wait until we get a bit more detail around this next stage of test work and sharpen those numbers before we went public with what that might look like in terms of CapEx cost for that to fully install the [indiscernible]. So I would hope that maybe during the Q1 update sort of later on in April that we could probably have a bit more clarity around the numbers there, so I'll just hold back on that, I don't want to put some numbers out there, but then sort of get this approval test work and we have to roll back for now, but the process is underway. And of course as you'd expect, once we've got those numbers in place, then we can start understanding sort of the IRR return on that investment as well. So that's where we are in terms of the gravity circuit, both timing process from here to install it and then obviously the sort of the returns of that metric as well. That's very clear. And I have another question on cost. Can you remind us what is the current diesel price in Egypt? And apart from the solar plant, what other cost savings have you factored into your cost guidance? So in terms of diesel it's set on a monthly basis by government and itâs set in EGP and then so we have to back it out against the exchange rate. But as we sit here today and if I could look at Ross, we are virtually separately [indiscernible] Iâm in London. But if I could look across the desk, I would look at Ross, and I'm going to say, we're sort of high-80s, just under $0.90 a liter at the current price for diesel. Is that correct, Ross. Don't embarrass me now, Ross, but is that correct? That's right. So I mean exited year [Multiple Speakers] $0.89, we've budgeted $0.90, we're sitting just on sort of just $0.75, it's EGP21.23 per liter. So, depending on which -- how that exchange rate moves in EGP and US, but basically that number. And that's key question in terms of where we sit, Marina, it's just how that fuel price moves in EGP in relation to the EGP-US dollar exchange rate, because that's been moving very quickly over this last year. Okay. That's clear. And then what other cash -- what other cost savings have you factored in your guidance apart from the solar plant? Yeah. So we factored in that full impact of a number of those initiatives that have come through our cost savings program. So the full impact of the truck trays, the impact of the solar plant, the decrease in the usage or utilization of a number of our processing cost and consumptions in terms of volumes. However, that has been offset in terms of some of the exit prices in terms of -- from a price perspective, so cyanide, caustic soda, grinding media, et cetera, et cetera. We've used that lower usages in terms of a number of those projects in the processing plant. But from a pricing perspective, we've used the December exit price that's gone through. And then going forward, it's obviously the grid power and a number of these other initiatives that we're allocating CapEx and cost and things that we've got to build those into future profiles. But that's more at end of '23, '24 type timing. Thank you, Seb. Not -- only two questions at the moment for you, Martin and Ross. First one is, you speak about striving to be a multi-asset producer. When do you think the company will diversify and bring online a second mine? So in terms of our in-house opportunities, obviously, in reverse order, EDX in Egypt is probably sort of the earliest stage. So I think anything stand-alone that we discovered in Egypt would be seven to nine years away. I do think there is opportunity to find satellite feed that would come into Sukari on a much more timely basis, maybe a three to five year basis and obviously that doesn't sort of strictly give us sort of country diversification or asset diversification, but we had another orebody that we can process. I'd argue slightly there is some diversification away from the Sukari pit. But Doropo clearly is at this stage the most advanced opportunity we have within the portfolio and timelines remain the same. So we've got until mid-September 2024 to deliver a feasibility study at Doropo. We remain on track to do that. And on the assumption that all lines up and is positive and a decision is made to go forward in mid-'24, that puts you towards the end of '25 for that to come through as first gold. So look, I think, that's where we sit on the current asset base that we have and that we can do have Doropo would be 25 a hub-and-spoke type satellite type opportunity within Sukari could be a sort of three year to five year window. And of course the longer-term opportunity, but that's a seven-year to nine-year type window within Egypt as well. I would say though that sort of with us having created this platform now having sort of got a sort of confidence in Sukari, confidence in West Africa, sort of a share price that has started to reflect confidence in the company again and obviously benefiting from gold price strength as well is that I think we're now in a position that we could consider inorganic sort of opportunities to grow. I would caution that they're incredibly hard to: one, find things that make sense; and then two, if you do find something also incredibly hard to execute in a sensible way as well. So, I don't think anyone needs to worry that we're about to rush out on a spending spree with the company credit card, but I do think that we remain opportunistically looking across the market for things that might make sense for us, but they are very few and far between things that are good tend to be sort of good and expensive because they are good. But I do think we now are in good position that if we were able to identify some of the opportunistically then we could react to try and for sure that's a multi-asset, multi-jurisdictional approach in there. Great. Thank you. So, unfortunately, a couple of other questions have come through since. So, one, which I think you have answered already, but you need to speak to the 1% to 2% potential upside in the recovery. When do you think that to be realized? 2024 on the assumption that all flows through. I think with the work streams and with the programs we're looking and the construction timeline, that feels that it would come online in 2024. Okay. Thank you. Then on the 2023 CapEx slide, you mentioned the dividend policy and 30% of free cash flow. Can you just clarify that a bit more, how the policy works? Yes, no problem. So our dividend policy is a function of free cash flow. It's a two-pronged policy. So the first 30% of any free cash flow generated gets allocated against the dividend part, and then we reassess and look at both growth opportunities and requirements for the business and allocating any portion outside of that from a free cash flow perspective against that dividend policy. So as part of the signing up of RCF and also as we announced in terms of the capital allocation a review that will complete Q1 and announced that will certainly before the half year, we'll be looking at and announcing our capital allocation and also looking at the dividend policy in conjunction with that to provide appropriate balance between both growth and dividends, and make sure that that balance is well met. But the dividend policy remains the same. And sorry, we pre flagged the '22 dividend, but there is no change in the policy as we stand today. Thank you. And then in view of the success, the company has had been the underground operations in house increasing productivity and lowering cost, would you consider doing the same for the waste stripping operation? Look, we sort of 12 to 18 -- well 12 to 18 months to go on that project. The sort of the capital expenditures, sort of, you know to acquire that fleet and bring it in house versus and having excess fleet available around the site, it doesn't feel to me -- look, I mean, it doesn't feel to me that that would be a particularly good use of funds to do that. There are other opportunities where we can I think use fund to do that. So certainly not something we contemplating this stage, I think we brought that the contract in on a capital efficiency basis we acknowledge that it was a slightly higher OpEx sort of cost in doing ore mining actually not that much more, given the fact that we were asking capital to do large scale bulk mining of waste and with a relatively short haul to dedicated dump. So it's not that much more expensive than our sort of our own use rates of course they go much deeper in the pit and hauling further to waste dumps. But we rapidly we acknowledge that there was an OpEx sort of increase for that, but when we balance that off about the sort of the capital cost of buying the equipment we need to buy to bring that into operate it at the trade-off show quite clearly that higher OpEx for a relatively short period of three-year short period of time was a better return on capital and buying additional fleet with only use for a limited period effectively as well. So that was a decision that we tendered and when we done back in 2020 and we have successfully through that project right now. I think without reading the numbers, but I would feel intuitively that it's the same because it make sense now to bring that in house. What is now effectively a minor end of the call. So without the thin end of the contract in terms of winning that off it. Yeah, look at. Yeah, it's a bit like triggers [indiscernible] only horses these trucks, they tend to sort of it's a four engine three truck trays and two chassis. So it's the same truck, but it's been rebuilt multiple times, but you would argue that that's a sort of seven to eight year window would be a reasonable assumption. Some have lots we're hours and that because I said have been built as suppliers, but yes. So a three year stricter requirements with an eight year piece of kit obviously what you do that the four to five years. And of course we've got to be cognizant impact of once you buy a piece of equipment, it belongs to Sukari because it belongs to Centamin and at the end of that equipment usable life we can't sell that equipment that equipment then is transfered to Emirate, the Egyptian states as well. So if we were -- if we had a under our terms of our concession, we were working in Senegal or Ghana for example we could buy a bit of equipment use it and then we could sell it and we keep some of the residual on that. Here, of course, we buy a piece of equipment, we use it for three years, and then we don't have the right to sell it. We then have to transfer it to Emirate as well. So I think people just need to think about that when they're looking at that contract and looking at how we do that please bear in mind that the assets are transfered to Egyptian state after their useful life at Sukari as well. So we wouldn't get that sort of, you know, we bought something for $3 million use it for three years, we couldn't then sell it to $2 million, we buy it for $3 million, use it for three years and have to give it to Egypt. And then obviously doesn't make sense for the business. And I guess one last thing I would add to that is just kind of perhaps misconception that actually the sentiment owner operator fleet is doing two-thirds of the material moved that is -- Yeah, with our own fleet is kind of got slightly massive and our own fleet is now operating at its highest ever level of material moved 92 million, 93 million tons and that is a record -- when I joined in 2020 we were moving around about 70 million tons. With the same equipment and same operators, we're now up to like 90 million tons as well. So our own fleet before we brilliantly through planning maintenance sort of optimization of haul routes, those are high capacity lightweight truck trays, all those things, these are our own fleet itself absolutely humming along and actually a bit of healthy competition between our own fleet and capital guys [indiscernible] as well, it's quite nice to see that, but our guys are absolutely flying along as well. Thank you very much. Well, look, in that case then, I would just like to thank everybody for joining us this morning. As I say, probably 2023 with a good momentum, quite a bit of excitement and confidence as we head into this next year. And I think, looking forward to another year of kicking off those milestones as we won't deliver Sukari back to 500,000 ounces at competitive all in sustaining develop the full potential within our portfolio both in Egypt and West Africa. And then look to those opportunities become a multi-asset multi-jurisdictional producer and in doing all that continues to position ourselves as offering both growth and returns for our shareholders as well. So I want to say thank you to everybody Happy New Year again and look forward to continue to update you about 2023. Thank you very much.
|
EarningCall_1177
|
Hey, everybody. My name is Chris Pierce with the Needham Research team. Welcome to the afternoon session on Thursday of the 25th Annual Needham Growth Conference. It's my pleasure to welcome Brendan Jones, President of Blink Charging. Cool. Why don't you give us 30 to 60 seconds just a kind of a brief overview, very brief on Blink, and then we can move into a fireside chat format. If any investors have any questions, throw those in the chat box in your screen, and we can work those in as well. Absolutely. So, Blink is a full-service EV infrastructure company. And we offer out to the public, to private industry, to auto OEMs, a full service of options to choose from. We sell equipment and services, including network services. And we also provide owner-operator solutions to a variety of real estate opportunities where we own and operate equipment and derive revenue from that. We pride ourselves at Blink of being the only fully vertically-integrated company in the industry today. And that means we design, manufacture, sell and own and operate and service our own equipment. And we have the ability through our flexible business models to never say no to a customer. So, whether they want to own the charger, whether they want us to own charger, whether they want a partner on it, we do this. And last part is, we just left CES where we announced five new products and offerings out there. So, from DC fast charging to L2 charging to in-home charging and fleet charging, we offer services and products across the board. Gotcha. Okay. Well, I think that might be a good place to start. You talked about the way to never turn down a client, it's because you offer these four options, you've got post-owned, Blink-owned, hybrid-owned, Blink-as-a-service. Can you walk through why you decide to structure the business that way to kind of check all four -- to check those four boxes? And are there approaches that resonate with some player more than other players? And how does home charging fit in the picture as well? Yeah, absolutely. So, the idea was flexibility, because different site hosts have different perspectives on charging. Some want a simple turnkey approach, where they say, "Look, I want it as a convenience for my customers, because they might be a retail establishment, but I don't want to manage it. I want nothing to do with it." That's perfect for the owner-operator model. Now, we have to maintain that it's the right investment and we have to look to see if we're going to have the right utilization numbers to work for us. Others just want to buy the equipment. Say, it is a workplace that wants workplace charger. They want to buy it, operate it and provide it as a service to those companies. Some might be a multifamily dwelling where a hybrid solution, where we go in, they pay for the install, we pay for the upkeep maintenance of the charger, and we split any revenue derived in those charger simultaneously. And some, to what you said on the service model and that's Blink-as-a-service, they want a monthly fee for everything. They don't want to pay capital upfront. They just want to make it an operational expense for everything, and we provide them a monthly fee for a five-year period of time to have that, and that derives a revenue and an income stream for us. So, it's about adapting our business practices to the different type of requests we get from site hosts, from municipalities, from utilities, et cetera, and auto OEMs, on what type of charging, on what type of business model they need. Yeah. I mean, home charging, we do direct sale to homeowners. We do that through Amazon, Best Buy, and a couple other sources. Customers can go log in and pick one of the Blink home chargers. And we offer two on that; a brand-new released HQ 200 model, which we just featured at CES, and then a Series 4 lower-cost model. And now what we see in the homeowners model is, they want connectivity, they want sometimes plug-in charge on their home charger, and they also want a degree of energy management with potential V2G, vehicle to grid, and vehicle to home ability, and we offer those as well. Gotcha. And of those four options, you kind of walked through the examples of each one, but is one approach winning out more with customers? Is it shifting to which -- like, customers used to prefer X, now they prefer Y? And is there one that you guys prefer from your revenue or financial model? Or one that investors kind of have a preference for? So, we have a bias long-term towards the owner-operator model. And we do that because we like the product revenue and it makes up the majority of our revenue right now. But we also believe that there's going to be a degree of commoditization on the product side, and you're going to have some suppressed margins as we move forward, especially hyper-commoditization, which we see happening mostly in the L2 market right now. So, we believe long-term that selling kilowatts on the owner-operator model and providing those turnkey service is going to provide that consistent sustainable revenue stream for the future. So, we're biased towards that, but we're never going to turn down a sale. So, the other advantage is, while we're looking at commoditization, we're also going to make sure that we control our own destiny with our manufacturing facilities. So, we expanded our footprint in India and we're expanding our footprint in the United States to make sure that we control [most our] (ph) sourcing to keep that cost of goods sold down, and that benefits us in two ways. Of course, we have a lower cost of goods and a better margin when we sell, but also our cost of acquiring equipment under the owner-operator model is equally reduced as well. So, one model, while we have a preference for owner-operator, they're mutually beneficial. And I'll give you an example of that. So, one of the things that we don't have to worry about at Blink is we don't build in a degree of obsolescence into our charging system, so that all of a sudden, we know we're going to get a replacement sale out of it. We need to build them to be durable. Because on the owner-operator model, we don't want obsolescence on that. We want long-term durability. So, we're not taking capital and putting it up replacement charges on that for at least a seven- to 10-year period of time. So, the models actually force us to higher quality and more robustness in our manufacturing standards and our attention to detail. Okay. And you talked about hyper-commoditization, I believe you said in the L2 market. Can you just kind of go a little bit deeper? Does that -- is that from the consumer side of things? Is that from the chargers all looking alike and acting alike? What do you mean by hyper-commoditization? Yeah. So, over time, -- and we looked at a lot of data from McKinsey and other sources on this, we said, you're going to see manufacturing become hypercompetitive, especially as more Chinese products enter the market. And we've seen that over the last year. Every time we turn another page, there's another charger manufacturer start-up who's producing new DC fast chargers, new L2 products across the board. So, we always want to hedge that bet with the owner-operator model, where we -- where you might get a reduced margin on a competitor, but we're going to offset any reduced margin there by generating revenue from kilowatt sales on the owner-operated model. And we want to stay ahead of it, right? That's why we want to control our destiny with our own manufacturing, so we can reduce that COGS where needed and where we can. Okay. And on the owner-operated model, I can see how it makes sense from a long-term perspective. You're selling power over 10-, 20-year period, utilization is upticking. But I'm just curious why a site owner would want to give up that upside that sounds pretty exciting, just kind of -- just laying it out in two sentences. Yeah. Some do, and some don't, exactly to your point. Some don't want the hassle, right? If it's purely as a convenience, right, so people come there and they want to take advantage of that time to say, "Hey, come shop in my location. Come to this place, because we have charging services for you, and you can charge your car while you do that." That makes it a very opportunistic thing. So, we look at those retail establishment and whether it's Kroger or some others on the grocery side chains which we have relationships with or other big box retailers out there. And they'll say, hey -- now, there's always a what's in it for them. So, it's not -- Blink never has a situation where we're not doing some type of revenue share with our site hosts. So, even if it's turnkey, we're still giving them 10% of the revenue. So, they still have it in it. They just don't have to do that capital expense. So, it's not on their books, the capital is on ours. And does that mean they don't have to talk to the power company about getting power to that site? They don't have to deal with any installation? Do you guys do that as well? Or is that kind of -- how does that process work? And sometimes you use host power, sometimes depending on, especially in DC fast charger situations, you have to bring in a transformer and negotiate a rate card out with the utility. So, all based on the site assessment, the type of charging for that particular location. Okay. And can you talk about -- you sort of touched on NEVI a little bit, but just kind of how is Blink positioned, given you have these multiple models? Is that -- does that kind of put you in position to talk to large construction companies that might be bidding for and building a site? But you can also bid for and build a site on your own? Or, like, how do -- like, I guess, how does it work as far as NEVI? Absolutely. So, we first -- we'll take a little bit and look at history. So, over the last two years, maybe two years and two months, about $27 million worth of grants and RFP, we've won as a company, right? And the majority of that is on DC fast chargers, all of it is on the owner-operator model. So, we already do that level of work. We're installing in Florida, Vermont, Ohio, Pennsylvania, and other states right now, DC fast chargers, and similar plan to NEVI. So, this is just rinse and repeat on that same model of owning and operating equipment and installing. Now, we work with construction companies and [indiscernible] to install these chargers, there are partners. Some work exclusively to others, they're servicing multiplicity of clients, including other EB infrastructure companies as well. Okay. And then, you've talked about DC fast charging versus AC charging. How does the Blink -- how do you see the feature shaking out when you've got home AC charging, you've got top off around town? And is DC thought of as just a quarter-type charging, or does DC have other applications as well? Well, I think to always to set us free, we got to go back to data and see what the general community of EV experts has come up with. We look at Mackenzie and Mackenzie recently released analysis that said 90% of global charging will be L2, the other 10% Blink. There was a Bloomberg announcement about four or five months, might be six months now going on, and they said 97%. We think that was a little extreme on that side. And then, we looked at the data on the percent of consumers say they're going to charge at home, which is about 80%. So, while DC fast charging and reengaging it heavily, it's fun, it's exciting, it's faster. It doesn't equate to faster is always better, especially from the capital side. So, it's about [15:1 to 20:1] (ph) ratio on the DC installation compared to an L2 installation. And that has variability depending on the site, size of transformer, everything that you got to bring in, and how fast you want on the charger. But clearly, if we look at just passenger cars, and according to the DOT, they sit 95% of the time, even though you and I pay a lot of money for those cars, where we actually have been said, we have to exploit opportunities to charge them where they dwell, and then we have to have convenient charging DC whether for opportunistic charging and quarter charging. So, we see DC as definitely quarter, 100% that's the way to go, shouldn't ever put an L2 or a low-speed DC on a quarter. It need to be -- put a high-speed DC. Suburban-urban REM [ph] charging, but the bolt when you're in a metro, let's use New York as example. You -- south of Central Park, you only have two gas stations left. So, the idea of suddenly you're going to say big depots of DC fast chargers bringing up is very unreasonable. But they've got some of the most robust garage infrastructure in the nation within New York. So, we have to inundate those situations with charging. You can bring some high speed in, but L2 is going to be the dominant form for sure. Okay. And then, Blink has been active on the M&A front. Can you walk through why Blink was compelled to act on the SemaConnect transaction, Electric Blue, Blue Corner? And just kind of talk about those charges as you add them to the network, what do you kind of -- what do you learn? Or what's the process to get one of those on your platform where they're all kind of talking to each other? Yeah, absolutely. So, the company's history is very inquisitive in its nature towards M&A. And it has a history. The company didn't start as Blink. It started as Car Charging Group. It bought Blink in a bankruptcy sale, and you could tell they went bankrupt back in 2014. So, the history of it is always to buy assets and buy companies that will add to its charging portfolio moving forward. And when we looked at companies in Europe and we looked at companies in the United States, we looked at what synergy and what scale are we going to get out of it. Clearly, the European purchases in Belgium and then in the UK gave us an opportunity to expand our market share. They're already owned and operated models. Now, we're investing in those models with our sales owner-operator, and then we're starting to commonize the manufacturing sources of those, meaning we'll use a Blink-produced charger in the future for those. SemaConnect was just a great partner. They had manufacturing facilities in India. They had assembly facilities in the United States. They had a great reputation, and they were scalable. And we looked at what SemaConnect needed, they had a 15-year-old technology stack. We were in the process of developing our new technology stack. So, we launched our new network here in the United States in July. We will convert the SemaConnect network over to that in the first quarter of this year, and then we'll convert all of the networks over to one global network. And the advantage that we're going to get there is you have a lot of legacy technology stacks out there, and you have a lot of other companies that have third-party technology stacks that they get the network from someone else and pay a fee. Well, we build our own. And this new network is designed to be plug and play. So, big issue when you're talking to clients is about integration, API integration, customized services, something different they want out of the network. Blink can do it on a dime now. We have 40 developers standing by ready to make development changes to our network. And we're going to be have one global platform and flexibility within that new technology stack to do whatever we need to do to service the community. Okay. And since you brought up the UK and Belgium and I brought it up with Electric Blue and Blue Corner, can you talk about the differences in the models in Europe versus the U.S.? And kind of what's more prevalent in where Blink is kind of better suited -- or not necessarily better suited, but what models do you apply in different markets? Yeah. So, the similarities are -- and we'll look at all of our operations there, including the Netherlands, et cetera, and in the Belgium and UK. The similarities are you have a lot of public activity going on, public dollars and tenders being moved to spur the EV market. And we're very active in both the UK and in Belgium and even in Holland on those fronts as we look at our expansion. The difference, specifically in the European market, is on the sales side of the equation. As an example, we have a very good contract with a company called LeasePlan out of Belgium. Most companies in Europe provide a car to their employees. And now those cars are switching to EVs, but it's like any other benefit. So, you need a smart charger. So, our agreement with the LeasePlan is they buy our chargers, and those are the ones installed in the consumers' home. And it has, of course, a kilowatt meter on it, so they are able to expense their home charging, as per their agreement. On their old agreement, when internal combustion engine, they've just expensed the gas expense, right, normally for it. So, it's a different model, because the ownership model of cars is slightly different in Europe than it is in the United States. We have a lot of leasing and you have a lot of company-sponsored ownership of vehicles, much more so than in the United States. But beyond that, we're still doing public tenders there for DC fast charger on roads and municipalities, and we're still doing a lot of L2 tenders there. So, the difference would be that Belgium and U.K. stand out also as high-incentivized markets right now. They still have a lot of public dollars available on the tender basis to install. Belgium is a little bit more mature. We have others that we won't announce just yet that we're moving into. As we're moving across Europe, there will be further announcements in 2023. Yeah, sure. And which revenue model tends to kind of play out more in Europe? Is it Blink sells the power? Or is it the host that owned? Okay. Got it. Okay. And then, when you see announcements like the Mercedes announcement this week or the GM announcement maybe a month ago, what are your thoughts when you see these OEMs building networks? Is it just, hey, that's great news, because that means that they're bullish on how many EVs they're going to sell? And is that's good news, because that's -- they're not going to build their own chargers, they're going to need to buy these chargers from someone, or like, what -- I guess, what are your thoughts when you see those headlines? You hit most of them there. So, it's all of the above. Look, one stat, I think this is a Bloomberg stat again. What was it? 400 -- almost 340 million to 490 million chargers needed by 2040. So, let's -- we can establish the fact, this is a big market. It's a really, really big market. U.S. has one of the highest TIVs in the world. And when you consider California, New York, Massachusetts, they're all banning the sale of internal combustion engines by 2035. Others will follow suit with that eventually. Yeah, it's a big market. The Mercedes market is a DC fast charger market. Their announcement fits in with DC fast charger infrastructure, that's out there today. It's going to have -- help drive sales, providing other opportunities for EV charging and multifamily dwellings, workplace, et cetera. So, we applaud more charging, more of public charging announcement. What we have to do as a community is we have to build range confidence. So, the announcement -- with more announcements that are out there that infrastructure is coming, the better for the space in general. So, we're bullish on it and we will continue. Now, we believe that Blink, with our model, is going to get our unfair share as we move forward. But we don't shy away from the competition and we are certainly not in the camp where we believe it's dilutive in its nature and it's going to take away from our revenue. The best is yet to come for this space and all ships will rise. So, we should think about it as multiple winners over the next multiple years in this space? That's how you guys think about? Okay. And then, can you -- you said you were in Las Vegas last week at CES. Can you kind of talk about the next generation of charges you unveiled both in the home and kind of outside of the home? And what -- I guess, now that you have these in there ready to go, what's the next step? Is it the sales process? Is it the channel process? Like, what happens next? So, again, we're going to focus on all of the above strategy. So, CES focused on some both international products. We announced our universal product for Europe, which is a 22-kilowatt unit that we're going to be selling in -- all across Europe right now from Greece to the U.K., where we have operations going on. It's a very flexible and adaptable charger. And it can have different feature sets, attitude it from connectivity, mobile app, Internet, V2G, and plug and charge, et cetera. And we also announced our new entry into the India market. We have a manufacturing and development center in India, where we're expanding that. And as that market is emerging now, we're expanding our charging services there. And it's unique and different. As you might have mentioned, the Asia is transforming differently than the rest of the world. And you have a lot of EVs and the two and three-wheeler perspective. So, we put a -- we announced that charger into the market that services that level and we're already servicing passenger cars in India as well. For in-home, we actually put two chargers out there, the Series 4, which is a low-cost charger, in an affordable number. And then, the new Blink HQ 200, which is a fully â full-feature charger for the home, where it has energy management, it is v2G capable, it's V2Home capable, and all network compatibility and everything. So, when you want to buy a good home charger, that's one of the ones to buy on there. And then, we did the Vision. And the Vision charger is an advertising unit with a 55-inch screen on both sides. It has two 19.2 kilowatt chargers. So, it can do simultaneous charging at 19.2 kilowatts. And it's ideal for advertising where site hosts are requesting that model. Blink will exclusively manage the charging side of it, and we have a partnership arrangement that will help us do the content managing on the ad revenue side, et cetera. So, we believe great excitement out of there. And we also did what is our Series 9 fleet DC low-kilowatt charging, and that's a 30-kilowatt compact easy-to-install wall-mounted DC. That's ideal for fleet charging where they want reliance on a bit of faster charging, but still take advantage of dwell time on it. So, -- and these are on top of other chargers that we're announcing. We also gave a hint at our 180-kilowatt DC fast charging, which will be of a Blink designed to produced charger that we're -- we've already finished the design. We're going through the engineering and validation aspects of that. That will be both built in India and in a manufacturing site where -- manufacturing location in the U.S. that we're in the final selection phases, as we speak. Okay. And how do you kind of get -- build consumer awareness of that home charger? And does -- winning in the home charger, does that help your network when people are out and about, they're using the Blink app, they're looking for a Blink charger? Or is it -- is that kind of the wrong way to think about it? Yeah. I mean, there may be a loose correlation between the two, but it actually goes back to the philosophy of not saying no, right? And then, offering a low-cost version as well. We designed the HQ to be able to work in multifamily dwellings as well as a lower cost alternative. So, we want to make sure that if we approach somebody, we have the solution for them, so that they can use it. Now, we prefer on the multifamily -- our multifamily charger, which allows for a degree of access control, so the owners of the parking garage, now, like, they can monitor the charging. But we have some situations where they want the lower-cost charger in the home charger and we'll install those. So, you go into this market for the home, but you make sure that's available for other positions as well. And it's -- you're going to have people that are cost sensitive and you're going to have people that are feature sensitive. So, make sure you have a solution for both. Okay. And when you say approach someone, does that mean, like, your salesforce is out there pounding the pavement to someone that has 10 parking garages in Idaho, and they don't have charges at all right now? Or, like, what -- like, what does that really mean? Yes. So, we've got a fairly large sales staff across the United States, in market, in all the big markets throughout the U.S. Well, they might not be knocking on the doors of an individual garage, they'll certainly find out who owns, maintains and manages that, starting a conversation with either sustainability manager or the person responsible for charging, and have a dialogue at how to meet their charging needs as we move forward. And they do that every day. Got you. So, let's say just, I live in Northern California. I used to work in San Francisco before COVID. I could throw a rock and hit four Teslas. The building I worked didn't had much charging station below. And the attendants in the garage, they move the cars around during the day as needed. But am I thinking of that, like, that doesn't exist now in other states or other states are moving towards that model quickly? Or, like, I guess, how should I think about that? Yeah. So, you have a different solution for densely-populated urban areas, such as San Francisco, where you do have a lot of valet situations at parking tents maneuvering cars. Now, they're all going to need more chargers because you're not going to have enough chargers to meet that ability. So, you're going to do -- you have some additionality there. You get to the Midwest, you have less garage-based infrastructure for workplace situations. And others, you have more -- it is flat parking lots that are exposed, so you do outdoor installs there. So, you're going to have variability depending on what type of urban environment it is? How dense it is? Is it more vertical in its nature? Or is it lower-lying buildings and open parking lot? So, you do the need-based assessment. It's all not the same. San Francisco mirrors a lot of the East Coast, and you see -- that's where you see a big amount of both workplace and multifamily dwelling charging. And now it's moving into the middle, and the solution is a little bit more varied as well. Chicago, New York, San Francisco, in the vertical side, all about the same in terms of the way you engage with multifamily dwellings and parking management companies. But the idea that I pull into a parking lot of Safeway and there's a charger there. I pull into the garage I used to work and there's three charges there. Is that just not the way it is in most of the United States at this point in time? It's the way it's becoming in most of the United States, depending on the market. I mean, California leads, as you know. There's a much more dense amount of chargers in California than any place else in the nation. And is that the growth that investors are focused on? Or investors are more focused on the NEVI growth and the quarter growth that perhaps that can help with range anxiety? I laugh because the industry created that term. So, I think, yeah, you do have the psychological effect on DC fast charging. And faster is better becomes something that you believe even though the reality is that the vehicle sit 95% of the time, right? So, when we look at it, if you're going to really believe in the data and the Bloomberg numbers, the opportunity from a market share and from a sales and services perspective is L2 and then DC fast charger for those quarters. We don't believe that's the long-term model. If you're just DC standalone, we believe you need something other than DC standalone to be able to have a long-term sustainable future. Okay. And what do you tell investors you may be over focused on the University of California study about industry ports out there, and 30% of them you pull up and it doesn't work, like that -- like -- is that just -- I mean, I guess, what do you -- when investors bring that up, how do you respond? Well, it's a concern. First, I mean, the industry has some issues to overcome on quality. And we have to investigate instead of everybody getting all excited about it. Really, what is true root cause analysis? And what does it tell us? We know a lot that point of failure is not really in a -- this is way mechanical failure of the charging. You do have a failure rate on charging, but usually it's the point of contact with the consumer. So, it's a credit card reader. California mandates credit card readers now with mag stripe on them. The failure rate on that, it will be the biggest because of the nature of credit card readers. You'll have less of a failure rate on tap to charge situations with mobile apps, et cetera. And then, then it goes back to network services going down. So, what we really have to do is get real about why the failures happened and why it suddenly increased. If you looked at plug shares across the board, everybody decreased in 2022. One of the main culprits behind that, which we won't have moving forward, was the sunset of the 2G and the 3G networks. So many, many, many chargers operated off that network. And unless they had an upgrade in the charger or a modem change, all of a sudden, the consumer goes up to that, and that charger doesn't work. And it didn't work because it was the old technology. In Europe, interesting enough, they banned that from happening. Because they believe they displace chargers. They didn't let the carriers sunset 2G and 3G, and that continuity of charging across Europe. So, what happens if a partner of yours calls about a charger? Do you have local representation? Or you have a contract worker that can go out and kind do what needs to be done to get that charger up and running? Or, like, what's the turn-around time there? Yeah. So, if it's an L2, that's out of service, within 24 hours, we dispatch a tech. That tech goes to the charger. He does not fix it in the field. He swaps the head, puts a new charger on, sends that back to Phoenix or Bowie, Maryland. They refurbish that charger, fix whatever was broken, and that gets back into circulation. On the L2 charger, we dispatch a tech. We first do over-the-air work through our network operation center. You have an addressability factor depending on DC fast charger equipment of anywhere from 60% to 80%, you can address the failure over air. When that does not work, then we roll a truck and we service that charger in the field. And you just talk -- you mentioned Bowie real quickly. Can you talk about manufacturing capability you have there? How it came to be? How you're thinking about it? And any constraints on manufacturing if they exist at all? Yeah. So, manufacturing in Bowie, basically, what happens in India is we build parts, right? We build a lot of parts in India. All of those subsystems go to Bowie and they are manufactured into chargers. And in Bowie, so they both do the manufacturing of those chargers. We are becoming Buy in America compliant with that. We meet the 60% standard of labor and local content that the federal government has put out under the Biden $2.5 million that's going to go, that focus primarily on L2 through those. We are going to expand that facility as we made an announcement during the acquisition and upping the capacity up there to get that out of -- to up to about 30,000 units on the L2 side out of that. So, we're expanding the existing footprint of that as we speak. Those plans are underway and in place right now today. So, again, that gives us control of our own cost of goods sold out of that and we can be very competitive in the market as it relates to sourcing issues of different components, et cetera. Got you. Okay. And then, just you talked about marquee accounts. I think it was mentioned on -- during the last earnings call, during the press release or the presentation. What is a marquee account for Blink? So, we categorize it in the two different groups, right? So, there's marquee on the sales front. And usually those are accounts that are in excess of $1 million, right, in gross revenue, right, from the sales of chargers. And we look at our account that we run through ABM or GM, that's a big dollar account. And it's already in the millions of dollars and it continues to grow up as we place more and more chargers at dealerships across the country. And we have others that fit into that same category, all above $1 million, some direct customers where we're installing the chargers, other resellers who are redistributing with us. Then, on the owner-operator side, we look at real estate companies and we look at that differently. We look at that from an opportunity perspective. And what companies have the most real estate under management or under control that we work with. And that's where we go marquee accounts in CBRE. We signed another deal with Cushman & Wakefield just recently as well to be their provider for L2 and DC fast charging in their facilities. In Europe, one of the larger parking companies in both London and in Ireland as a whole, we are their exclusive provider on the owner-operator model there as well. So, when they need charging, they go to us. So, owner-operator model, it is the strength of the portfolio where we can install charging on the owner-operator, and on sales, it's the dollar value of that portfolio over time that fits the marquee title. Got you. Okay. And then, when you -- you talked about Cushman & Wakefield, is there a competitive process? Or is your sales -- like -- I guess, I'm just curious, is it like a bake-off between charges, or is it we're not at that stage yet because there's so many charges that need to go up, there're so many companies are -- there's opportunity for everybody right now? So, you get status with one or two others is the dominant, right? That's what we're seeing as maybe. There are ones where it's pure us, with the parking company in the U.K. and Ireland, it's just us. But there's others where you're one of the preferred choices with one or two others. Okay. So, just kind of last question to bring it home here. How do you see the charging market or Blink's kind of portfolio looking in two or three years? Are we talking about the amount of chargers in the field is still growing 20%, 25% annually? Or Blink is kind of we're beyond that level of growth, and it's kind of about the power generation and owned and operated sites rate at that point? So, we want to keep pace with the industry, both on the sales front and the owner-operator front, and we want to outpace them. And, look, based on -- we can't give -- we don't give guidance. And I can't report yet on Q4, as you know. But the trend numbers indicate we're doing so. And what we look at Blink is keeping getting better, right? To be a sustainable company, you have to make sure you're exploiting all opportunities in the space. And you make sure and you have to self-improve, and you got to stay nimble. If I go back to the beginning, we're having debates on 110 versus L2. And DC fast charging [indiscernible] didn't work. So, you have to stay nimble on what type of market share? What type of chargers? We're installing 350 kilowatt chargers now that five, six years ago, people wouldn't have fathomed. And there's megawatt chargers coming online now. So, our goal is stay ahead of the industry, but stay in that sweet spot industry, where the volume is and where sustainability is going to exist for the long term. We believe that is in L2, in high-speed L2, and in DC fast charging as well. And that's where volume and economy of the scales are going to occur, and we're going to make sure that's where our investment dollars go. Perfect. All right. Well, Brendan, thanks for your time this afternoon. Have a great rest of the day. We appreciate you dialling in.
|
EarningCall_1178
|
Greetings and welcome to First Republic Bank's Fourth Quarter and Full Year 2022 Earnings Conference Call. Today's conference is being recorded. During today's call, the lines will be in a listen-only mode. Following the presentation, the conference will be opened for questions. [Operator Instructions]. I would now like to turn the call over to Mike Ioanilli, Vice President and Director of Investor Relations. Please go ahead. Thank you, and welcome to First Republic Bank's fourth quarter 2022 conference call. Speaking today will be Jim Herbert, Founder and Executive Chairman; Mike Roffler, CEO and President; Mike Selfridge, Chief Banking Officer; Bob Thornton, President Private Wealth Management; Olga Tsokova, Chief Accounting Officer and Deputy Chief Financial Officer; and Neal Holland Chief Financial Officer. Before I hand the call over to Jim, please note that we may make forward-looking statements during today's call that are subject to risks uncertainties and assumptions. We also discuss certain non-GAAP measures of our financial performance which should be considered in addition to not as a substitute for financial measures prepared in accordance with GAAP. For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements and for reconciliations of the non-GAAP calculation of certain financial measures to the most comparable GAAP financial measure see the bank's FDIC filings including the Form 8-K filed today, all available on the bank's website. It was a very strong year for First Republic. Our time-tested business model and service culture continued to perform really well. In fact, it was our best year ever in many ways. Our new 2022 Net Promoter Score, which was announced this morning, is our highest ever client satisfaction level. Itâs actually extraordinarily strong. Our non-performing assets at year-end were just 5 basis points. This is low even for First Republic. Exceptional client service and our strong focus lending led to safe organic growth during the year. In 2022, total loans grew $32 billion, a record and we had record earnings for the year. In uncertain times like these, and ability to continue to grow safely is quite viable and very rare. Let me take a moment to provide some perspective on the current rate environment and the Fed tightening cycle as we see it. Since our last call about 90 days ago, the Fed has raised rates another 125 basis points. At the same time, the 10-year Treasury has declined 50 basis points. The resulting increased rate inversion has begun to put some pressure on our net interest margin and net interest income. However, history and experience has shown that this type of inverted yield curve has a limited duration. Cycles are just that they are cycles. During First Republic's 37-year history, there have been five tightening cycle. We've continued to grow and prosper through them and especially after each one. On average, over the last 40 years, the Fed has started to cut rates less than a year after the 10-year yield has peaked. The market currently expects the Fed to start cutting rates during the back half of this year, which will be consistent with prior tightening cycles and is also our current assumption. We're staying focused on executing our model and we remain very committed to delivering solid results through all market conditions. The bedrock of our performance is providing truly exceptional differentiated service, maintaining very strong credit, delivering safe, organic growth and the results follow. Thanks, Jim. 2022 was a terrific year with record loan growth, record loan origination volume, record revenue and record earnings per share. Let me begin by covering some key results for the year. Total loans outstanding were up 24%, total deposits have grown 13%, wealth management assets were down only 3%, while the S&P 500 was down more than 19% over the same period. This strong growth in turn has led to strong financial performance. Year-over-year, total revenues have grown 17%, net interest income has grown 17%, earnings per share has grown 7%. And importantly, tangible book value per share has increased 11% during the year. As we look to a more challenging year ahead, we remain well positioned to deliver safe, strong growth through the consistent execution of our service focused culture and business model. We remain very well capitalized as a result of raising capital methodically and opportunistically over time. Our Tier-1 leverage ratio was 851 at quarter-end, credit quality remains excellent. Net charge-offs for the fourth quarter were less than $1 million. For the entire year, net-charge offs were less than 3 million or less than 1/5 of a single basis point of average loans. Non-performing assets ended the year at only 5 basis points of total assets. As Jim mentioned, this is one of our best levels ever. We do not stretch on credit quality to deliver loan growth. Our growth is driven by consistent execution of exceptional client service, one client at a time each and every day. Today, we released the results of our 2022 Net Promoter Score survey, our client satisfaction scorecard. We're pleased to have achieved a record high score of 80. This is an increase from last year's score, which was also a record at the time. At the same time, client satisfaction is declined for the overall banking industry. In 2022, the Net Promoter Score for the U.S. banking industry declined to only 31. Our service focused model is truly differentiated, even more so during challenging and disruptive environments. During 2022, we also continued to make thoughtful investments that support service excellence and growth. We expanded into the Seattle area by opening our first banking location in the market. We brought on 13 new wealth manager teams, one of our best recruiting years ever. And we successfully upgraded our core banking system, the largest technology project we've ever undertaken. As Jim mentioned, since mid-November, we have been operating with a challenging yield curve. To help us navigate the margin pressure in the near term, we continue to moderate our expense growth. At the same time, we remain focused on the long-term and continue to leverage our reputation of exceptional service to drive new business and grow total households. Our focus on service drives our growth as clients stay with us, do more with us and refer their friends and colleagues. In fact, during 2022 and driven by our highest ever level of client satisfaction, total households increased a very strong 15%. This is nearly double the growth rate of the prior year. Over time, this growth compounds continuing to deliver shareholder value and consistent profitability as it has for 37 years since our founding. Overall, 2022 was a very strong year for First Republic. Thank you, Mike. Let me provide an update on lending and deposits across our business. Loan origination volume was a record for the year at $73 billion. Our real estate secured lending remained well diversified. Both single family residential and multifamily achieved record volumes for the year. Purchase activity accounted for 54% of single-family residential volume during the year and 64% during the fourth quarter. As refinance activity has slowed, so have the repayment rates. This provides a strong base for loan growth. We continue to expect to deliver mid-teens loan growth for 2023. I would note that loan originations have some seasonality with the first quarter typically being somewhat slower. In terms of credit, we continue to maintain our conservative underwriting standards. The average loan to value ratio for all real estate loans originated during the year was just 57%. Turning to business banking, we continue to deepen our relationships by following clients to the businesses they own or influence. Our relationship-based model also leads to a strong level of referrals to new business clients. In 2022, our business client base grew by 18%. Business loans and line commitments were up 14% year-over-year. The utilization rate on capital call lines of credit increased slightly to approximately 33% during the fourth quarter. Our capital call line commitments grew 16% during the year as we continue to acquire new clients. Turning to deposits, we are pleased that total deposits were up 13% year-over-year, and 2.4% quarter-over-quarter. We continue to see a shift in deposit product mix as a result of rising rates. Checking represented 59% of total deposits at year end down from 64% in September, and CDs accounted for 14% of total deposits at year end up from 9% in September. Preferred banking offices continue to provide an important service channel for our clients and drive deposit gathering. Over the next year, we expect to selectively open new offices to deepen our presence in our existing footprint. Our programs for acquiring and growing our next generation of client relationships, which began more than a decade ago, continue to deliver strong results. In 2022, millennial households grew 17%. These younger households are the same high-quality clients that we have always attracted and are part of our strategy to see the long-term growth of First Republic. As Mike and Jim noted, our exceptional Net Promoter Score continues to demonstrate our ability to deliver differentiated client service. Let me take a moment to provide some additional detail. For clients who identify us as lead bank, our net promoter score is 87 even higher than our overall score. And importantly, nearly two thirds of our clients now consider us as lead bank. Remarkably, our net promoter score increased in each of the past three years, as we have dealt with a pandemic, and rising levels of economic uncertainty. And as we implemented a new core banking system in early 2022. And during this time, our consistently high scores also increased across every region, every line of business and every generation of clients. Our high client satisfaction remains the driver of our long-term growth. Thank you, Mike. It was a very successful year for our wealth management business. During the year, total assets under management were down only 3%, while the S&P 500 was down more than 19%. Investment management assets actually increased during the year driven by strong net Client inflow. Wealth management fee revenue was up more than 15% from the prior year. This includes strong growth in fees from brokerage trust, insurance and foreign exchange services. The combined fees from these services increased 29% year-over-year and the strong growth in these products is also further diversified our wealth management fee revenue. As we've noted before, our exceptional client service is even more highly valued by clients during times of market volatility. We take these opportunities to engage our clients and understand their needs as market conditions change. In fact, a key strength of our business model is our holistic approach to meeting our clients banking and wealth management needs. This benefits clients and is driven growth through a strong level of internal referrals, and a deepening of client relationships. In this regard, 2022 was a particularly strong year, our bankers referred over $11.5 billion of AUM to wealth management, and deposit balances from new relationships referred by our wealth management colleagues during the year totaled more than $3 billion. Wealth management referred deposits and sweep balances now represent over 13% of the bank's total deposits. Our integrated banking and wealth management model also continues to make First Republic a very attractive destination for successful wealth professionals. In 2022, we welcomed 30 new wealth manager teams to First Republic, and one of our strongest years ever. This included five teams in the fourth quarter alone. So far in 2023, we've already welcomed two new wealth management teams to First Republic, reflecting our continued investment in the long-term success of this business. Overall, our team continues to execute very well. I'm excited, these are a great opportunity to demonstrate our exceptional service, deepen existing relationships and acquire new households. Thank you, Bob. I will briefly discuss our strength and stability. Our capital position remains strong. During 2022, we added over $400 million of net new Tier-1 capital through a successful common stock offering. At year end Tier-1 leverage ratio was 8.51%. Liquidity also remains strong, high quality liquid assets for 13% of average total assets in the fourth quarter. Our credit quality remains excellent. Net charges off for the year were only $3 million. Over the same period, our provision for credit losses was $107 million, which was driven by our strong loan growth. This is a multiple of nearly 40x. Heading into 2023, our balance sheet remains strong. And now I'll turn the call over to Neal Holland, Chief Financial Officer. Thank you, Olga. It was a very strong year. Our exceptional client service and strong credit powered our safe growth. Our 2022 results were in line with or better than the expectations communicated at the start of the year. Let me take a moment to talk about the year ahead. With the rapid rise in rates in the current inverted yield curve, we continue to experience margin pressure. We currently expect the Fed funds rate to peak at 5% and then the gradually decline in the second half of the year. As a result for the full year 2023, our expected net interest margin to be approximately 25 to 30 basis points lower than the fourth quarter. As a growth bank, we create value by consistently compounding our asset base, a direct result of the exceptional service we provide. Therefore, net interest income is a key metric for our differentiated business model. Despite the current margin pressure, we expect net interest income for the full year of 2023 to be down only 2% to 5% given our continued strong growth in loans, and investments. As we look to 2024, we expect continued strong loan growth in a more normalized rate environment. As a result, we expect to deliver strong double-digit net interest income growth in line with our past performance. As Jim mentioned, the years following tightening cycles have historically been strong for the bank. Turning to expenses for 2023, we expect expense growth in the high single digits. As a reminder, expenses are typically higher in the first quarter due to the seasonal impact of payroll taxes and benefits. As we discussed at Investor Day, we continued to prioritize our expenses in a way that will not sacrifice client service, growth or safety and soundness. We have identified $150 million and planned expenses that we will not incur in 2023. This is already having a positive impact on our expense base and helped us keep expenses flat from the third to fourth quarter. With respect to income taxes. The full year tax rate is expected to be around 24%. While the current rate environment is challenging, our model is strong. We will continue to deliver exceptional client service, grow new households and provide safe growth in 2023 and beyond. Thank you, Neal. It was a strong year with record client service levels, record loan growth, and record credit performance. Our time-tested service model remains solid. Our entire team remains focused on executing our client service strategy, one client at a time. So from a big picture view, if we look at the NIM outlook, it's a bit worse than what you had guided to it at the Investor Day. And before I get into my deeper questions, what's changed since the Investor Day, which is driving the lower NIM outlook for the year? Yes, Steve, thanks. I think if you look at Investor Day, what's happened since then, and I think we highlighted this a bit in the prepared remarks, the 10-year has gone down 50, 60 basis points. And so the inversion of the yield curve has a pretty significant impact on just rates in general. And obviously, the macro environment is the thing that we can't control. The things we can control are our service levels and how we acquire households. And so with that inversion, which, as we noted, won't last a very long time and we are now partway through it. And so I think that is the biggest driver for the change in outlook relative to about 65 days ago. Got you. Okay. Mike, it sounds like you're upping the expectations for expense management. And I think you guided to about a 65% efficiency ratio for 2023. Is that still intact when you put these pieces together? Because of the margin outlook, it will be a little bit higher. But we have identified incremental expenses that will be deferred, not planned for the current year. Yes. I mean, just because of the revenue side of the equation, it's just doing the math of 2% to 5% decline with net interest income, it's about 66% to 68%, with that guideposts with high single-digit growth rates of expenses. Got you. Okay. And then, just to dive into the deposit side a little deeper. So it's pretty remarkable to see that with the rate being paid on checking balances more than doubled from the prior quarter, but average balances still came down about 9 billion. Can you take us behind the scenes in the quarter? What's the typical conversation you had with customers? And maybe underlying the NIM assumptions, where do you see the rate paid on checking moving to and maybe where does that mix stabilize? Thanks. Well, importantly, I think there's still about 67 billion, I think, of zero cost checking, which is operating balances and costs. Obviously, as rates have gone to 4.5%, the conversations between our client facing people and clients have talked about, where might they be able to achieve a bit better yield. And as a service organization, that's what we continue to focus on is that relationship with our clients to ensure they're leaving the right balance of in checking for their operating needs, and their other yield alternatives either in wealth management, money market, certificates of deposit, different alternatives. I think we communicated a low 30s data on overall deposits in the past. And we feel like sort of 30 to 35 is about the right range still at this point, and that's consistent with what we said before at Investor Day. O kay. And then, if I could just squeeze one more, Mike, going back to the new NIM outlook. I know Jim said in his commentary that you guys expect rates of decline more in line with the market in the second half of 2023. If rates were to move to say, by 5%, 5.5% rates and stay there and not come down in the second half, how would that change your NIM outlook for 2023? Thanks. Once it stabilizes, you sort of stabilized from there, but I don't think it changes that a whole lot. I think the pace of change is what has happened this year that led to the increase, or the increase in funding costs. And the real impact if you think about it is, in the future, if you leap forward to â24 and you're stable, is when you'll start to see the inflection where net interest income starts to grow. Right now that that looks like the back half of the year on a linked quarter basis. If the Fed delays that might delay that a quarter. But then you start to see the inflection higher thereafter. Just starting on NIM guide a real quick, are you assuming for the funding of earning asset growth, primarily CDs and borrowings at this point? Maybe you just talk about the mix there and the growth of deposits that you're thinking about. And then you did have a decent amount of one off and non-interest bearing, which a lot of banks are experiencing at this point. Was just curious, how should we expect this type of pace to continue? Or do you see a level at which you'd expect the trend to sort of subside and then get down to more of a sticky base that's remaining? Where do you see that sort of trailing off? Thanks. Yes. Maybe on the -- what you're getting on is, the average balance size, it has come down. So our average balances per account peaked, probably at the end of last year, they have come down closer to their pre-pandemic levels. And then obviously, as I mentioned earlier, there's a level of operating needs that clients have to have to operate with. I think that the outlook, we're going to largely fund loan growth with deposits, and then there'll be a mix of borrowings that is also utilized just like we have in the past. And the growth rate will probably be greater in CDs than it will be in checking given where the rates are this year and that's reflected in our outlook. Okay, great. And then maybe just on capital, Tier-1 leverage looks good. Notice the CET1 ratio did down a little bit below 9%. Is that an issue at all? And just how are you thinking about that level going forward? Thanks. No issue with our capital currently. As always, we remained opportunistic and methodical relative to capital won't be a preferred or common. Great. And then maybe one last one on loan production rates. Maybe if you could just kind of go through the key products and talk about where your pricing was today. That'd be great. Thanks. Sure. Dave, it's Mike Selfridge, I will give you a couple of indicators here and look more -- rather look more at the locked pipeline as of today. So single family or locked pipeline, these are deals that are in the queue. And due to close soon, single family mortgages about 5.80, multifamily, about 5.4%, commercial, about 5.6% and the whole locked real estate loans right now are little over 5%, maybe 5.10. The business banking side, nothing's changed their capital call lines tend to be the larger part of the pipeline, and that still remains in the prime minus 75 to prime minus 100 basis point range. I just wanted to follow up on the margin, on two things. One, I think Mike you mentioned, still expect the 30% to 35% deposit beta. In the world where rates don't actually get caught and the forward curve doesn't play out. Just handicap the risk. I think the concern on the margin outlook generally has been the deposit costs mix shift we've heard from some of the other big banks today could be much worse than we've seen just given that we've not tested for this in a long, long time, what's your comfort level on the 30 to 35 beta holding? So that -- is our best perspective at this point in time, given our outlook. And as Jim mentioned this doesn't last forever given history of 40 plus years. And so the 10 year is also telling you something where it's jumped to 344, as of yesterday, as to where the market feels, rates are moving. And so the beta could be a little bit higher if they hold an extra quarter or two. But the fact that the pace is slowing, there'll be a little bit of what I call a catch up, that always is at the end of a cycle. But the pace slows, because the time just passes. And so I would say that we feel pretty confident where we are. And it'll be depending upon macro-outlook, which is the one thing that you all know, we don't control and nor does anyone know anyone else. Understood. And just -- so if I missed it, did you talk about like in terms of the margin? I'm assuming there's some benefit in the back half, as you assume rate cuts in your NIM guidance of down 25 to 30 bps? How should we think about the NIM trajectory? Like does it fall closer to 2%, by the middle of the year by the second or third quarter before rebounding in the back half. No, I wouldn't go to 2%. It's sort of stabilizes that the middle part of the year. And importantly, after you have a little bit of a dip in net interest income here in the first half, then you start to see it increase towards the back half of the year and starts to have a real positive trajectory into 24. Understood. And just one last question around growth. I know. Jim, you've talked about market share environments like this, just give us a sense of, is this environment any different in terms of gaining market share and how your customers -- it's been a ton of wealth destruction? How was that factoring in, in terms of just the appetite to buy homes and in terms of mortgage loan growth today versus the last 10 or 15 years? Well, this disruptive moment, and we all know that mortgage market is being disrupted a little bit is an extraordinary opportunity for us to take share. The moments like this are very special. The volume of demand is lower. We all know that. Although my guess is, it will pick up in the spring quite a lot. But the disruptive nature, the disruption that's going on in the mortgage market, people pulling back, et cetera is just hanging us up. It's on a silver platter. And does that create some pricing power like as the yield curve, Mike, you mentioned earlier dropped -- did the spreads widen on this product? But I'm just wondering, are you able to see better spreads when the yield curve? Or is the pricing on these like the 5.80 Mike mentioned? Will that send more or less with whatever happened with the yield curve? Let me turn this to Mike. But the pricing on the acquisition of a new well-off household on a short-term asset like a four- or five-year mortgage, is [semi] [p] irrelevant. You take it into a household like this. They stay with you for life. Yes. And Abraham, I want to clarify on Dave Rochester's comment at the lock production on the single families -- a little under 5% is what I meant to say about 4.80. But these are still as we've said, in the past, eight plus clients and they get very good pricing for full relationship and full service at first Republican. Operating leverage question for 24. Appreciate that the guide on NII up low double digits next year. Just wondering, just given that you guys are doing a good job on the expense front and deferring. I think you bumped it up to 150 million. Just wondering, do we see a catch-up next year on all this expense deferral? Or is there an opportunity to improve the efficiency ratio from that 66, 68 when NIM starts going in the right way? Yes. There's a strong opportunity in 24 to see a very strong improvement in our efficiency ratio as we're really looking for ways to optimize prioritize make the company even more efficient than we are today. We expect strong operating leverage into the future. Okay, very good. On the switching gears to the loan growth, can we get a sense for how the pipeline is doing at year end versus 9/30? Hi, Casey. Mike Selfridge. I would say -- I would characterize it as healthy, it's down from the last quarter, but it's up year-over-year. And obviously, there's been headwinds on the refinance side. And that's been more difficult. But there's other parts of the pipeline, I would note that are doing very well. Business Banking, for example, is at a high, other avenues PLP, PLOC, securities lending. So again, healthy pipeline going into the quarter. I was just going to say, the loan growth itself. I'll also note that CPR are down. And so that gives us a good base from which to grow. Yes. And then the capital call that came in a little bit stronger than certainly what you were sort of experiencing in November, just any color on? Does that business picking up? I would say, well, a little bit of improvement from 32% to 33% utilization That's down from a year ago, which was just over 40%. So that industry is still seeing, it's challenged in the sense of slower velocity of deals just like last quarter slower pace of fundraising, but cautious, but still active investors. And there was a slight hiccup in private equity activity overall for the industry. And that drove a little bit of the utilization for us. Okay, great. And just one more -- the spot deposit costs at 12.31 versus 99 bps in the quarter, and also the spot CD costs, if you can provide that given that's a critical driver here. Yes. We ended the quarter with an average of 99 basis points. And looking at where we ended spot at 1231. We were up about 30 basis points from there. It just tends to move around, depending on where we're trying to position. So I don't think it's a meaningful, I think the 129 spots the right place to be. I had a question on the duration of the CD book. Some of the promo CD durations that you were offering or some of the promo CDs you were offering in the past are closer to four months. So my question is, what do you think clients doing there? Are they just rolling those CDs over for the same term? Or perhaps maybe extending the term a little bit given that you're also offering an eight-month promo rate right now? Then, if you have any comments on what the duration of the CD book is, and what percentage will likely reprice over the course of the next couple of quarters? Currently I'd say clients are a little more inclined on the eight and 10 month versus shorter. Usually every rollover opportunity presents an opportunity for us to demonstrate our extraordinary client service. And so our bankers in the offices and are engaging with clients to talk about their needs? And maybe do they want to be shorter? Do they want to lock in a little bit more? Do they have other cash needs? And so I think what's important is the role of opportunity drives a conversation with the client most importantly. Given what we talked about with the cycles earlier. Staying in sort of what I'll call a four-to-seven-month range for us has made a lot of sense, if you believe that the cycle does rollover, sort of mid-year. And so that's been our -- duration has been pretty much in that range. Got it. So should we assume a majority of CDs are going to reprice over the course next -- three to six months? Okay, great. And then maybe just related to that, you've said in the past that you like CDs over FHLB funding, given that CDs are a good customer acquisition tool. Is there anything you can share there on -- maybe the number of new customers that are you bringing in through the promo CD offerings and so they typically come with some checking account openings as well? And is there a rate you have in mind in which it might make more sense to pivot to FHLB over CDs? Thanks. So I think we'd always choose the client first, on the first part there. And typically, the CD pricing actually a little bit more attractive than the FHLB, especially right now. And so those are two benefits, but the first being the client, first and foremost. And absolutely, when they come into an office, they experience something different, versus other offices. And so our service level is meant to -- one bring them in, but second developer relationship where we have their checking and their primary banking. And so typically, we're able to get checking accounts on a very good percentage of those and build the relationship over time, which is the most important because we're playing for the long-term client relationship, not just the rate offering in the current moment. Let me just circling back on the expenses and the deferred expenses. Could you maybe separate those out on how much of that is coming from maybe deferred hiring versus systems or technology spending versus overall, marketing and general spending? So Jared, it's a good question. I think it's really broad base. Um, some of it is we've hired a lot of people in the last couple of years. So we have efficiencies from the new core system, maybe we will hire a little bit less in certain areas. As Mike Selfridge said, in like any gym mortgage volume, there's less refinance, so you need less growth in headcount there. And so some of it is, if we had projected to grow headcount, we're going to grow a little bit less, Olga, I think, and Neil had mentioned this at Investor Day, there's some natural adjustment to our compensation levels, given the mix of business we're doing that's also factored in. And then everywhere else is a team approach in marketing it everywhere, where the team really bands together and think about where's the best dollars to spend for client service, and to make sure we continue to be safe and sound to grow. And that's how we're focused. For example, we've hired already announced two teams this year and wealth management, as Bob mentioned, that's a great opportunity for us to hire terrific people, bring them over and have new clients come into bank at the same time. And so it's a little bit more of prioritizing and optimizing our spend to continue to drive safe, stable growth over time. Okay, great. Thanks. And then, just finally, for me, I guess on the securities portfolio, can you give an update on reinvestment rates and what we should expect as maybe a target securities in cash to total assets as we go to the next few quarters. Hi, Jared, this is Olga Tsokova, look at our purchases in the fourth quarter. The yields on HQLA as a lower end low five, and the munis came higher and low six like 6.1, 6.3. And if we look at the yields today, with just a quarter and a subsequent to quarter end and HQLA remained relatively similar levels at 5, 5.25 in a quarter. And munis, yields lowered slightly from what we've seen during the quarter there at 5. 5.5. Can we expect to keep cash at the same level of the total assets through the next year. Great, thank you. On the loan growth on the mid-teens growth expectation, could you perhaps going to break it out by loan category, what you're thinking is a reasonable expectation for growth? particularly on the on the mortgage side, given where we're, we're looking at rates as well as purchase activity if you can give us a breakdown of that mid-teens and the key drivers that would be really helpful. Thanks, John, it's Mike. Yes, mid-teens loan growth we're comfortable with that. I would say the mix is going to be consistent as it has been in years previous. So nothing unusual there and where it's coming from, as Jim mentioned, the disruption going on, it's never been a better time to acquire clients at First Republican. That's true for the lending side as well. We were pleasantly surprised that even refi mix was 36%. And keep in mind, those are new households, as well, the majority those reviser other banks clients that we acquire, so nothing unusual in terms of the mix. Okay. All right. And then separately on the C-side, just wondering what non-interest income growth expectation, do you have baked into that 66% to 68% efficiency range? And then more specifically, can you kind of give us some color on how you're thinking about growth that is likely in investment management and brokerage and investment fees, curious what type of upside you see there, and maybe what your base case assumption is for the S&P and how it could impact their wealth management revenue. This is Bob, maybe I'll start. So we're looking -- the first quarter, we're looking at investment management fees, somewhere in the range of $150 million. In that reflection part, we had a number of team hires late in the year that we hadn't seen fully reflect, but we got some of the benefits. S&P is up since September 30. In new team hires, so we look for this year to be a pretty strong year in terms of our overall growth and investment management fees and total wealth management fees. Yes, John. And if I just stand back for total non-interest income, we'd expect it to be in double digits, which is inclusive of wealth management is a big part of that. And then the other items that we also have had, loan fees, deposit fees, et cetera. Okay, got it. Thanks, Mike. And then my last question is just around the LTV comment and you mentioned 57% loan to value on all your real estate loans in the produced, I guess that was, I think over the year, but maybe if you can give us a little more color on commercial real estate was the -- what is the LTV at origination in your commercial real estate portfolio? And more importantly, what is -- do you have an indication of what the refreshed LTV is in that portfolio. John, it's Mike. The last two years and that would go for today the median LTV on commercial real estate origination has been about just under 50%, about 46% to be precise, median size about $2 million. Okay. Do you have a refreshed LTV for your commercial real estate book to try to give us an idea of how the how that book is positioned here as you start to see pressure in office and other areas? Yes, no, change from our conservative underwriting standards. We have always been conservative and cautious, even more cautious, and I even think our clients are more cautious. So just expect very conservative underwriting. I wanted to follow up on the NIM commentary, your net interest spread is down to 174 basis points versus your NIM at 245 basis points, how would you address the growing divergence across those metrics, including concerns that the net interest margin will eventually converge with the spread? Well, Bill, I think the big thing that, difference between those two items is the spread doesn't factor in the nearly $67 billion of non-interest. So we're much more focused on as we talked about earlier, net interest income, versus what the, the margin will be and so the divergence doesn't really concern us at all. Okay. And then on that topic is we sort of think about like remixing, the CD mix, you move back closer to pre-COVID levels, but there's growing concern that we could see CD Max revert to pre GFC levels. In this rate environment, your mix of CDs was just over 30% of deposits back in 2010. Now, are you thinking about like the remixing of non-interest-bearing deposits, essentially the mix of non-interest-bearing deposits coming lower and CDs remixing higher? Any thoughts on that would be helpful. Yes. There is a level of operating accounts that our business clients and consumers do need. And as we mentioned earlier, average balances are approaching and starting to close in on pre-pandemic. We have run CDs higher in the past. And some of our outlook that we provided earlier does reflect that we expect that to continue here into 2023. And, as we mentioned earlier, it's a terrific way to get trial with new households and continue to deepen relationships with clients. And so it's a tool the bank has used for 37 years. In some periods, you just use it a lot less than others. And now it was one of those periods we are using it more. Understood. If I may, with a final question on, you guys have historically done very little with derivative financial instruments with the yield that you're earning on cash now roughly in line with your loan yields. Does that dynamic influence in any way? Whether you consider putting on swaps or at all, change how you thought about the use of derivatives? My first question is for Mike Roffler. I think that, how the market is responding to, your guidance today is a clear indication that they expected difficulty in 2023 and, are looking ahead to 24. And to that end, could you share with us what you envisioned to be the natural efficiency ratio for First Republic, as we think as we put more volatile rate moves behind us, we think about a more normal investment cycle, and also contemplate the impact of HQLA bill to a modified LCR, goal. Thank you, Erika, I think you're right to look forward to 2024. And I think when you get through this period, where the margin and net interest income is a bit under pressure, and then you go forward, when after we stabilize, when the cycle turns, you'd come back to sort of a 62 to 64 range, which is where we've been, for many years. Thank you. And as a follow up there, obviously, in 2024, the investors are starting to think about cuts to Fed funds. And to that end, right, it's been a while since we've seen a terminal rate above zero. How should we think about where your deposits would settle to deposit costs would settle to relative to the terminal rate, right, we're just we've been so used to, where deposits have troughs relative to zero. And when we've looked at other points, historically, deposit costs tend to trough above, where Fed Funds troughs. So perhaps give us a sense of how you how much you think you can cut deposit costs, as the Fed starts easing? Erika, thanks for the question. It'll be very mixed, driven, right. And so one of the things that we've talked about is that through 2023, checking ends up about 50% of our deposits by the end of the year, which continues to be extremely valuable. From a relative cost perspective to wherever the terminal rate ends up. And that's reflective of the client relationships and the growth and the business banking. And then money market and CDs will again depend on client appetite, and where do they want to walk in possibly for CD versus money market. And it's hard to project what that will be just because the mixed shift from time-to-time like it has now. But I think the most important thing is the value of the checking. We have the terminal rates above zero continues to be very strong relative to going forward. Erika, itâs Jim, I might add for a little bit of -- of little historical perspective. The long-term as Mike said the long-term checking if you go back many years even when we bought the bank back but even before that, tends to be in the 50%, 55% range and the CDs range between sort of 10% and 20% of total. It is a mix issue and in between that is the money market. What rate they land, it's hard to predict. But the mix is actually the driver. We got it was an abnormal mix when checking went up into the high 60s. Just a quick modeling question. Most of the margin questions, I think have been addressed. The bolly run rate any, any help there. And I know you lowered the tax rate a bit. But any help. I know there's some seasonality quarter to quarter but kind of a full year comment on bullying coming. Great. Thanks. Hi, Chris. So in the fourth quarter, we have a couple of items that contributed to increase from the third quarter of the year. One, we had a benefit from the life insurance policy which we realized in the fourth quarter. And also, we had a positive impact for mark-to-market on some of our insurance contracts. And just to remind you, I think we brought it up on the last spot the loss goals that we use to offset some of the increases and changes from our benefit costs. So those two components contributed to the change from the third quarter. And yes, if you think about the run rate for the quarter, removing those two items, I would say still within 2022 fill in the quarter. I was wondering if you could add some more color on the new offices and in 2023, certain markets that you think present the best opportunities and strategically is the near-term focus on deposits, and/or kind of capturing some of the market disruption that Jim mentioned earlier on the call. Terry, the answer is yes. We are capturing a lot in terms of the disruption that Jim mentioned. But we're focused on relationships and with relationships comes the full breadth of what we offer. We probably expect maybe around six offices over the next year or so existing footprint. And then as Mike mentioned in his remarks, we're delighted to have expanded into Bellevue, Seattle. And we expect good things out of that region. One last question, checking account attrition in 2022, did that differ at all from that? I think it's at 1% longer term average you guys put in the investor presentation? Just a question on credit. Everything else been asked and answered. Are you seeing anything concerning out there? And when you do expect credit return, what areas of the portfolio would you expect to see the most stressed? Andrew, it's Mike, we feel very good about our positioning right now in credit. We don't expect any issues going forward. So the answer is, it's business as usual, from our perspective. And Mike noted the credit quality in his remarks and look at the three basis points of net charge offs over a 23-year period. So sticking to our knitting, being cautious, selective focusing on relationships. I had a question about the wealth management team profitability. You've been having a lot of the teams there lately, both last year and even in the first few weeks of this year, historically, how long is it before you start tend to see these teams reach the runway profitability? How long does it kind of take to wrap up there? Yes. It's actually relatively quick, usually within a year to 18 months. And that's really a function of fact that the teams we hired generally have a lot of traction with their clients. And then also we're getting the deposit benefit from those teams as well, which has been quite successful. And that concludes today's question-and-answer session. At this time, I will turn the conference back to Mike Roffler, for any additional or closing remarks. Thank you, everyone for joining us on today's call. We're optimistic about the future and continue to look forward to the year ahead. Have a wonderful weekend.
|
EarningCall_1179
|
Hello and welcome to the Fourth Quarter 2022 AXIS Capital Earnings Call. All participants will be in listen only-mode. [Operator Instructions] Please note today's event is being recorded. And now I would like to turn the conference over to Miranda Hunter, Head of Investor Relations. Ms. Hunter, please go ahead. Thank you, operator. Good morning, ladies and gentlemen. I'm happy to welcome you to our conference call to discuss the financial results for AXIS Capital for the fourth quarter and year ended December 31, 2022. Our earnings press release and the financial supplement were issued last night after market closed. If you would like copies, please visit the Investor Information section of our website at axiscapital.com. We have set aside an hour for today's call, which is available as an audio webcast on our website. With me today are Albert Benchimol our President and CEO; Pete Vogt, our CFO; and Vince Tizzio, CEO, Specialty Insurance and Reinsurance and our future group CEO. Before I turn the call over to Albert, I will remind everyone that the statements made during the call including the question-and-answer section which are not historical facts may be forward-looking statements. Forward-looking statements including but not limited to our comments on January renewals involve risks, uncertainties and assumptions. Actual events or results may differ materially from those projected in our forward-looking statements, due to a variety of factors including the risk factors set forth in our company's most recent report on Form 10-K and our other reports the company filed with the SEC. This includes the additional risks identified in the cautionary note regarding forward-looking statements in our earnings press release issued last night. We undertake no obligation to publicly update or revise any forward-looking statements. In addition to this presentation may include non-GAAP financial measures. Reconciliations are included in our earnings press release and our financial supplement. Thank you, Miranda and welcome to your first AXIS conference call and good morning everyone and thank you for joining us. As we commented in our press release, this was a strong quarter to cap a milestone year for AXIS. Over the past few years during these investor calls, we've shared our journey with you as we work diligently and steadfastly to reposition AXIS to be a leading specialty underwriter and create a stronger more resilient book of business, while placing the company on a pathway to generating lasting profitable growth. To accomplish this, we've significantly transformed our business. We drove consistent growth in attractive specialty markets, reduced our exposure to catastrophes and created a faster, more integrated and more efficient operating model. We're a very different company today than we were a few years ago, a focused specialty underwriter delivering steadily improving results. To be clear, we're not declaring victory and we're committed to continue increasing our growth, our profitability and our efficiency. But we are progressing into 2023 with accelerating momentum underpinned by years of improved underlying performance, strong positions in our chosen markets and rising demand for specialty coverages. We're confident that we'll not only continue to build on this progress but we're well on our way to taking the business to even higher levels. Let's get to the results. So notwithstanding another year, where the industry was challenged by catastrophes, financial and social inflation and Russia's invasion of Ukraine, excluding the impact of mix we've improved in our key performance metrics. During the year, we generated record premium production, reduced our expense ratio, grew our underwriting income by 35% and improved our overall combined ratio by 1.7 points to 95.8%. Our specialty insurance business continued to produce excellent results for the quarter and for the year. For the year, we grew our specialty insurance gross written premiums by 15%, net earned premiums by 18% and underwriting income by 46%, and produced an all-in combined ratio of 89.6%, improving both our loss and expense ratios. For AXIS Re, notwithstanding the finalization of our exit from property and property catastrophe markets mid-year as we focus the business on specialty reinsurance, our market presence remains strong and relevant as indicated by recent renewal activity. I'm pleased to report that we performed very well the 1/1 renewals. We maintained our disciplined underwriting approach and standards, exited non-target business, all the while remaining close to our customers and brokers. In the end, we successfully balanced substantially all the non-property-related renewals that met our thresholds. We estimated losing less than $10 million of desired renewals due to our exits from property and property cat reinsurance where our shares were reduced. In the end of our of our addressable non-property-related renewals, we estimate a 90% retention ratio, 12.5% rate increases and 7% new business with more than half of the new business coming from targeted credit and surety, cyber and A&H lines. So overall, we achieved mid single-digit growth ex-FX on the renewed part of the portfolio. We're encouraged these statistics indicate that our decision to exit the reinsurance property and casualty markets did not materially impact our ability to access and retain the business that we wanted. Our performance during the 1/1 renewal speaks to the value that AXIS Re brings to the market through the knowledge and expertise of our underwriters and the deep relationships that we share with our customers and brokers. We operate in a competitive environment for sure and the year is only beginning. But I believe that our performance in recent renewals demonstrates that we have a strong focused reinsurance business within a broad specialty underwriting company. Importantly, we are in the markets where we want to be and where we have strong positioning that allows us to take advantage of what we expect will be continued favorable conditions for the foreseeable future buoyed by rising demand for specialty coverage. We've achieved our plan of rebalancing our business in 2022. On a pro forma basis specialty insurance made up 71% of our gross written premium and we should report in excess of 75% this year. Moreover, we're taking concerted actions to sustain our growth and build upon our momentum, while delivering increased value to our customers. This includes the launch of our dedicated wholesale division with expanded products and resources, investments in production in product innovation and digital capabilities, expansion into lower middle markets and efforts to further leverage our global platform to benefit our strategic partners. And we've made this progress, while cultivating a strong team and a purpose-driven culture that's earned AXIS recognition as the best place to work. We're confident that the best days are ahead for AXIS and we look to the future with excitement. On a personal note, it's been a real privilege to lead AXIS during this time of transformation. As we announced last month after 11 years as President and CEO of AXIS, I'll transition my responsibilities to Vince Tizzio on May four at our Annual General Meeting. In Vince, we have a fantastic leader who I'm confident has the vision, industry knowledge, grit and tenacity to lead AXIS to even greater levels of success. I'm incredibly excited for the future of this company and I'm confident that with Vince at the wheel, AXIS will be in very capable hands. On that note, I'm sure you're eager to hear from both Pete and Vince. And so given the CEO transition we've adjusted our typical call format. I'll now pass the floor to Pete who will share our financial summary. Vince will then deliver commentary on the markets. I'll come back with some closing comments and then we'll have our Q&A. But I want to close by saying that for AXIS, I firmly believe that our moment has arrived. And with that I'll pass the floor to Pete. Pete? Thank you, Albert and good morning, everyone. This was an excellent quarter for AXIS. During the quarter, we generated net income available to common shareholders of $41 million and an annualized ROE of 4.2%. Operating income was $167 million with an annualized operating ROE of 16.9%. Diluted book value per share increased $3.45 or almost 8% to $46.95 at year end. This was principally driven by net unrealized gains reported in other comprehensive income and net income generated. This was partially offset by common share dividends declared. As noted in our press release, adjusted for net unrealized losses on available-for-sale fixed maturities, the book value per diluted common share would be $55.49. The company produced consolidated current accident year combined ratio ex-cat and weather of 90% an increase of 0.5 point over the prior year quarter and a consolidated current accident year loss ratio ex-cat and weather of 55.5% an increase of 1.2 points. Both of these metrics were impacted by mix of business. This quarter's pre-tax cat and weather-related losses net of reinsurance and reinstatement premiums were $64 million or 4.7 points. This compares to $54 million or 4.3 points in 2021. Out of the $64 million of cat losses $32 million or 2.4 points was due to weather primarily attributable to Winter Storm Elliot. Additionally, we had $23 million attributable to the COVID-19 pandemic. These losses were attributable to a handful of A&H contract A&H catastrophe XOL contracts, in Japan. We have no exposure to other countries in that region. We also had $9 million of losses due to the Russia-Ukraine war. These losses were in the insurance segment, with approximately two-third associated with political risk and one-third associated with marine war. Net favorable prior year development was $8 million. This was equally split between the segments. As announced in December, we were pleased to complete loss portfolio transfer reinsurance agreements with RiverStone International for reserves in our professional lines and liability lines in the insurance portfolio. These reserves relate to businesses, that we had generally exited years ago. We acquired the protection at a cost substantially in line with our carried reserves. The net financial impact of the transaction in the quarter was a cost of $11 million, including adverse prior year reserve development of $5 million and acquisition costs of $6 million. We have included an exhibit at the back of our investor financial supplement, which illustrates the income statement financial components of the transaction. As noted in the press release issued by RiverStone, on December 15, the transaction covers net reserves for losses and loss expenses of approximately $400 million and provides ground-up cover to a policy limit of $605 million. The consolidated acquisition cost ratio was 20.6% in the quarter, an increase of 0.2 points over the prior year and this was driven by an increase in the reinsurance segment, largely offset by a decrease in the insurance segment. The consolidated G&A expense ratio was 13.9%, a decrease of 0.9 point over the prior year quarter. This was largely attributable to good expense control and net earned premium growth. We continue to focus on our expense controls. This can be seen as our quarterly G&A expense growth rate was only 20% of our net premiums earned growth rate. The normalized G&A expense ratio in the quarter was 11.9%. This was two points lower than the current quarter G&A expense ratio, largely due to corporate expenses of $15 million attributable to our CEO transition and performance-related compensation costs. Reorganization expenses of $9 million were mainly related to the exit from catastrophe and property reinsurance lines of business. Reorganization expenses are excluded from operating income. And lastly, on a consolidated basis, fee income from strategic capital partners was $12 million in the quarter compared to $27 million in the prior year. Before I discuss the segments, I'd like to bring to your attention some updates that we made to our lines of business for disclosure purposes. You will see on Page 8 of the financial supplement in the insurance segment, we have made the following updates. Cyber is now a separate line of business. It was previously reported within professional lines. Property and terrorism lines of business have been combined. The new line of business will be referred to as property, as our terrorism business mainly covers physical damage and business interruption following an act of terrorism. And lastly, we combined Marine and Aviation into a single line of business. In addition, also on Page 8 within the reinsurance segment, the catastrophe property and engineering lines of business are now identified as runoff lines. This update will apply to all our public company disclosures. Prior year amounts have been reclassified in the business descriptions in our financial supplement also reflect these updates. Now, let's move on to our discussion on the segments. I'll start in insurance. Once again, insurance had a strong quarter, with good performance across a number of metrics. Gross premiums written increased by 12% to $1.5 billion, making it our highest production quarter ever. The increase primarily related to new business and favorable rate changes in property and liability lines as well as new business in marine and aviation lines and accident and health lines. The current accident year loss ratio ex-cat and weather decreased by 1.5 points principally due to improved loss experience in property, marine and aviation and cyber lines. On a run rate basis, it's better to look at the full year loss ratio. The acquisition cost ratio decreased by 0.3 point in the fourth quarter. Excluding the loss portfolio transfer, the acquisition cost ratio would have been 17.9%, a decrease of one point from last year. The decrease is primarily related to a decrease in profit commission costs. The underwriting-related G&A expense ratio decreased by three points in the fourth quarter, mainly driven by an increase in net premiums earned and a decrease in performance-related compensation costs and personnel costs. Now let's move on to the reinsurance segment. I'll remind everyone that the fourth quarter is the smallest quarter for gross premiums written for reinsurance, representing just over 10% of the segment's annual gross premiums. Reinsurance segment's gross premiums written increased by $40 million or 16%, compared to the prior year quarter. The increase was primarily attributable to increased line sizes and new business in credit and surety, as well as favorable premium adjustments, notably in motor and professional lines. These increases were partially offset by a decrease in catastrophe lines attributable to the exit from this line of business, as well as a decrease in liability lines, due to timing differences. The current accident year loss ratio ex-cat and weather, increased by over six points, principally due to changes in mix of business associated with the exit from catastrophe and property lines of business. Additionally, we reviewed our loss cost trend assumptions and given the current inflationary environment, we increased the year-to-date loss ratios in our motor liability and professional lines of business, and this impacted the quarter by over one point. For a better view on the ongoing run rate of our reinsurance business, I would look at the full year loss ratio for the business, ex-property and cat, which is 67.3%, essentially flat from 2021. The acquisition cost ratio increased by 1.2 points, primarily related to changes in business mix, driven by our exit from catastrophe and property lines of business and adjustments attributable to loss-sensitive features, driven by improved loss performance, mainly in the credit surety business. This was partially offset by the impact of retrocessional contracts. The underwriting-related G&A expense ratio increased by one point, mainly driven by a decrease in fees related to arrangements with strategic capital partners. This was partially offset by a decrease in personnel costs, related to our exit from catastrophe and property lines of business. Net investment income was $147 million, compared to net investment income of $128 million for the fourth quarter of 2021. In the quarter, investment income from fixed maturities was $105 million, up over 57% from $67 million in the fourth quarter last year, as the yield on the portfolio has increased 160 basis points from 1.9% to 3.5% over the last 12 months. At year-end, as I just noted, the fixed income portfolio had a book yield of 3.5%, at a duration of three years. Our market yield was 5.6%, 210 basis points above the book yield. I would note that since year-end, rates have declined a bit and our market yield is now at 5.25%. Given the duration of our portfolio and the current market yields, we would expect net investment income from fixed maturities to be at least $150 million greater in 2023, than we reported in 2022. Overall, the continued improvement in most operating metrics and positive momentum in our core underwriting book, this was a strong quarter for AXIS. Thank you, Pete, and thank you, Albert for your earlier comments and kind words. In just a few short months, I will succeed Albert as our company President and CEO. I'm honored to do so and count it a privilege to advance our company strategy, along with our colleagues and build upon further our stakeholders' trust. I'd like to provide a general view of the market, an overview of our rate performance across our businesses and share our outlook. Let's just jump in. Within our insurance segment, conditions remain largely favorable, across most of our measures of production, new business writings. And in most classes, we continue to see rates generally in line or ahead of loss cost trends. As evidenced in our financial results, our distribution partners importantly continue to seek the value of our underwriting specialists, our broad product set and our little platform. Let me provide more color on our insurance market. During the quarter there were a number of factors at play with different business lines performing at different points in the underwriting cycle. As an example, we saw firming conditions in many lines such as property, liability, credit and political risk all of which achieved rate increases in the fourth quarter that were higher than their annual averages. Further, as Albert has commented in the past quarters we continue to see deceleration and in some instances flat to negative rate change in the public D&O and financial institution markets. As a final example, in cyber we're seeing a moderation in rate achievement, though pricing increases still remain at double-digits. I'll speak more to this last point in a bit. Overall, conditions are favorable as market dislocations continue to drive more risks into the specialty channel. For AXIS, we're continuing to pursue a highly targeted and disciplined underwriting strategy across every line we write, across all channels of our distribution. We remain focused on driving ambitious profitable growth in attractive markets as we continue to provide outstanding service to our broker partners. Let's get into the numbers in more detail. Within our insurance book the average rate increases was nearly 6% for the quarter and close to 9% for the year, marking 21 straight quarters of positive rate change and bringing the cumulative rate change for our insurance book to almost 60% since the beginning of 2018. By region, international produced rate increases of 8% for the quarter and nearly 10% for the year. In North America, rate increases were 4% for the quarter and nearly 8% for the year. Looking at rate by underwriting division AXIS wholesale which is a key area of investment for AXIS generated increases of more than 8% in the quarter and 7% in the yea, these results were fueled by a resurgence of pricing across property and select casualty lines. Property rates were up more than 10% in the quarter and are over 8% for the year. We anticipate this momentum to continue as the market reacts favorably. Casualty lines are averaging an increase of more than 7%, with primary casualty strongest at 11% for the quarter and more than 9% for the year. Excess Casualty is up over 4% for both the quarter and year. I noted earlier that in cyber, we saw a deceleration in rate momentum but continued to experience firm market conditions with an average rate increase of nearly 22%. This is compared to an average year-to-date increase of almost 50%. I will add that within AXIS we have benefited from compounded rate increase of almost 140% over these past three years. Within professional lines we saw a decrease of 2% in the fourth quarter. As Albert has remarked in prior calls, public D&O is seeing the most challenging conditions with rates down more than 22% year-to-date. This is driven by a number of factors including the reduction of IPO and de-SPAC business, while traditional business is exhibiting more modest reductions. Given the changing factors we are writing much less public D&O business than we did this time last year, while closely adhering to our risk selection and pricing adequacy standards. Importantly, our London-based professional lines unit which does not write U.S. public D&O is both growing and achieving average rate increases. To give a complete picture on the rate front, during the quarter, 88% of our insurance portfolio renewed flat to up. And for that -- for the year-end that figure was 91%. Overall, new business pricing metrics have been at least as strong if not better than renewal pricing. In summary, we are well positioned to capitalize on favorable conditions across our key insurance markets including, a resurgence of rate in certain lines as mentioned. We have deep relationships with our customers, our distribution partners, a strong product set to service all of our channels of distribution, and we look forward to the continuance of these results. Let's turn to reinsurance. Within reinsurance given the shifts in our property catastrophe market this quarter was marked by significant disruption. As Peter noted the -- for AXIS the fourth quarter only represents approximately 10% of our reinsurance portfolio. Nevertheless, pricing in our reinsurance business approximated 11% within the quarter. We're observing a market reflecting strong steering in the form of pricing, terms and conditions and yes capacity deployment as evidenced by the 1/1 renewal cycle that went down to the very end. I'll concentrate my comments on the 1/1 renewals where for us 45% of our business renewed at that point. Albert spoke earlier about our performance during the 1/1 renewals. I'll spend some time now talking about what we saw on the rate front. Across our reinsurance book, pricing was up more than 12% with most lines of business seeing positive rate momentum. By way of line motor performed the strongest with a 24% increase; marine was up 17% and we produced double-digit increases in A&H at 13%, liability at 11%. Professional lines was up 8% and credit and surety were flat. To the credit of our underwriting team, we approached the 1/1 renewal season with a focused and disciplined underwriting strategy grounded in our commitment to our chosen markets and with a clear and responsive communication stance with our trading partners. Stepping back and looking at our business in total, we continue to be encouraged by the favorable rate environment we see across the vast majority of lines that we write and we anticipate that these conditions will last throughout 2023. We are committed to answering the call from our customers for specialty products, services and capabilities. Thank you Vince and Pete. So there you have it. As we look at the year ahead, our specialty insurance business continues to fire on all cylinders and we're investing to create new avenues of revenue growth within our key markets. The reinsurance market is firming up and we're active and engaged participants in our chosen specialty lines. And across both businesses, we're generally seeing favorable market conditions that should sustain throughout the year. Yes. Thank you. At this time, we will begin the question-and-answer session. [Operator Instructions] And this morning's first question comes from Brian Meredith with UBS. Yeah. Thanks. First, Albert just all the best in your retirement and the next stage of your, I guess, your career here. First question for you is just maybe digging a little bit on this LPT cover that you bought. A little more understanding as to why you bought it. Obviously, there's a cost to it not only the costs you booked in the quarter, but just the lack of investment income you're going to have on the cash and invested assets that you transfer over to NSTAR [ph]. So maybe a little bit more behind why you thought this was necessary? Thank you, Brian, and thank you for your comment. So Pete is going to get into the details. But bottom line, we felt that this was opportunistically a very good move for us. First of all from a capital efficiency perspective. It's ROE accretive, because of the fact that we're releasing capital, which is helpful. But more importantly we -- these are lines of business that have given us some issues in the past. We think they're highly exposed to inflation. And so we felt that given the terms that we had that this was an attractive transaction for us. Yeah. I guess, what I would expand on is just overall Brian I think it really reduces our reserve risk going forward. This is really centered in the insurance pro lines and liability from 2019 accident year and prior to that. It includes a number of product lines that we've exited and it's just good to get that uncertainty off of our balance sheet. And we did it with a good trading partner at what we think was a good price point, so. And as Albert noted it is accretive to the ROE and it does help free up some capital. So all-in-all, I think these are opportunistic and we just felt that this was a good opportunity to actually move some of those reserves off. Makes sense. Thanks. And then the second question just curious what is your ceded reinsurance program going to look like in 2023? And how could that affect, call it I know you had a pretty decent acquisition cost in your insurance business in the quarter. Could we see higher acquisition cost ratio there on some of your quota shares? How is it going to affect your appetite for property business going forward? Just maybe a little color on what you're expecting that to look like? Yeah. I appreciate that. So the first thing I would say is that most of our large programs do not renew at 1/1. So as you may be familiar, our property program renews in May and then we'll have a professional and casualty programs in the middle of the year. But we certainly renewed a lot of our specialty programs. We renewed our cyber program, so we can give you some insights on that. By and large, we came in with the capacity that we wanted. We came in by and large within the pricing that we expected and that we budgeted for. The one area where we gave up a little bit was on the cyber program. We gave up a point of ceding commission, but that's frankly because we wanted to achieve a 60% quota share and we felt that that was the right thing to do. But by and large, I would say that we did not get any surprises. We've got an incredible team on our ceded side. They stay in touch with our reinsurers all year long. And so we had a pretty good idea of where the capacity was what the pricing would be, and so we're very satisfied that we got the reinsurance program that we needed in place. I think going forward, everything that I hear is that obviously, we'll pay market conditions, but we think that we ought to be among the better treated cedents given the history of profitability of our relationships on the reinsurance side. But we'll do those as we get into May and June and we'll tell you about it when we do that. But that's already been incorporated in our modeling. It's been incorporated in our pricing and we feel very good about where we are. Pete, anything you want to add to that? I would just reiterate that last point Brian is one we've already reflected anticipated increased costs or lower ceding commissions in the pricing that we're actually out in the market with on the insurance side. So our guys are on the front foot there. Good morning, everybody. And I'll jump in on the congratulations and best of luck to Albert on retirement. Hopefully, you get to enjoy watching the weather as a spectator. I guess my first question goes to the catastrophe losses. Have you run an exercise to try and determine what the natural weather catastrophe losses would have been for AXIS had you not exited the property and property cat reinsurance book? Hey, Yaron, this is Pete. We haven't gone back and said gee what would the net cat losses have been if we had not actually exited the program. I guess what I can tell you is, what I did look at, because I could definitely see, it was an interest in the market out there. But if we look at our actual cat loss ratio in the fourth quarter this time, it was materially below our average cat loss ratio in the fourth quarter whether you look over a five year horizon or a 10-year horizon. And that is adjusting that cat loss ratio to take out the impact of COVID in 2020 which we did put some up in the fourth quarter of 2020. But I mean if I look at an all-in group number, we were down more than 50% from where we had been historically. And I think that's probably the best metric to look at rather than trying to redo the book. I would just say on a true numbers basis, when you go and look at our fourth quarter's average the last five years 2017 to 2021 or the last 10 2012 to 2021. And our loss ratio was down 9 points and 6.6 points on a cat basis. And I think that's sort of a testament to where we're going with our view on natural cash going forward. So Pete, correct me if I'm wrong, but I think if I -- if we just take a look at nat cat to loan in this quarter it's like around 2-point something nat cat loss ratio? So I think that gives you a sense of our exposure to nat cats compared to where we would have been in the past. Okay. Thank you. And then Pete, I think you mentioned that you took -- you raised the loss picks made some inflation adjustments, I guess in the reinsurance portfolio. Were there any adverse prior year development associated with that? Yes, Yaron. Right now, obviously, we don't have the Q out, so you can't see it. But when we file the K, you'll see all the details by line of business what the PYD was in the quarter. So I won't get into specifics here. But we really feel good about the view, we've got for inflation, as I mentioned in reinsurance, we moved the quarter up by about 1.25 points. And I do think that you'll see some adjustments when the K comes out, as well as the global loss triangles, which we will also get out in the first half of this year. Okay. Maybe if I can sneak one last one in. Can you maybe talk about the source of the COVID-related losses in the quarter? Yes. A couple of things to make sure we clarify there. The losses are all associated with 2022 accident year. And it's primarily associated with the seventh wave of COVID outbreak that happened in the early summer in Japan. We have some Japanese cedents where we provide a catastrophe XOL for A&H. So these are basically per diem hospitalization benefits and it's a straight simple indemnity benefit. But with the regulatory change there where if you were at home under the careable position it was at "deemed hospitalization" our cedent saw a real spike in these per diem costs and it actually started to hit their cat XOL layers. So that's what it's associated with. It's a handful of clients that we have in Japan and we have no other contracts like that in the area. So we're not exposed to other countries. Hi. Thanks. Good morning. You guys pointed to looking at the insurance right attritional full year loss ratio, which I think was just under 51% as thinking about go-forward modeling. You also right mentioned pricing of 6% in insurance in the fourth quarter. I'm not sure where the current view of loss trend is. But when you think about pricing and loss trend, how should we think about the level of improvement you could see from that 51% baseline in insurances in 2023? Well, I think, as you pointed out, we have 9% average for the year, 6% in the quarter. But to be fair, we are taking a prudent view on loss trends and inflation. So we think it's in the mid single digits, so there's opportunities for improvement, but not massive. But I think the book is in a really good place now. To be fair, we're delivering this year a sub-90 combined ratio. We think the book is where we want it to be. The goal for us frankly is to write more. At these margins, I mean, it's really -- growth is very accretive for us. So we feel positive about the book that we have the premiums that we earn as I said are basically at or ahead of loss costs. And the goal here is to keep the book where it is and grow. Okay. And then in terms of debt when you guys typically look at debt to prefer to total capital right still above 30%. Is the goal still to get that to the mid-20s? And is that a level that you need to see to think about capital return? Yes. Elyse, this is Pete. I think as we continue to evolve more into an insurance specialty where we don't necessarily need to have as low a ratio that -- we're going to look to get that ratio, I'd call it to the mid- to high 20s. And I don't think we need to exactly be there to have any opportunistic plays of what we want to do with capital, but we are looking to get it below 30% and I would like to see it get into the mid- to high 20s. But before we do, we're probably talking about the share repurchase program. I'd like to actually see the capital those ratios get below 30%. But I don't think we need to get all the way to 25%, but I'd like to be comfortably in the mid to high 20s. Yes. I'd add a couple of comments to that. I think the mid-20s is a good number for a reinsurer with volatile results. I think the kind of company we are. I think if you look at specialty peers, they can afford a higher leverage. But the other thing that I would point to is, as you know the increase in the leverage ratio came only because of the market value of the bonds and given our high-quality portfolio in three-year duration we think there's a significant amount of opportunity for book value growth and leverage reduction simply with the return to par of the bonds that we have in our portfolio. And then you guys have -- we've seen the PMLs come down at most return periods. I did notice the Japan windstorm PML did go up a little bit in the quarter. What's going on there? Hey, Elyse this is Pete, I'll handle that. At year-end we had some of our third-party capital partners. Those are calendar year contracts. And so some of the protection on the property book for reinsurance ended at 12/31 and then the Japanese renewals happened April 1. So, you will see those -- those jumped up because we didn't have that outwards protection on the reinsurance book from our third-party capital partners but it will come down again on April 1. Again it kind of leaves us exposed a bit on reinsurance if there happens to be a quake in Japan in the next 90 days. However, I'm not too worried about a typhoon in the next 90 days. But that's what that was about. And you'll see that adjust again as we get to April 1. Thanks. I'm going to ask the same sort of question as Elyse, but maybe retrospectively. The press release didn't attribute the insurance segment underlying loss ratio improvement to a gap between rate and trend. I'm wondering is that an accurate reflection of how you've been booking losses? Hey Meyer, this is Pete. We've had some benefit of rate over trend. I just think in the quarter the predominant movement was because we had such good results coming out of those three areas due new experience. So, we are still seeing a little bit of rate over trend in the insurance segment but it did slowdown in the second half of the year and the predominant reason was I think those three lines of business really had good experience in the quarter. Okay, that's helpful. The second question so I think also Pete you'd emphasize that the loss portfolio transfer -- sorry applies to product lines that are mostly exited. And I'm wondering if you could break down the reserve development on the professional lines and liability lines or products that you're still in because we've seen the overall numbers but I'm wondering if there was a material difference in terms of how the exited product lines reserves have performed versus the ongoing longer term lines? Hey, Meyer this is Pete. I had not planned on doing that. Again when we do our global loss triangles and we need to make any comment in that document about maybe exited lines we'll think about maybe adding some color there. But I was not planning on trying to break those reserves out and do them separately for you. As we think about the GLTs, we'll kind of take that advice under advisement and see what we can do to help you understand the ongoing book better. Yes. I'm going to add of course the reparatory of people with congratulations to Albert and Pete. Albert, thanks for all you've done and best of luck. So, two things -- just two things I want to add Pete's name, so don't worry Pete, I'm still around until May. That's true. That's true. And of course I mean Vince not Pete of course I know Pete. And so my question involves the new disclosure. I'm really happy. I love the new disclosure. And I'm looking at the cyber growth. And you grew fairly strongly in cyber in the first three quarters of the year and the growth slowed in fourth. I'm wondering if there's anything we can read into pricing of cyber as the year ended. I got 31% gross premium growth in the first nine months of the year and just three in the fourth quarter. Is there anything we can learn about the markets there? No. Maybe I think what I can do is just give you a context, right? So, we've been for close to two years now rightsizing our exposures and we were very happy taking absolute exposures down, while we were benefiting from pricing increases. And as Vince mentioned earlier, we had 20% rate increase in the quarter we had 50% average rate increase in the year. So you actually have the same rate of reduction in exposures, but you're getting a lower amount of rate increase. And so hopefully you understand what I'm trying to get to on the math. But, I guess, if I could just take a bigger picture on cyber. I continue to believe that cyber is going to become one of the most important lines of business for insurance. And whoever you talk to in terms of observers talk about the strong growth that's expected over time. But I think we also recognize that it's an important product, but it's a young product. It's emerging. I think that there are -- the understanding of the risk and the tail is growing a lot. I think the industry is doing a very good job of trying to manage around the tail exposure. And as we've told you we're big fans of the line. We're very good at it. But we want to manage our tail exposure where it is until we get even more comfort around the tail exposures, around reinsurance capacity, around wordings and so on. So we feel very good about the fact that we are sustaining leadership positions on the cyber side which I think is a great investment in the future. But on the other hand, we're not going to do it by taking excessive risk in the near-term. And so we've got great incoming business. We've got a very strong reinsurance program. And we think that right now that's the smartest way to approach cyber as we add more comfort around the tail risk. Okay. And then second on similar vein the new gross premium disclosure. You guys already know what our 1/1 renewals look like. I'm wondering if there's any help you can give us on thinking about the new terrorism/property disclosure versus property only. How much premium decline should we think about in the sum of the former two versus the current given what you know about your 1/1 renewals? So I apologize. I don't follow the question. Are you asking about anticipated terrorism and property premiums on the insurance or reinsurance? Yes. I mean in my mind that you're not doing property reinsurance anymore, but the new disclosure calling terrorism and property I think I might be mishandling a 1/1 -- a first quarter reinsurance volumes because I'm making a mistake about things that are terrorism and things that are property. Maybe you can sort of clarify a little bit about what we should expect the new properties premium. Yes. Appreciate that. So number one, I think, property premium there's a couple of left -- on the reinsurance side there's a couple of left over premiums, but we're talking like single-digit millions. We wouldn't worry about that. I think that the combination of property and terrorism is on the insurance side not on the reinsurance side. And I would tell you that our position right now is that we expect to grow property and terrorism going into 2023. We're seeing very strong market conditions in both. And our posture on it right now is that we would expect to see growth in property and terrorism. Vince, anything to add? Okay. And again in the useless advice category that Meyer just started is a great opportunity given the new segmentation to give those triangles a look in the K and I fully support that. Yes. Thank you for the note Josh. We will be separating cyber out because it will be in the K now. So when we do the GLTs you will be able to see cyber separately. So I'm assuming that will be a nice big improvement for you. Yes. Thanks. Good morning. I just want to follow up on Josh's cyber question. I was -- hopefully you could just peel back the onion a little further. Can you talk a bit about kind of modeling tools how you view P&Ls, kind of, some -- Albert some of those things you talked about in terms of management of the risk, but just RDSs maybe how much aggregate rate online has moved. You mentioned kind of pricing over the year, but as kind of you view rate online a few years ago versus now what are we looking at? And then lastly, any view on rating agency potential actions or views of the line in terms of how they think about risk aggregation and some requirements it might put in place? Right. Thank you for that. So again just kind of unstructured answer on cyber. We try to manage our exposure on the front end and on the back end. On the front end as you know we've significantly increased our underwriting standards and guidelines in terms of making sure that we don't ensure any more, anybody who doesn't have good cyber hygiene in place. We've got our own wordings making sure that we exclude law and infrastructure in our coverages. And then, we analyze those, we use -- I got to say at least half a dozen different models including our own. So I think that we try to make sure that we capture everybody's perspective on that. And so you can imagine obviously, we're at Lloyd's, we use the Lloyd's RDS scenarios, we use our own scenarios and they go through it all. And at the end of the day, as you know, we buy a 60% quota share we buy an ag stop loss, because we feel that right now additional security is a good thing. So we're certainly not stretching any more than we need to on that one. We let our people go crazy on threats and PML scenarios and just make sure that our wordings cover through it. Look, my hope is that in this year, the industry will continue to make progress on wordings. We're starting to see some pickup in potential CAD bonds and capital markets participation. So I actually think that this is a line of business that's going to evolve, favorably for the insurance industry. But as you've heard me say to Josh earlier, we are continuing to reduce our exposure counts while we're managing the tail. And I think right now, we still have some opportunities for growth in dollars and we'll do it cautiously. Great. And then, I mean just one follow-up you mentioned wordings a few times. There are a couple of your big peers in the sector have put in some exclusions, sublimits on I guess systemic risk would be the best term for it. Is that something you guys have taken a look at, and active in any way or I think the industry might adopt more broadly? Excuse me. So as I mentioned I think a number of organizations are looking at wordings. I think that -- and we certainly, are among them. As I said, we've already got some limitations in there. I think there's still some work that's being done on the wordings and their coverage and their judicial enforcement. But again, my expectation is that during this year, we will see additional progress on the wording side. And you can rest assure, that we're not going to be standing back and providing more risk and -- assuming more risk than we need to in the market. So my expectation is that we will see progress on wordings and reinsurance capacity developing in 2023. Thank you. And this concludes the question-and-answer session. I would like to turn the call to Albert Benchimol for any closing comments. Great. Thank you very much, operator and thank you all for joining and for your time this morning. Obviously, as you can tell from our results, we feel very, very pleased with 2022. It was a terrific year for AXIS, one in which we took critical steps in bringing forward to life our vision of becoming a leading specialty underwriter. I cannot say this enough. We are in the businesses we want to be, and where we are well positioned to take advantage of opportunities in the market. And that's really due to the hard work of our team and I want to express my appreciation to our team for their hard work, their commitment, their relentless focus on the profitability of our business. And I want to thank our customers and our brokers, for supporting us for making us part of their business and part of their success. I couldn't feel more optimistic about the future for AXIS. And I look forward to still being here next quarter and reporting hopefully, a good first quarter to you. Thank you all and have a great day.
|
EarningCall_1180
|
Welcome to the Fourth Quarter 2022 Phillips 66 Earnings Conference Call. My name is Emily, and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. Good morning, and welcome to Phillips 66 Fourth Quarter Earnings Conference Call. Participants on today's call will include Mark Lashier, President and CEO; Kevin Mitchell, CFO; and Brian Mandell, Marketing and Commercial; Tim Roberts, Midstream and Chemicals; and Rich Harbison, Refining. Today's presentation material can be found on the Investor Relations section of the Phillips 66 website, along with supplemental financial and operating information. Slide 2 contains our safe harbor statement. We will be making forward-looking statements during today's call. Actual results may differ materially from today's comments. Factors that could cause actual results to differ are included here as well as in our SEC filings. Thanks, Jeff. Good morning, and thank you for joining us today. In the fourth quarter, we had adjusted earnings of $1.9 billion or $4 per share. We generated $4.8 billion in operating cash flow. For the year, adjusted earnings were $8.9 billion or $18.79 per share. Our diversified integrated portfolio generated strong earnings and cash flow in 2022, supported by a favorable market environment and solid operations. Our cash flow generation allowed us to strengthen our financial position by repaying debt and resuming our share repurchase program. We returned $3.3 billion to shareholders through share repurchases and dividends. We continue to focus on operating excellence and advancing our strategic priorities to deliver on our vision of providing energy and improving lives as we meet global demand. In Midstream, we continue integrating DCP Midstream to unlock significant synergies and growth opportunities across our NGL wellhead to market value chain. Additionally, we completed Frac 4 at the Sweeny Hub, adding 150,000 barrels per day. Our total Sweeny Hub fractionation capacity is 550,000 barrels per day, making it the largest fraction -- or the second largest fractionation hub in the U.S. In Chemicals, CPChem is pursuing a portfolio of high-return projects, enhancing its asset base as well as optimizing its existing operations. This includes construction of a second world scale unit to produce one hexene in Old Ocean, Texas, and the expansion of propylene splitting capacity at its Cedar buying facility. Both projects are expected to start up in the second half of 2023. CPChem and Qatar Energy announced final investment decisions to construct petrochemical facilities on the U.S. Gulf Coast Ras Laffan, Qatar. CPChem will have a 51% interest in the $8.5 billion integrated polymers facility on the U.S. Gulf Coast. The Golden Triangle Polymers facility will include a 4.6 billion pounds per year ethane cracker and two high-density polyethylene units with a combined capacity of 4.4 billion pounds per year. Operations are expected to begin in 2026. In January, the Ras Laffan petrochemical project was approved. CPChem will own a 30% interest in the $6 billion integrated Polymers complex. The plant will include a 4.6 billion pounds per year ethane cracker and two high-density polyethylene units with a total capacity of 3.7 billion pounds per year. Start-up is expected in late 2026. In Refining, we're converting our San Francisco refinery into one of the world's largest renewable fuels facilities. The Rodeo Renewed project is on track to begin commercial operations in the first quarter of 2024. Upon completion, Rodeo will have over 50,000 barrels per day of renewable fuels production capacity. At our Investor Day, we announced priorities to reward Phillips 66 shareholders now and in the future. We're holding ourselves accountable, and we know that you are as well. Slide 4 summarizes our progress. We are delivering returns to shareholders. Since July 2022, we've returned $2.4 billion to shareholders through share repurchases and dividends. We're on track to meet our target return of $10 billion to $12 billion by year-end 2024. In January, we reached an agreement to acquire all of the publicly held common units of DCP Midstream. We expect the transaction to close in the second quarter of 2023, at which point, we will have an 87% economic interest in DCP Midstream. The increase in our economic interest from 28%, prior to the third quarter transaction, is expected to generate an incremental $1.3 billion of adjusted EBITDA, including commercial and operating synergies. We're executing our business transformation. The team achieved savings in excess of $500 million on an annualized basis at the end of 2022, setting us up well for 2023. This includes cost reductions of over $300 million, mostly related to reducing headcount by over 1,100 positions during the year as we redesigned and streamlined our organization. In addition, our 2023 capital program includes a $200 million reduction of sustaining capital. We're transforming to a sustainable lower cost business model and expect to deliver $1 billion of annualized savings by year-end 2023. We're laser-focused on executing these strategic priorities to deliver returns and increase distributions in a competitive and sustainable way. We look forward to updating you on our progress. Thank you, Mark. Starting with an overview on Slide 5, we summarize our financial results for the year. Adjusted earnings were $8.9 billion or $18.79 per share. The $442 million decrease in the fair value of our investment in NOVONIX reduced earnings per share by $0.71. We generated $10.8 billion of operating cash flow. Cash distributions from equity affiliates were $1.7 billion, including $574 million from CPChem. We ended 2022 with a net debt-to-capital ratio of 24%. Our adjusted after-tax return on capital employed for the year was 22%. Slide 6 shows the change in cash during the year. We started the year with $3.1 billion in cash and generated record cash flow during the year. Cash from operations was $10.8 billion. We received net loan repayments from equity affiliates of $590 million. During the year, we paid down $2.4 billion of debt. This includes $430 million of debt paid down by DCP Midstream since we began consolidating effective August '18. We funded $2.2 billion of capital spending and returned $3.3 billion to shareholders, including $1.5 billion of share repurchases. The other category includes the redemption of DCP Midstream's Series A preferred units of $500 million. Our ending cash balance increased by $3 billion to $6.1 billion. Slide 7 summarizes our fourth quarter results. Adjusted earnings were $1.9 billion, or $4 per share. The $11 million decrease in the fair value of our investment in NOVONIX reduced earnings per share by $0.02. We generated operating cash flow of $4.8 billion, including a working capital benefit of $2.1 billion and cash distributions from equity affiliates of $261 million. Capital spending for the quarter was $713 million, including $310 million for growth projects. We returned $1.2 billion to shareholders through $456 million of dividends and $753 million of share repurchases. We ended the quarter with 466 million shares outstanding. Moving to Slide 8. This slide highlights the change in adjusted results by segment from the third quarter to the fourth quarter. During the period, adjusted earnings decreased $1.2 billion mostly due to lower results in Refining and Marketing and Specialties. In the fourth quarter, we made certain changes to the composition and reporting of our operating segment results. Our slides reflect these changes and prior period results have been recast for comparative purposes. The 2022 and 2021 quarterly information has been recast and is included in our supplemental information. Slide 9 shows our Midstream results. Fourth quarter adjusted pretax income was $674 million compared with $608 million in the previous quarter. Transportation contributed to adjusted pretax income of $237 million, up $8 million from the prior quarter. NGL and Other adjusted pretax income was $448 million compared to $412 million in the third quarter. The increase was primarily due to record fractionation volumes as well as a full quarter of consolidating DCP Midstream, Sand Hills Pipeline and Southern Hills pipeline. The fractionators at the Sweeny Hub averaged a record 565,000 barrels per day, reflecting the start-up of Frac 4 at the end of the third quarter. The Freeport LPG export facility loaded a record 271,000 barrels per day in the fourth quarter. Our NOVONIX investment is mark-to-market each quarter. The fair value of the investment, including foreign exchange impacts, decreased $11 million in the fourth quarter compared with a decrease of $33 million in the third quarter. Turning to Chemicals on Slide 10. Chemicals at fourth quarter adjusted pretax income of $52 million compared with $135 million in the previous quarter. The decrease was mainly due to lower margins and volumes partially offset by decreased utility costs and the impact of legal accruals in the third quarter. Global olefins and polyolefins utilization was 83% for the quarter, reflecting planned turnaround activities and the impact of the winter storm in December. Turning to Refining on Slide 11. Refining fourth quarter adjusted pretax income was $1.6 billion, down from $2.9 billion in the third quarter. The decrease was primarily due to lower realized margins. Our realized margins decreased by 27% to $19.73per barrel, while the composite 3 to 1 re-adjusted market crack decreased by 16%. Turnaround costs were $236 million. Crude utilization was 91% in the fourth quarter and clean product yield was 86%. Slide 12 covers market capture. We are now using a composite 3 to 1 in adjusted market crack to be more consistent with peers and more comparable to our realized margin. The 3 to 1 rent-adjusted market crack for the fourth quarter was $23.50 per barrel compared to $28.18 per barrel in the third quarter. Realized margin was $19.73 per barrel and resulted in an overall market capture of 84%. Market capture in the previous quarter was 95%. Market capture is impacted by the configuration of our refineries. We have a higher distillate yield and lower gasoline yield than the 3 to 1 market indicator. During the fourth quarter, the distillate crack increased $8 per barrel, and the gasoline crack decreased $10 per barrel. Losses from secondary products of $3.59 per barrel were $0.09 per barrel higher than the previous quarter. Our feedstock loss of $0.03 per barrel was $1.45 per barrel improved compared to the third quarter due to more favorable crude differentials. The other category improved realized margins by $0.46 per barrel. This category includes freight costs, clean product realizations and inventory impacts. Fourth quarter was $6.66 per barrel less than the previous quarter, primarily due to lower clean product realizations and inventory timing. Moving to Marketing and Specialties on Slide 13. Adjusted fourth quarter pretax income was $539 million compared with $828 million in the prior quarter, mainly due to lower domestic and international marketing margins. On Slide 14, the Corporate and Other segment had adjusted pretax costs of $280 million, $34 million higher than the prior quarter. The increase was mainly due to higher net interest expense as well as a transfer tax related to a foreign entity reorganization and higher employee-related expenses. Slide 15 shows the change in cash during the fourth quarter. We had another strong quarter of cash generation. We started the quarter with a $3.7 billion cash balance. Cash from operations was $2.7 billion, excluding working capital. There was a working capital benefit of $2.1 billion, mainly reflecting a reduction in inventory and a decrease in our net accounts receivable position. We received a loan repayment from an equity affiliate of $426 million. During the quarter, we repaid $500 million of senior notes due April 2023 and funded $713 million of capital spending. We returned $1.2 billion to shareholders through dividends and share repurchases. Additionally, the other category includes the redemption of DCP Midstream's Series A preferred units of $500 million. Our ending cash balance was $6.1 billion. This concludes my review of the financial and operating results. Next, I'll cover a few outlook items for the first quarter and the full year. In Chemicals, we expect the first quarter global O&P utilization rate to be in the mid-90s. In Refining, we expect the first quarter worldwide crude utilization rate to be in the mid-80s and turnaround expenses to be between $240 million and $270 million. We anticipate first quarter corporate and other costs to come in between $230 million and $260 million. For 2023, Refining turnaround expenses are expected to be between $550 million and $600 million. We expect Corporate and Other costs to be in the range of $1 billion to $1.1 billion for the year. We anticipate full year D&A of about $2 billion. And finally, we expect the effective income tax rate to be between 20% and 25%. Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question today comes from Neil Mehta of Goldman Sachs. Please go ahead, Neil. Your line is open. Yeah. Good morning, good afternoon, guys. I guess the first question I have is around refining. And if I try to isolate what the market is reacting to today, I think it's the capture rate, surprised folks relative to a lot of your large-cap peers. And so maybe you can simplify it for us and talk about what you're seeing in the system. Is there anything that you feel was more temporary versus structural? And give us confidence that that capture rate is going to continue to improve as we think about the progression through the year? Hey, Rich here. Yeah, that's a really good question. When I look at that capture rate for the fourth quarter, the three simple things that stand out to me are really the impact of our turnaround activity. That's the first one. It was centric in the Gulf Coast and the Pacific Northwest. And the Pacific Northwest was an actual entire refinery shutdown that shouldered the third and fourth quarter of the year. So I look at those as temporaries. There was also some product differentials that played out across our system the Atlantic, the difference between the European distillate price and the New York Harbor price is reflective in that market capture. There was a significant reduction in diesel price there in Europe as well as the turnaround effect in the Pacific Northwest and also Northern California product prices were dislocated from the Los Angeles market as well. And the third influence in fourth quarter capture was really centric around the Keystone shutdown of the pipeline as well as the winter storm events in there. So that's -- when I look at those three effects, there's the majority of the impact associated with the capture rate in the fourth quarter. I might just add, the turnaround activity occurred in October and early November, which was the highest margin part of the quarter. Thanks for that. And the follow-up to that is just as we think about Q1, how some of these dynamics potentially reverse especially given it's going to be a pretty heavy turnaround quarter, it looks like, with the utilization guides in the mid-80s? Or do we really see that improvement materialize potentially more Q2 through balance of the year? Well, I'll start with the turnaround guidance part of that and then kick it over to Brian, you can talk about the market outlook a little bit there for the first quarter. So our first quarter turnaround, you can tell by our guidance there that Kevin provided our annual guidance is in the 550 to 600 range. And our first quarter is a majority of that spend. So we are heavy centric first quarter on our turnaround. And those are primarily related in just a couple of sites. So I don't -- I see that as really impactful to our Atlantic coastal operations there as the biggest part of that impact on the turnarounds. There is also some Gulf Coast turnaround activity as well that is less impactful. So although there is a heavy spend, it's centric really in one primary facility. And I would add in talking about European to New York distillate prices and Pacific Northwest and Bay prices to L.A., they should both normalize. We saw New York is over Europe. That's unusual. Europe imported a lot of Russian distillate prior to the price gap next week. And New York, because of the winter storm, didn't get all the barrels that it needs. So the reason why New York is over Europe now it's a prompt issue. And if you look at Colonial Pipeline, it's running at full rates now. New York will get fed back and then Europe will be over -- or under -- or over New York rather going forward. And the Pacific Northwest versus and Bay versus L.A. that was -- that's a temporary issue as well. Our pad refineries ran really well in November, December, we saw inventories really build across the markets. And given the oversupply, the markets needed to price to incentivize exports and the infrastructure for exports is in the Bay and Pacific Northwest. So that's where the exports came from. And also, we need to aggregate barrels for the exports. So some of the barrels that normally went to L.A. didn't go to L.A. at that time. So that increased the L.A. price, decreased the Pacific Northwest and Bay price. But going forward with heavy Pacific Northwest turnarounds and work in the Bay, we'd expect inventories to moderate as we get back to seasonal demand spreads between the north and south will come back into normal areas. Well, thank you. Good morning everyone. I wonder if you wouldn't mind, I'm going to try -- I'd like to build on Neil's question, if I may, but ask it a little differently. Is there any way, Kevin that you can quantify the lost opportunity cost in the fourth quarter to help us kind of reconcile that capture rate question? Is that possible? Yeah. Doug, that's -- we've historically not done that in terms of what we've put out there into the market. We've talked about the kind of areas where that has shown up and Rich walk you through that. But it is a -- in any given period, there's invariably some element of LP component. And certainly, what we saw in the fourth quarter was quite a bit higher than what I would consider. I mean, ideally, you don't want any of it, but there's usually some degree of that. It was significantly higher than that. So not something we've historically given out. But I guess, to give you some some help, it's probably -- the number is probably in the order of $100 million to $200 million of LPO in the quarter. Okay. I guess -- thank you for that. I know it's a top tricky one to answer. So my follow-up is really more of a kind of an outlook question. And speaks to your comments about Northeast. I realize everyone is probably pushing product up to the Northeast during the winter because of all the noise around heating oil margins. But it occurs to us that, that was probably the first normal winter without Philadelphia Energy Solutions in 2019 when fire hasn't come back since. So we think about what does the Northeast look like in a normal summer driving season without Philadelphia Energy Solutions? And I'm just curious if you have -- given any thought, given that you did push product up to the Northeast, how you're thinking about what the gasoline market could look like in the summertime in the U.S.? Yeah, I think we -- it's always an import market for gasoline typically up to 800,000 barrels a day. We do expect that to continue being an import market. The imports may come from different locations in the future, but we would expect that we still need to import gasoline about that level. I guess what I'm asking is, do you see the risk of an outside spike in gasoline the way we saw an outside spike in heating oil in the Northeast? I would say any market that is short needs resupply and the resupply comes from some distance away, has that opportunity for volatility. The same thing that happens on the West Coast, West Coast that we supplied is further away four weeks away. And then in -- and just in the Pad 1, but any time resupply is in close, you have that opportunity volatility. I think the other thing I'd add is you look at gasoline, diesel and jet inventories, they're all below five-year ranges and it looks to us as though we've got an above-average industry refining turnaround period plan for the spring. So it looks tight from our vantage point. Good morning, everybody. I guess I'll continue with the theme of hammering on capture and expectations of capture. Just curious why this quarter did change the index that you're using? And then I know you explained the gasoline and the diesel aspect. So configuration, I guess, makes sense. What maybe went on with secondary products? And is that something that we might see carry through to '23 here? Yeah. Really, it's -- we're setting up for -- we've talked about this for a while, and we're setting up for 2023 and the cleanest way to make that change is to do it in the fourth quarter, and that enables us to restate or recast in our supplemental information, the prior 2021 and 2022 all on that same basis. And then the first results we report for 2023 will be on that same basis. And so it's just the cleanest timing to make a change like that. It's something we've considered for a little while, but we thought it was the appropriate thing to do. Yeah. And then the secondary products, I'll kick that off and then turn it over to Brian maybe for some outlook on it. But third quarter to fourth quarter, in refining, we see those relatively flat actually. There are some puts and takes associated with that, asphalts and fuel oils drop off in price and volume, but butane picks up and offsets a lot of that. So the overall impact of our secondary products was relatively flat quarter-over-quarter. I'd say we continue to think that high sulfur fuel oil will remain weak, just with all the Russian cargoes coming on the market, both high-sulfur fuel oil and heavy crude cargoes coming out in the market. So I think we'll continue to see that in the market. Good morning. Thank you for taking my question. So just hoping for a little more color on the DCP synergies that you called out in your press release, I think $300 million. I think you've probably been pretty anxious to speak about those numbers. And so any buckets you can speak to and anything on timing and how that should trade in? Yeah. I think, John, the $300 million really falls into two categories. Operating synergies that we're actively pursuing upfront now even before the close of the roll-up of the publicly held units. And then there's, I think, even more prolific commercial synergies that we can capture as we combine -- or as we roll the business into our own. Tim, you can provide a little more color there. Yeah. At this point, Mark is correct. Look, we're looking at this. It's going to probably over a time frame, we came out with $300 million. We think it's probably about third with regard to costs. You got two third on the commercial side. We're anticipating this is going to take us around two years to fully capture this. It's like anything else, once you get into it further and deeper, we're hoping there's more there and initial indications are that they're likely are. And hopefully, I can update you another call later to validate or confirm that, but we do see the commercial side is probably driving that. It just makes sense. When you look at the integrated value chain, you put these two entities together, we, in effect, now have gas processing in the key regions. We now have fractionation capacity at Conway, Mont Belvieu, also at Sweeny and long-haul pipelines coming in out of the DJ and coming out of the Permian. When you look at those, there are tremendous opportunities to make sure the barrel gets the right place. And in our world, the right place means where it creates the most value. Okay. That's helpful. And then just looking at the chemicals market, do you expect that we've seen a bottom there? And how does China reopening impact the future of that market? And then let's just say hypothetically, the market doesn't improve from here. Is there any risk of CPChem's ability to self-fund the two growth projects? Yeah. I think, John, that you've seen at the ethane -- that the polyethylene value chain margins kind of hit bottom. Those producers that were really squeezed pulled back on production. So you can see that clearly -- we've hit a point where there's great discipline and nobody is going to operate while they're bleeding cash, and we've kind of passed through that period. Margins have modestly ticked up, and you'll continue to see as the capacity that's coming online in North America gets digested, we'll be at that bottom for some time, but then start to work our way out because demand globally continues to increase. And China is certainly an upside and there are number of signs that China is coming back. We're not going to call at their back. I think it could come in fits and starts, but certainly, the noise coming out of China is productive directionally. Great. Thanks. Maybe starting out with one on shareholder returns. The buyback was strong this quarter. As we think about 2023 going forward, you've provided guidance at the recent Analyst Day that would suggest something on the order of $500 million to $700 million a quarter of buyback in a mid-cycle environment. We're clearly above the mid-cycle environment. You were at the high end of the guided pace this quarter. How should we think about the use of that excess cash? Should the backdrop remain very constructive? And how aggressive might you look to be on shareholder returns versus building more cash on the balance sheet? Yeah, Ryan, it's Kevin. So, you're right, we did the high end of the range in the fourth quarter, and I think it's reasonable to assume that we would continue somewhere round about that level. We're also -- we're sitting on a decent healthy cash end of the year just over $6 billion. And just to give some context to the overall balance sheet condition relative to where we were before the pandemic. Over the pandemic, we added $4 billion and I'm ignoring the impact of BCP debt consolidation here. We added $4 billion over the pandemic. We subsequently paid off 3.5 of that but we've improved our cash position by $4.5 million since the end of 2019. So net-net, we've enhanced the balance sheet by $4 billion from where we were going into the the pandemic. And so that gives us a lot of flexibility. But we've also got the DCP roll-up to take care of, which we expect to be sometime in the second quarter. So that's a $3.8 billion transaction. And while we won't use all cash for that, we want to make sure that we retain plenty of flexibility as we go into that and close on that rollout. But I do think what it all speaks to we continue to see these above mid-cycle conditions, we will have some good flexibility to -- I would tell you really do a bit of all of it. We'll want to pay off some incremental debt, especially as we think about the impact of the DCP roll-up, but we should also be positioned to look at the cash returns to shareholders, both in the context of the dividend, we would expect to increase the dividend. This year, we remain committed to a secure, competitive growing dividend. And we'll look at the buyback pace. We're clearly at a very healthy level today, but there's potential flexibility on that. And so, we -- it's something that we'll prioritize and keep very focused on. But in the near term, we're probably pretty comfortable with where we are given that we've got the DCP transaction out there ahead of us. Excellent. And then maybe shifting gears somewhere else. I wonder if you could discuss a little bit about what you're seeing and what you expect going forward in European refining. There's some big moving pieces in recent months, the natural gas spread between Europe and the U.S. has declined significantly and you've got an upcoming Russian product ban going into effect. What are you seeing in the market right now? And any thoughts on expectations in the coming months? I think with natural gas coming off some. We're not -- I mean Rich can talk about the natural gas issues at the plant. So, natural gas for us, certainly has some impact on our operations, primarily for the purchase of electricity, but we see that really not as a disadvantage to our peers either. So, the competitive nature of refining will continue to be there with some cost impacts associated with higher natural gas and that's the numbers we put out in the past are still in play today as well. The challenge for that will be the continued impact of the Russian supply scenarios and then the resupply are that will set the really the minimum price for those marketplaces, and we'll see that shapes up here as the market moves forward. I'd like to circle back. I don't think I covered one of the questions that John asked around Chems and that's the risk -- the market risk of CPChem generating enough cash to self-fund these two projects. Both of those projects, they own 30% of the Ras Laffan project, 51% of the U.S.-based project, both will be off-balance sheet project finance, mitigating their cash outflows, substantially mitigating our exposure there. So you can never predict that there is no risk, but I think it's highly mitigated because of the debt structuring they're going to undertake to support those projects. Hi, guys. Good morning. Maybe for Kevin, can you go back into the CPC with the two major cracker is going to be under construction? How is the CPC distribution to [Indiscernible] for the next several years we should assume? So we assume that it's going to be quite minimum and that they will build up their own financing and also some cash in the year given that there's a heavy spending ahead? Or that do you think that the decision is that they will just use more of that capacity and continue to payout? If you look -- again, if you look at those projects and if you look at the assumptions on project financing, I think we had talked about earlier, maybe even at Investor Day, that our exposure to foregone dividends is really probably about 10% of the aggregate capital spend if you look at those two projects combined. And that's spread out over four years. So it's not a major impact on our ability to generate cash overall. Kevin, do you want to -- Yeah. So just to expand on that a little bit. The -- when Mark talks about off-balance sheet financing, he is specifically referring to project level financing. So financing those projects at the Ras Laffan Petrochemical project level and at the Golden Triangle Polymers project level. So that's not on CPChem's balance sheet, and we're not anticipating that CPChem would have to go to its own balance sheet to fund its equity contributions into those joint ventures to fund those projects. And in fact, we'll still be able to do that and continue making distributions to the owners. Obviously, there is a dependency on what the overall market environment looks like. But based on what we're seeing, we still expect to be receiving distributions from CPChem through this period. Clearly, there's an impact. Anything -- any discretionary spend by CPChem into a capital investment is cash that's not available for distribution out, but it's all pretty manageable within the overall expectation of where their cash flows will be. Kevin, do you have any rough estimate whether you expect CPC to sensory pay out to earn 100% or 50% or 75% or any estimate that you have? Yeah. Well, you would expect it to be less than 100% because they do have the capital projects underway. So there's the two big ones that we've been talking about, and then there's a slate of smaller projects, several of which will actually finish this year. So it's going to be less than 100%. We've never given specific guidance on what we expect the distributions to be. And our history has actually been pretty strong with regard to cash coming back from CPChem. Hey, good afternoon. I wanted to first ask on M&A in midstream. And I know when you rolled up PSXP part of the rationale was to have more flexibility across the whole portfolio, and you've, obviously, brought in DCP. So I wonder on the other side, is there any desire to reoptimize some of the midstream assets that you have in the portfolio that may not be core at this point? And then my second question is just on the marketing business, which has continued to perform pretty well. I was wondering if there were any dynamics in your markets that continue to support margins. And is there an outlook that, that margins can maybe be above mid-cycle in that business for 2023? Thanks. Yeah. Jason, this is Tim Roberts. I'll handle that front end hand it off to Brian. I think it's important, you're right. We did talk about simplifying our overall structure. And you have PSXP done in the process of completing DCP. We do think we'll be in a much cleaner position with regard to ownership levels and just had a cleaner side work from. We do recognize as well that this market is evolving. There is some consolidation going on in the industry, producers are consolidating. You'll see some of the midstream infrastructure guys doing that too. So we're going to pay attention to that. And what's happening out there, if there is opportunities, but I think it's probably going to be real clear as we've got a task at hand. Our task at hand right now is to get DCP integrated and integrated well. We want to be successful at it. It's going to take us, we believe somewhere towards the end of the year. It may leak into 2024, but our expectation is get it done by the end of this year and deliver synergies. You drove most along those and that's pretty impactful with regard to value of the company. So we ant to do that, but do rest assured, not that we're out on any spending spree, we always have an eye open, what's going on out there and what can create value for our shareholders. And if there's something that's truly compelling, we'll talk about it and see if it makes sense. But right now, it's being integrated successfully. On the marketing business, I'd say that we will continue to perform well, perhaps not as well as 2022. That was a record year. But with increased volatility in the market, that generally drives better business. We also had a joint venture retail record year last year, and we continue to grow our retail joint venture in the U.S., and that continues to perform. Also, there are issues in the European market that have helped us, even things like expanding our credit card business has been helpful to growing our business. So I think we'll continue to grow the business. You'll see the earnings strong, but perhaps not quite as strong as 2022. Hey, good morning. Thanks for taking my question. I wanted to ask about the WCS discounts, so they're pretty favorable. Could you talk about what's driving that? And will you be able to capitalize on these wide WCS discounts in Q1 in the Central Corridor? And then finally, how do you think the Trans Mountain expansion might affect these discounts? Thanks. Well, we'll start with WCS differentials. There were a number of things that we're kind of pushing and pulling on supply and demand. Inventories north of the board in Canada have been very high, and you had Keystone off the market for 22 days, which was 10 million barrels off the market. North of the border, you had about 4 million barrels of production off the market in December, another 0.5 million barrels off the market in January. And then you had the winter storm where refiners shut down. There was 27 million barrels of crude backed out, not all that's heavy crude, but refiners weren't pulling as much of the WCS. So all of that -- if you kind of add all that up, it meant that WCS dips were weaker than they have been. TMX provided an update in early January that they said that their 75% of the pipe is now in the ground. They haven't changed their in-service date for the fourth quarter of this year. Our internal expectations are that start-up will slip into 2024 and full rates won't be achieved immediately. We don't think you need another pipeline to exit the product that is in Canada. So we don't see it doing much. The first call for those barrels will always be Pad 2 and Pad 3 before they go to China or anywhere overseas, so they'll have to price to get into those markets. Hey, guys. Just real quick. Because of the keystone downtime, can you share that how much is the WCS that you run in the fourth quarter? And then what do you expect you're going to one year in the first quarter? And also, I believe with -- after the turnaround actually has been running at a pretty depressed way. I think at one point, about 60%, 65% and where are we in the Wood River? So we generally don't, for commercial reasons, talk about what we run into refineries and how much we run. But of course, Wood River had some hiccups. In Q4, we ran less WCS in our system than normally. We are the largest importer of Canadian crude to the U.S. We expect, as Wood River comes back up, we'll run more, Rich, maybe you can talk about where we are in Wood River. Yeah. So Wood River, there was an unplanned event incident that occurred at Wood River and -- let me start by saying our thoughts go out for the affected employees, contractors and their families that were associated with that event. But there was an incident there. We are working diligently right now to increase the utilization that was affected by this, and we expect that utilization to continue to increase through the first quarter and returned to normal operations early second quarter is our current outlook on that, Paul. Thanks, Emily. Thank all of you for your interest in Phillips 66. If you have questions after today's call, please call me or Owen Simpson. Thanks for your time.
|
EarningCall_1181
|
Hello, and welcome to the Robert Half Fourth Quarter 2022 Conference Call. Today's conference call is being recorded. [Operator Instructions] Our hosts for today's call are Mr. Keith Waddell, President and Chief Executive Officer of Robert Half; and Mr. Michael Buckley, Chief Financial Officer. Thank you. Hello, everyone. We appreciate your time today. Before we get started, I'd like to remind you that the comments made on today's call contain forward-looking statements including predictions and estimates about our future performance. These statements represent our current judgment of what the future holds. However, they are subject to the risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. These risks and uncertainties are described in today's press release, in our most recent 10-K and 10-Q filed with the SEC. We assume no obligation to update the statements made on today's call. During this presentation, we may mention some non-GAAP financial measures and reference these figures as adjusted. Reconciliations and further explanations of these measures are included in a supplemental schedule to our press release today. Our presentation of revenues and the related growth rates for each of our contract functional specializations includes intersegment revenues from services provided to Protiviti in connection with the company's blended talent solutions and consulting operations. This is how we measure and manage these businesses internally. The combined amount of intersegment revenues with Protiviti is also separately disclosed. The supplemental schedules just mentioned also include a revenue schedule showing its information for 2020 through 2022. For your convenience, our prepared remarks for today's call are available in the Investor Center of our website, roberthalf.com. 2022 was a very successful year across the entire Robert Half enterprise. We grew full-year revenues and earnings per share both by more than 12% and achieved new record levels for each. All of our major practice areas, contracts, permanent placements and Protiviti reached all-time highs over and above the very strong growth in the prior year. We enter 2023 optimistic about our ability to navigate the uncertain global macroeconomic environment and the tight labor markets around the world. For the fourth quarter of 2022, company-wide revenues were $1.727 billion, down 2% from last year's fourth quarter on a reported basis, but up 1% on an as-adjusted basis. Net income per share for the fourth quarter was $1.37 compared to $1.51 in the fourth quarter a year ago. Cash flow from operations during the quarter was $202 million. In December, we distributed a $0.43 per share cash dividend to our shareholders of record for a total cash outlay of $47 million. Our per share dividend has grown 11.2% annually since its inception in 2004, the December 2022 dividend was 13.2% higher than in 2021. We also acquired approximately 800,000 Robert Half shares during the quarter for $61 million. We have 3.8 million shares available for repurchase under our board-approved stock repurchase plan. Return on invested capital for the company was 39% in the fourth quarter. Thank you, Keith. Hello, everyone. As Keith noted, global revenues were $1.727 billion in the fourth quarter. On an as-adjusted basis, fourth quarter talent solutions revenues were down 1% year-over-year. U.S. talent solutions revenues were $964 million, down 2% from the prior year. Non-U.S. talent solutions revenues were $264 million, up 5% year-over-year on an as-adjusted basis. We have 317 talent solutions locations worldwide, including 86 locations in 18 countries outside of the United States. In the fourth quarter, there were 61.2 billing days compared to 61.7 billing days in the same quarter one year ago. The first quarter of 2023 has 63.3 billing days compared to 62.4 billing days during the first quarter of 2022. Billing days for the remaining three quarters of 2023 will be 63.3, 63.1 and 61.1 for a total of 250.8 billing days during the year. Currency exchange rate movements during the fourth quarter had the effect of decreasing reported year-over-year revenues by $39 million, $27 million for talent solutions and $12 million for Protiviti. This negatively impacted our year-over-year overall revenue growth by 2.2 percentage points, 2.1 percentage points for talent solutions and 2.4 percentage points for Protiviti. Contract talent solutions bill rates for the quarter increased 7.8% compared to one year ago, adjusted for changes in the mix of revenues by functional specialization, currency and country. This rate for the third quarter was 9%. Now let's take a closer look at results for Protiviti. Global revenues in the fourth quarter were $499 million, $401 million of that is from business within the United States and $98 million is from operations outside of the United States. On an as-adjusted basis, global fourth quarter Protiviti revenues were up 4% versus the year ago period, with both U.S. and non-U.S. Protiviti's up by 4% on an as-adjusted basis. Protiviti and its independently owned member firms serve clients through a network of 89 locations in 29 countries. Company-wide fourth quarter public sector revenues were $83 million, of which $60 million was reported by Protiviti and the balance reported by talent solutions. Currency exchange rates had the effect of decreasing year-over-year public sector revenues by approximately $3 million during the quarter. Full-year public sector revenues were down approximately 8% or 3% adjusted for currency. Turning now to gross margin. In contract talent solutions, fourth quarter gross margin was 39.9% of applicable revenues compared to 39.8% of applicable revenues in the fourth quarter one year ago. Conversion revenues or contract to hire were 3.7% of revenues in the quarter. Our permanent placement revenues in the fourth quarter were 12.7% of consolidated talent solutions revenues versus 12.4% of consolidated talent solutions revenues in the same quarter one year ago. When combined with contract talent solutions gross margin, overall talent solutions gross margins were 47.5% compared to 47.2% of applicable revenues in the fourth quarter one year ago. For Protiviti, gross margin was 27.2% of Protiviti revenues compared to 28.7% of Protiviti revenues one year ago. Adjusted for deferred compensation related classification impacts, gross margin for Protiviti was 28% for the quarter just ended compared to 29.3% one year ago. Moving on to SG&A. Enterprise SG&A costs were 31.6% of global revenues in the fourth quarter compared to 30.8% in the same quarter one year ago. Adjusted for deferred compensation-related classification impacts, enterprise SG&A costs were 30.4% in the quarter just ended compared to 29.7% one year ago. Talent solutions SG&A costs were 38.9% of talent solutions revenues in the fourth quarter versus 37.7% in the fourth quarter of 2021. Adjusted for deferred compensation-related classification impacts, talent solutions SG&A costs were 37.2% for the quarter just ended compared to 36.2% one year ago. The higher mix of permanent placement revenues this quarter versus one year ago had the effect of adding 0.2 percentage points to the quarter's adjusted SG&A ratio. We ended 2022 with 9,300 full-time internal employees in our talent solutions divisions, up 5% from the prior year. Fourth quarter SG&A costs for Protiviti were 13.6% of Protiviti revenues compared to 12.9% of revenues in the year ago period as operating expenditures returned to more normalized levels. We ended 2022 with 11,700 full-time Protiviti employees and contractors, up 2.4% from the prior year. Operating income for the quarter was $174 million. Adjusted for deferred compensation related classification impacts, combined segment income was $199 million in the fourth quarter. Combined segment margin was 11.5%. Fourth quarter segment income from our talent solutions divisions was $127 million with a segment margin of 10.3%. Segment income for Protiviti in the fourth quarter was $72 million with a segment margin of 14.4%. Our fourth quarter tax rate was 27% up from 24% in the same quarter one year ago. The higher tax rate for 2022 can be primarily attributable to higher non-deductible expenses in 2022 as well as lower stock compensation deductions due to the company's stock price. At the end of the fourth quarter, accounts receivable were $1.018 billion and implied days sales outstanding, or DSO, was 53.1 days. Before we move to first quarter guidance, let's review some of the monthly revenue trends we saw in the fourth quarter and so far in January, all adjusted for currency and billing days. Contract talent solutions exited the fourth quarter with December revenues down 6% versus the prior year compared to a 1% decrease for the full quarter. Revenues for the first two weeks of January were down 7% compared to the same period one year ago. Permanent placement revenues in December were down 1% versus December of 2021. This compares to a 2% increase for the full quarter. For the first three weeks of January, permanent placement revenues were down 23% compared to the same period in 2022. We provide this information so that you have insight into some of the trends we saw during the fourth quarter and into January. But as you may know, these are very brief time periods. We caution reading too much into that. With that in mind, we offer the following first quarter guidance: revenue, $1.685 billion to $1.765 billion, income per share $1.10 to $1.20. The midpoint revenues of $1.725 billion are 5.4% lower than the same period in 2022 on an as-adjusted basis. The major financial assumptions underlying the midpoint of these estimates are as follows: For revenue, on a year-over-year as adjusted basis, talent solutions, down 7% to down 12%. Protiviti, up 6% to up 9%, overall, down 3% to down 7%. Gross margin percentage: contract talent, 38% to 40%; Protiviti, 24% to 26%, overall, 39% to 41%. SG&A as a percentage of revenue, excluding deferred compensation classification impacts: talent solutions, 36% to 38%, Protiviti, 14% to 16%, overall, 30% to 32%. Segment income for talent solutions, 8% to 11%, Protiviti, 8% to 11%, overall, 8% to 11%. Tax rate, 27% to 28%; shares, $106.5 million to $107.5 million. 2023 capital expenditures and capitalized cloud computing costs, $100 million to $120 million, with $20 million to $25 million in the first quarter. We limit our guidance to one quarter. All estimates we provide on this call are subject to the risks mentioned in today's press release and in our SEC filings. Thank you, Mike. Global labor markets remain tight and the demand for talent remains high despite continued economic uncertainty. Clients continue to hire, albeit at an even more measured pace, which has the effect of lengthening the sales cycle. Although recent metrics have come off their all-time highs, talent shortages persist in the United States, unemployment stands at 3.5%, a 50-year low, and remains even lower for those with a college degree where the rate is 1.9%. Job openings and quit rates remain elevated. Unemployment claims remain low. Similar reports across the globe also point to labor market resilience. Protiviti continues to have a very strong pipeline across an increasingly diverse offering of solutions. Both the regulatory risk and compliance practice and the technology consulting practice show particular strength. In 2022, Protiviti achieved record high revenues of nearly $2 billion, even while overcoming the wind down of very large financial services project and a shift in the trend of public sector engagements to projects more applicable to talent solutions. Demand for Protiviti services remains robust and is only mildly impacted by current economic conditions. While there remains volatility in the macroeconomic environment, we are optimistic about our outlook for 2023. We've successfully navigated many economic cycles each time achieving higher peaks. This was demonstrated by our ability to achieve the fastest recovery in our company's history following the COVID-19 downturn. We also continue to benefit from Protiviti's resiliency, which stems from its diversified solution offerings that are much less tied to the economic cycle. Longer term, we are encouraged by the growth and margin prospects from our ongoing focus on services related to talent with higher skill levels. These include management resources, full-time engagement professionals, managed solutions, Robert Half Technology and Protiviti. In addition, the structural shift to remote work, particularly for higher skills, creates new competitive advantage as it highlights our numerous strengths, including our global brand, office network, candidate database, and advanced AI-driven technologies. Also, our very successful investments in innovation and technology, which continue to position us to meaningfully improve both the digital and recruiter experience for our clients and candidates and the internal productivity of our staff. We remain committed to our time-tested corporate purpose to connect people to meaningful and exciting work and provide clients with the talent and subject matter expertise they need to constantly compete and grow. I could not be more proud of all our global teams, including talent solutions, Protiviti and corporate services professionals who put so much energy and dedication into our results this year. Their efforts made possible a record number of awards and accolades in 2022. Fourth quarter recognition included being named one of the best workplaces for parents and honored by Forbes as one of the world's top female-friendly companies. We are particularly proud of the recognition we continue to receive for our commitment to diversity, equity and inclusion. Now Mike and I'd be happy to answer your questions. Please ask just one question and a single follow-up as needed. If there's time, we'll come back to you for additional questions. Good afternoon, Keith and Mike. Wondering if you can talk a little bit about Protiviti. You're basically guiding to a reacceleration with regards to the revenue growth. You obviously mentioned that regulatory risk and compliance as well as technology continues to be a source of strength. But I'm wondering if you can give a little bit of detail, a little bit of what are you seeing from a visibility perspective, to what extent is it being driven by any sort of reacceleration in terms of public sector or how you're assuming about that? And to what extent is R2 integrated contributing to the reacceleration? And it seems like R2 is fairly small with about 40 employees, but wondering if that's having an outsized effect or how we should just think about the reacceleration in Protiviti? Well, so first of all, the impact of the wind down of financial services project and public sector impact their growth rate by about 11 points. So you take the 4% growth that was reported, that becomes 15% on a core basis. That 15% is due to, as you spoke about, the regulatory risk and compliance where they've got some regulatory consent order remediation projects that are quite good. On the technology side, you've got managed technology solutions, you've got data analytics, you've got security. All of those are good. The R2 integration, it's small. It doesn't move the needle overall, but we're very happy to have those capabilities around digital transformation, customer experience, primarily based on the Adobe platform, which ironically, we're going to use internally to replatform our own websites in 2023. If you look at the guide for the coming quarter, midpoints high-single digits, the drag from the big project line down and public sector becomes 5% or 6%. So you're still in that mid-teens double-digit growth rate for Q1. Protiviti's pipeline is very strong. It's very diversified. They feel great about where they are. We feel great about Protiviti overall. From a profitability standpoint, as is always the case, quarter one seasonally is their lowest. They have all their raises that are effective Jan 1, they front load their staff additions to some degree and in their internal audit and SOX business, it always seasonally slows while their clients focus on external audit focused on following their SEC documents, which, to some degree, crowds out SOX and internal audit. So Protiviti, we're very bullish about the profitability you see is typical seasonal impacts, as I just described. That's perfect. And then can you give us a little bit of help on the contract staffing just in terms of thinking about â you gave the overall guide, but just how we should think about it in terms of finance and accounting versus admin and customer support and technology. And to what extent â what are we thinking with regards to just the temp contract gross margin just from a sequential perspective? So we did give the overall guide, which is hopefully the most conservative we've been in quite some time. From a practice group standpoint, we're seeing strength in finance and accounting, particularly at the senior level and above. Within that, our full-time engagement professionals remains incredibly strong, has held up incredibly well. Administrative and customer support has been impacted by public sector falloff. It's been impacted by less open and real mix. It's also impacted to the extent clients get more cost-conscious, stretching their administrative staff seems to be one of the first places they go. So ACS would have a bigger negative impact in Q1 than F&A. Tech looks more like F&A, again, because our tech clients are largely SMB, as is the case for F&A. Our tech nature of services skews largely to infrastructure and operations rather than software and applications, and they tend to be a little more impacted than is the case with software and applications. Sequential gross margin, the fourth quarter, we got a lift as we trued up estimates to actual for workers' comp and for state and federal employment. We got some credits. Those credits don't repeat. And so frankly, most of the sequential difference Q4 to Q1 is the absence of those true-up credits. Pay bill spreads continue solid. Conversions were a little lighter in Q4 consistent with perm and that same kind of level is what's embedded in the Q1 guide. Hi, Keith. I know you guide for talent solutions, which is your contract business and our perm business together. When thinking about the midpoint for the first quarter margins for talent solutions of 9.5%. Could you just give us a sense of how that might break down between perm and temp? I know you just gave us a little sense of why the contract gross margin will be down. It just still feels like a kind of a sequential conservatism when you're trying to model â when I'm trying to model the contract operating margin in the first quarter even past the gross margin comment that you just made. Well, contract versus perm, we don't split out our guidance. I think it would be safe to assume based on the Q4 trends, the early post-quarter trends that our perm assumption is lower than our contract assumption for the first quarter. From a contract operating margin standpoint, since our stance toward headcount adjusting has always been never to anticipate, but pretty much to just coincident with what we see at the topline, there's always going to be a one or two-quarter lag between the actions we take on our cost, particularly headcount and how they show up in the P&L. And so you'll see a little bit of negative leverage in contract operating margins in Q1 for that reason, which adjusts, autocorrects, shows up, if you will, in Qs two and three. And then lastly, when you say you're optimistic about 2023 and you use that where we enter 2023 optimistically, do you mean like Robert Half is ready for whatever scenario the economy brings? Or are you saying you're optimistic that the economy will hold up? It's more of the former. We've been through many downturns of different intensities and durations. We've emerged from every single one of them to make new highs. We're the most nimble we've ever been with our cost structure. We manage our headcounts on an individual basis relative to how they stand, relative to a standard given their tenure. And so we just feel really good about where we are with our cost structure, where we are with the capability to take advantage of what business is there. We have some businesses growing quite nicely, quite double-digit. We talked about Protiviti before, but in talent solutions, management resources, higher-level F&A, still growing nicely double-digit. Full-time engagement professionals growing at really high double-digit levels. And so we've been particularly pleased with the way that has held up, and we'll add to staff there. So our optimism is whatever hand we are dealt, we'll deal with it. And we believe we'll emerge on the other side, whatever the other side is higher than ever. Hi. Thank you. I appreciate you taking my question. You talked about being nimble with your cost structure and you gave a little bit of color around headcount. I would love to hear how you're thinking about the investments you're making in your business, and you've been making your business and managing those costs. And then also with regards to headcount, I think in the past, you typically have adjusted SG&A to be kind of in line with sales, although with a lag. Is that how you're thinking about things currently in this environment? Thanks. We're not thinking any differently than we traditionally have thought. As to headcounts, we adjust to topline, as we just talked about, there's a lag of a quarter or two, but trading that against anticipating downturns that may not occur, will take that lag of a quarter or two as it relates to technology, AI innovation. The thought is our spending for 2023 will be flattish with what we spent in 2022. We're very pleased with the returns we've gotten, particularly in AI. They've transformed how we identify and select candidates. We're turning our attention to using AI to identify the warmest leads for our field professionals on the sales side. It's early days, but we're optimistic. I talked earlier about we've got a new website coming. We're replatforming that. We're very focused on improving the digital experience of our clients and candidates. That new website will come sometime second half of the year, probably the latter part of that. So we're continuing our innovation technology spending pretty much at a level flat with 2022, which we think is strategic and we think is appropriate. But other than that, our cost structure is the most nimble it's ever been. Our highest cost by leaps and bounds is our branch payroll cost, and as I spoke to earlier, we have the tools to manage that individually the best we've had in our history. And one quick question on the January trends. I think in the July quarter, you had noted that because of the July 4th holiday, there can sometimes be some noise in those three-week trends. I'm curious just given that January, you're coming off the holidays, if there's any seasonality or noise that may be in those numbers? Thanks. Well, holiday impacts are always hard to predict. Generally speaking, I'd say for the Christmas, New Year holiday we had more clients take time off. We had more internal staff take time off, which had some impact. The view was they came back a little later than normal, but that's anecdotal. It's hard to get a super precise read on holiday impacts. We've always talked about in perm placement, which was the weakest in January as we reported. It's also the least predictive if you take the early part of a quarter for perm, relative to the full quarter, the early part is the least predictive of the fall. And so to some extent, we always discount the post-quarter early following quarter results of perm. That said, would I'd rather be up 20% than down 20%? Sure, I would. But by the same token, we don't get overly excited about post-quarter perm. I wanted to focus on contract Talent Solutions bill rates. They were very strong in the quarter. Do you expect them to stay at this level? I'm just curious what's incorporated in your outlook for the first quarter and what should we expect for the rest of the year? We would expect them to subside somewhat. And so while that might have a topline impact, as we've talked before, they will have not much gross margin impact because with the higher pay rates, we pretty much pass them through intact and haven't expanded gross margins. So if that unwinds to some degree, which I think would be reasonable, given economic expectations that rather than be at 7%, 8%, 9%, it would return to something more normal, call it, 3%, 4%, 5%. It's going to more be a topline phenomenon than a margin phenomenon. Okay. That's helpful. And then on conversion fees, you gave us a little bit of color what we should incorporate in terms of 1Q. Can you just remind us what the historical range of conversion fees have been for your company in up cycles and down cycles? And any reason to think things will be different this time? Well, depending on what time frame you use, I can remember saying many times the typical range is 3% to 5% of revenue, but that 5% is long ago, if you look at the past 10 years, and I'm not looking at anything specifically, it tops out probably more in the low 4s than getting to 5. And so there's downside 100, 150 basis points versus where we are. It tracks to some degree with permanent placement, which as a percent of the total, also gets smaller. But again, very normal and comes back strong. In fact, if anything, perm in conversions come back stronger when things improve, that is the case on the contract side. This is Ronan Kennedy on for Manav. Thank you for taking my question. You shed some light on this to a certain extent with regards to the comments on the labor markets remaining tight, demand for talent high, clients continuing to hire at slower pace. Just wondering, with all the news and the data we see on the labor markets, I think even recently, there were headlines on the contributions from SMB and four out of five open rolls are for SMB, although December had the highest levels of termination at temp since early 2021. Can you just kind of reconcile what you saw throughout the quarter in December in the first two weeks in your lead comments and results with the broader headlines and narratives within the news media on the labor market? Well. First of all, I think this is the most anticipated downturn ever. And the cumulative impact of all that negative news clearly has an impact on confidence. And I believe the same story you're referencing, toward the end, also talked about the NFIB small businesses. Their optimism index was down 12 straight months lower than their 48-year average. And so while the hard data seems to be hanging in there pretty well, the softer data, which is about expectations be it NFIB, be it conference board's leading indicators, being the NABE, which also had some negative expectation data. I think all of those would point to some continued softness. But there's no question that there's tension between the very resilient labor market data, which clearly is indicative of supply and the forward-looking expectations data of the groups I've talked about, which we see as more consistent with our clients. Having said that, orders have not dried up. We want to make that clear. It's just taking longer to get them closed. Our clients are less urgent. They're taking more steps. They want to see more candidates. They want to involve more people in an interview process. It simply lengthens the sales cycle. We still have orders. Orders have not dried up. That helps. And maybe just shift gears to margins and the dynamics of margin drivers. Could you talk about the importance of mix and conversions versus, I think, what most people less familiar with Robert Half would think is place an emphasis on wage rate and inflation and bill pay spreads? Well, as we talked earlier from a bill rate increase, pay bill spread increase, the point is, for the most part, at these elevated levels, they've been pass-throughs. So we've been 7%, 8%, 9% higher wage rates, bill rates recently, which have had very little margin impact. Conversions on the other hand, have almost a dollar-for-dollar percent-per-percent impact. And so conversions so far this cycle at a high were 4%, 4.1%. I think this quarter, we're back down to 3.7%. And so clearly, they have a margin impact, but we talked earlier on the call about the traditional range. And while they do show volatility on the downside, as I mentioned, they show volatility on the upside as well. And you'll see if you study prior up cycles, perm and conversions recover the most quickly as clients ramp up their staff, particularly if they're coming from tight labor markets, they want to lock up their good staff early in an up cycle, which benefits perm, which benefits conversions. Hi. Good afternoon. Thanks for the question. I wanted to know if you have seen any maybe signs of wage inflation being a little bit more subdued or even the other side companies pushing back on what has been a really tight market and a tight wage inflationary environment. So any improvement there? Well, we would say we're definitely seeing clients pushing back more than they were in part because they think they can, which is understandable. As I talked earlier as well, we would expect some dialing back of the wage rate pressures we're seeing as well as the bill rates that go along with that. So as things soften a bit, we would expect pay rates and bill rates to dial back a bit. But as I talked about, we don't think that have much of a margin impact for reasons that I talked. Right. No, absolutely. And then just continuing, as we think about â as you look at across talent solutions for the quarter, finance and accounting, administrative and customer support and tech. Were there any of those that surprised you in terms of the performance? Well, the biggest positive surprises were we had strong double-digit growth in management resources, and we had really strong double-digit growth in full-time engagement professionals. And so that was good. On the negative side, I'd say ACS was a little more impacted. I think clients as they get more cost conscious, tend to go first to their administrative staff in dealing with that, and we saw that in our ACS numbers. Yes. Tech is interesting. Tech is interesting. On one hand, you've got big tech that over-hired that with great fanfare is announcing all their layoffs. And while we're not directly impacted much by big tech, I'd say there's a psychological and sentiment impact to all tech and that there's a perception that there are a lot of tech people on the market that the tech market has loosened a lot. The reality is a lot of those layoffs aren't even tech people. They're recruiters, HR, back-office people at tech companies. Further those that are getting laid off, typically are finding new positions fairly quickly. And so we would say that the tech market, in fact, is stronger than the perception that's being led by big tech, which has very specific, in many cases, company-specific circumstances. Absolutely. And then, sorry, last one for me. And maybe at this more if you can provide a little bit more of a history lesson just from prior down cycles. Do you feel like SMBs were in prior cycles slower to kind of respond or slower to see the impact in a weaker economic environment? Or how would you think that kind of played out throughout a cycle? And any reason why this cycle might be different from those in the past on SMBs? Thanks. History would say SMBs are more nimble, more cost focused and would respond more quickly, not more slowly to macro uncertainty. By the same token, they would recover more quickly than larger enterprise organizations. That's been the consistent experience we've seen at least across the last three cycles, and we have the reason to believe it wouldn't be the case again. Hi. Thanks, good afternoon. Your goal has been to replace COVID-related public sector Protiviti spend with other forms of public sector spend. How do you expect federal budget constraints to potentially impact public sector spending on Protiviti? And what's your embedded assumption around public sector spend in your first quarter guidance for Protiviti? Well, so first of all, just to kind of step back for public sector for a moment, going into 2022, there was all this concern that there was going to be this cliff event due to the absence of unemployment claims processing that would have to be replaced. As 2022 was ultimately reported, we were down 3% adjusted for currency 2021 for 2022. And so from where I come from, we were essentially flat in 2022 versus 2021, the feared cliff event didn't materialize, and we were successful at replacing that work. As we move forward into 2023, we're optimistic that on an enterprise basis, you can't just look at Protiviti. You can't just look at talent solutions. You have to put the two together that on an enterprise basis that we're on solid footing. We've got good foundational client relationships that we can leverage, and we feel good about that given its overall size relative to Protiviti and/or to talent solutions. We don't plan to make a lot of specific disclosures about public sector going forward because, quite frankly, we have many sectors, many practice groups, many industry groups that are way larger than public sector. And given that this feared cliff event is behind us, we didn't feel the need to do so, but we're very pleased at how we manage through and replaced all that unemployment claims processing work. We're effectively flat and we'll build from there. Got it. You mentioned that lower 1Q margins reflects the seasonal impact from compensation and headcount. Your guide for 1Q Protiviti SG&A as a percentage of revenue of 14% to 16% looks like it comes above the prior year's 1Q SG&A as a percentage of revenue of 13%. Can you unpack that a little bit? What's driving that since it seems like it's a little bit more than seasonality? Well, if you look at the progression over 2022 of Protiviti's SG&A percentage, you will see that it grew quarter by quarter by quarter to get back to more normal levels because 2021, early 2022, they didn't have as much training. They didn't have as much practice development. They didn't have as much marketing. And so those have returned to a more normal level. So from a Q1 only perspective, you're comparing Q1 2023 with normal levels of spending to Q1 2022, that hadn't yet built back to normal levels of spending. But the featured fight, the main event for understanding Protiviti's Q1 segment margins, operating margins is what happens at the gross margin line, and that's where they're impacted by all the raises that come in all at once on Jan 1, the front ending of some of their hires and from the seasonal softness in their internal audit serving actually that happens every year that they recovered from nicely. Protiviti had 14% operating margins in Q4. We were very, very pleased with that, though stepped down in Q1, which is very consistent with how they've stepped down in prior years, and that step down is mostly about gross margin, not necessarily about SG&A. Great. Thanks so much. Just to unpack the Q1 guidance a little bit. Again, I know there's some seasonality there, but it looks like the range is similar to Q4. And if you take the revenue, looks like the midpoint of the EPS about $0.21 less. Is that the typical seasonality? Or is there anything else in there that you'd kind of call out one way or another, maybe utilization being a little bit lower. I know there's always the typical seasonal step down. But is there anything else? Because again, the revenue range looks pretty close kind of Q4 to Q1? I'd say you've got typical Protiviti seasonality and maybe it's a little more this year than last because the raises were a little higher this year than last. That would be Point one. Point two, because our perm assumption is more conservative than contract, you've got a smaller perm mix, which has higher margins. Point three, there's some negative SG&A leverage because of this one to two quarter lag that I talked about earlier as we adjust our headcount to current levels of revenue. You put on top of that, the tax rate is elevated. It was elevated in Q4. It will be elevated again in Q1, in part has caused the stock prices down. But if you compare Q1 to Q1 a year ago, the tax rate is up pretty significantly. So it's essentially about Protiviti seasonality, less perm mix because of conservative guidance, some negative SG&A leverage because there's a one or two-quarter lag between topline and how we adjust heads. But otherwise, pretty much as expected. Got it. And then Keith, you've been around a couple of cycles, I think as a lot of us have any â no two are the same, but if you were to parallel any â I mean it's just so tricky with COVID out and the stimulus â as you think about the outlook, like in your preparing and again, no two are the same, is there any time in history you draw similar parallels to just based on what you're seeing today? Well, they're all so different, and there's never been as strong an underlying labor market. We're right through the softness like there's been this time. So one would like to think that that would provide some buffer, make this one milder. As I said earlier, this is the most anticipated downturn ever and the debate continues about soft landing, hard landing, recession, no recession. So I can't really say it feels like the financial crisis or it feels like the dot-com. It's just too different. Clearly, COVID-19, it's way different than that. But what is the same, and I'll say it again, in every one of those cycles, no matter what their duration, no matter what their intensity, we came back and made new highs. And we're very confident we will come back and make new highs. We have our most experienced people absolutely engaged and in place to help us participate in that upside when it comes. Our cost structure is as nimble as it's ever been. So we feel good about what our cost structure looks like, what our margins will look like until that happens. But the point is when it gets better, we will be there, and we've proven that many times. That's helpful. And then did you â and if you can [indiscernible]. Did you say what the impact of the R2 acquisition was in terms of the guidance on the first quarter â is the revenue contribution... Itâs very small. I think they had a total of 70, 75 people. It's very small. But important, but important and gives us a capability we didn't have, and that's an important capability. So we love as part of the family. Mike and Keith, I wanted to ask you a little bit more about permanent placement. Mike, you had indicated that the first part of a quarter, especially first part of a month is difficult to gauge. And I'm wondering if you look at your clients and the number of job openings they have compared to maybe what they had before, if that's a way to kind of look at it and maybe that's why the conservatism on your part on the conversion. And just on the permanent placement, just trying to figure out maybe what the reality is compared to maybe what the first three weeks of January might have shown? Well, you can't really look to the number of openings either because it takes so much longer to close an opening today than it did a year ago. And so if your client very urgently is filling a need, the time from order to fill is going to be pretty close. If in fact, they don't sense that urgency, they've got all kinds of reasons how they can slow play you, slow walk you, however you want to call it, it just takes longer. And so there's no magic metric that we can say, well, we understand the revenue say this, but in fact, the order say this, the order flow isn't bad. But it's the time it takes to close an order that's the issue, not the presence or absence of an order. Fair enough. And then just one last one. Just on Protiviti. In terms of competition, are you seeing anything change? Or would you say the environment is about the same? Yes, I'd say the environment is about the same. I'd say that in that environment, we're getting a larger and larger share because we have something their competitors don't, and that's under one roof. We have talent solutions and Protiviti. They have access to the operational resources at scale that none of their competitors have. We're winning more and more every day. And further, as they compete with their traditional big four competitors, I believe even their clients would tell you that Protiviti's resources are more specialized as to industry. They're more specialized as to their capabilities because Protiviti doesn't have near as broad a solution offering as those other firms do where many times they're leveraging the staff across those solution offerings in a way to keep their chargeability up that Protiviti doesn't have to. So a, Protiviti is more specialized, b, Protiviti has access to talent solutions, both of which give Protiviti competitive advantage and they're increasing market share and they're doing great. I recognize we're out of time, but I wanted to ask this in a public forum. Just are you seeing any sort of differences from a regional perspective just in terms of the trends, whether it's Northeast California versus, say, Texas, Florida, or industry differences that are illuminating in any way, shape or form. And then if you want to discuss briefly just the potential impact of AI in terms of increasing the efficiency of your operations from a longer-term perspective? I guess the only regional comment I would make is that the coasts are a little softer than the middle of the country. I would also point out that Germany and the U.K. had very good quarters. They have much better outlook for this quarter than we would have expected. So our international results are, frankly, a little better than our United States results in Germany, particularly in U.K. as well impact that. As to AI, we've talked before to totally transform how we identify talent. We have 30 million people in our proprietary candidate database. In real time, we can get a short list of the most matching candidates, of candidates that have a proven track record with us, of candidates that are active in the job market. We, in real time, can access through that 30 million number of people in that candidate database, which is a huge competitive advantage for us. It's making our people more productive. It's allowing our people to earn more money. It's â internally, we call it ART, AI recommended talent, but ART is now a household word in Robert Half. A year ago, that would not be the case. We would like to do the same thing on the client side, on the lead side, as I talked about earlier. So we would like to have an ARC as well as an ART, receiving AI recommended clients. And so that's where we're focused at the moment. I'm cautiously optimistic we'll have an impact there. But we couldn't be more pleased with what AI has done for our organization. This concludes today's teleconference. If you've missed any part of the call, it will be archived in audio format in the Investor Center of Robert Half's website at roberthalf.com. You can also log in to the conference call replay. Details are contained in the company's press release issued earlier today. You may now disconnect.
|
EarningCall_1182
|
Welcome to the M&T Bank Fourth Quarter and Full Year 2022 Earnings Conference Call. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Brian Klock, Head of Market and Investor Relations. Please go ahead. Thank you, Gretchen, and good morning. I'd like to thank everyone for participating in M&T's fourth quarter and full year 2022 earnings conference call, both by telephone and through the webcast. If you have not read the earnings release we issued this morning, you may access it, along with the financial tables and schedules by going to our website www.mtb.com. Once there, you can click on the Investor Relations link and then on the Events & Presentations link. Also before we start, I'd like to mention that today's presentation may contain forward-looking information. Cautionary statements about this information as well as reconciliations of non-GAAP financial measures are included in today's earnings release materials as well as our SEC filings and other investor materials. These materials are also available on our Investor Relations web page and we encourage participants to refer to them for a complete discussion of forward-looking statements and risk factors. These statements speak only as of the date made, and M&T undertakes no obligation to update them. Thank you, Brian, and good morning, everyone. As we reflect on 2022, we want to start by taking a moment to recognize the hard work and dedication of our more than 22,000 colleagues, your tireless efforts to support our customers and communities during challenging times are the heartbeat of M&T. We also give a shout out to #3 and the early responders who saved his life, you remind us all about the bigger game of life. A year ago, we outlined three key objectives for 2022: complete our long-awaited merger with People's United; deploy excess liquidity to reduce asset sensitivity while protecting shareholder value; and to distribute capital that isn't required to support lending in our communities. Achieving those objectives, we believe, aligns with our goal to build a customer-focused bank and resultant balance sheet that produces consistent, predictable earnings over long periods of time. Against those objectives, here are a few key highlights of the work done in 2022. We closed the acquisition of People's United, the largest in our history. We also completed the systems conversion and continue the process of integrating this valuable franchise. The financial benefits of this combination are consistent to slightly better than our expectations at announcement. We repositioned the balance sheet to deploy excess liquidity, reducing our interest-bearing deposits held at banks from $41.9 billion at the end of 2021 to under $25 billion at the end of 2022. In deploying that excess liquidity, we reduced costly wholesale funding. We organically, that is, excluding the impact of Peopleâs, grew loans by $4.1 billion and added $7 billion in net investment securities growth. These efforts, which also included the retention of most of the residential mortgage production as well as the acquired Peopleâs United $12 billion longer-duration securities portfolio have led to a reduction in asset sensitivity, helping to protect our net interest margin from future rate shocks. In terms of capital, we resumed common share repurchases in last year's second quarter now having repurchased $1.8 billion in common stock, representing 6% of outstanding shares, and our common dividend grew by 7% in 2022 representing the sixth year of consecutive increases. And despite the impact from the acquisition and the rapid rise in long bond yields, our CET1 ratio remained strong at 10.4% which continues to exceed our median peer bank. Our hard work translated into strong full year financial results. GAAP-based diluted earnings per common share, which include merger-related charges, were $11.53 compared to $13.80 in 2021, down 16%. Net income was $1.99 billion compared with $1.86 billion in the prior year, improved by 7%. These results produced returns on average assets and average common equity of 1.05% and 8.67% compared to 1.22% and 11.4%, respectively, in 2021. We note that these results were impacted by merger-related expenses associated with the People's United transaction. Such expenses amounted to $580 million in 2022 or $2.63 per share. Those same expenses were $44 million or $0.25 per share in 2021. In accordance with the SEC's guidelines, this morning's press release contains a reconciliation of GAAP and non-GAAP results, including tangible assets and equity. Consistent with our long-term practice, M&T provides supplemental reporting of its results on a net operating or tangible basis, from which we have only ever excluded the after-tax effect of amortization of intangible assets as well as any gains or expenses associated with mergers and acquisitions. We believe this information provides investors with a better picture of the long-term earnings power of the combined institution. Net operating income which excludes the after-tax impact from the amortization of intangible assets as well as merger-related expenses was $2.47 billion during 2022, up 30% compared to what was $1.9 billion in the prior year. Net operating income per diluted common share was $14.42 compared with $14.11 in 2021, up 2%. Net operating income for 2022 expressed as a rate of return on average tangible assets and average tangible common shareholders' equity was 1.35% and 16.7%. This compares with 1.28% and 16.8%, respectively, in the prior year. On a net operating basis, we generated 4% positive operating leverage and 43% growth in pre-tax pre-provision net revenue. This was due in large part to the $2 billion or 53% increase in taxable equivalent net interest income as the net interest margin increased some 63 basis points year-over-year. We are pleased with the results we achieved in 2022 in the face of many challenges, not the least of which was a rapid shift in monetary policy. But our work is not done. We will continue to recognize the value created by our merger while building a more capital-efficient, less asset-sensitive balance sheet that will produce stable and predictable revenue and earnings over the long term. Let's take a look at the results for the fourth quarter. Diluted GAAP earnings per common share were $4.29 in the fourth quarter of 2022, up 22% compared to $3.53 in the third quarter of 2022. Net income for the quarter was $765 million, 18% higher than the $647 million in the linked quarter. On a GAAP basis, M&T's fourth quarter results produced an annualized rate of return on average assets of 1.53% and an annualized return on average common equity of 12.59%. This compares with rates of 1.28% and 10.43%, respectively, in the previous quarter. Included in GAAP results were after-tax expenses from the amortization of intangible assets amounting to $14 million in each of the two most recent quarters, representing $0.08 per common share in both quarters. Pre-tax merger-related expenses of $45 million related to the People's United acquisition were included in the fourth quarter's GAAP results. These merger charges translate to $33 million after tax or $0.20 per common share. M&T's net operating income for the fourth quarter, which excludes intangible amortization and the merger-related expenses, was $812 million, up 16% from the $700 million in the linked quarter. Diluted net operating earnings per common share were $4.57 for the recent quarter compared to $3.83 in 2022's third quarter. Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholders' equity of 1.7% and 21.3% in the recent quarter. The comparable returns were 1.44% and 17.89% in the third quarter of 2022. Both GAAP and net operating earnings for the fourth quarter of '22 were impacted by certain noteworthy items. Fourth quarter results included a $136 million gain related to the sale of M&T Insurance Agency reported in other revenue from operations as well as a $135 million contribution to M&T's Charitable Foundation reported in other costs of operations. These items collectively net and did not materially impact net income. Let's take a deeper dive into the balance sheet and the net interest margin. Taxable equivalent net interest income was $1.84 billion in the fourth quarter of 2022, an increase of $150 million or 9% from the linked quarter. The increase was driven largely by the $143 million impact from higher rates on interest-earning assets, inclusive of the effect from interest rate hedges, an incremental $19 million from volume and mix of earning assets, partially offset by a $12 million reduction in interest received on nonaccrual loans. Net interest margin for the past quarter was 4.06%, up 38 basis points from the 3.68% in the linked quarter. The primary driver of the increase to the margin was higher interest rates, which we estimate boosted the margin by 32 basis points. In addition, the margin benefited from a reduced level of cash held on deposit at the Federal Reserve, which we estimate added 6 basis points. Total average loans and leases were $129.4 billion during the fourth quarter of 2022, up 1.5% compared to the linked quarter. Looking at the loans by category. On an average basis compared with the third quarter, commercial and industrial loans and leases increased by $1.7 billion or 4.5% to $40 billion, with $1.2 billion or 4% growth being broad-based across our core commercial banking clients and $542 million or 22% growth in average dealer floor plan balances. During the fourth quarter, average commercial real estate loans decreased by $592 million or 1% to $45.7 billion, driven largely by declines in average construction loans. On an end-of-period basis, construction balances increased slightly from the linked quarter. Permanent average commercial mortgage balances were nearly flat quarter-over-quarter. Residential real estate loans increased $372 million or about 2% to $23.3 billion due to the continued retention of new mortgage originations retained for investments, partially offset by normal amortization. Average consumer loans were up $384 million or about 2% to $20.3 billion. Recreational finance loan growth continues to be the main driver. These average loans grew $325 million or 4%. Average earning assets, excluding interest-bearing cash on deposit at the Federal Reserve increased by $3.2 billion or 2% due to the $1.9 billion growth in average loans and $1.4 billion increase in average investment securities. Average interest-bearing cash balances decreased by $5.7 billion to $25.1 billion during the fourth quarter of this year, essentially in line with our projections. The sequential quarter decline was due to the drop in deposit balances and the cash deployed to fund loan growth and to purchase investment securities. Average deposits decreased $3.8 billion or 2% compared with the third quarter. Our efforts to grow and retain deposits has helped reduce the rate of decline compared to recent quarters. However, due to the rapidly rising rate environment and increased competition for deposits, there has been a mix shift within the deposit base to higher cost deposits. Average demand deposits declined $2.6 billion. Savings and interest-bearing checking deposits declined by $2.3 billion, partially offset by a $1.1 billion increase in time deposits. Average commercial deposits declined $4.8 billion as business owners shifted money into both off and on balance sheet sweep accounts, paid down debt and made distributions. On balance sheet sweep, average balances increased $2.5 billion during the fourth quarter of 2022. Turning to noninterest income. Noninterest income, excluding the $136 million gain from the sale of the M&T Insurance Agency, totaled $546 million in the fourth quarter compared with $563 million in the linked quarter. Trust income was $195 million in the recent quarter, up 4% from the $187 million in the third quarter. The increase was due largely to the impact of better market valuations on assets under management and administration. Service charges on deposit accounts were $106 million compared with $115 million in the third quarter. The decline primarily reflects the waiver of service charges in October and November on acquired customer deposit accounts. These service charges were also waived in September. Mortgage banking revenues were $82 million in the recent quarter, down 2% from the linked quarter. Revenues from our residential mortgage business were $54 million in the fourth quarter compared with $55 million in the prior quarter. Both figures reflect our decision to retain the substantial majority of the mortgage originations for investment on our balance sheet. Commercial mortgage banking revenues were $28 million in both the third and fourth quarters. That figure was $49 million in the year ago quarter. Other revenue from operations, excluding the gain from the sale of the M&T Insurance Agency were $131 million, down $22 million sequentially. The decrease was due to the impact of two fewer months of revenues related to the M&T Insurance Agency, which was sold in October, lower commercial loan fees, reflecting lower capital markets activities and a write-down on the underlying assets in certain bank-owned life insurance contracts. Turning to expenses. Operating expenses for the fourth quarter, which exclude the amortization of intangible assets and merger-related expenses, were $1.35 billion or $138 million higher than the linked quarter. This increase was largely due to the $135 million charitable donation in the fourth quarter. Excluding merger-related expenses, salary and benefits expense decreased by $30 million due to one less business day, the realization of acquisition synergies and the impact of the sale of the M&T Insurance Agency. The quarter included $21 million in higher sequential advertising and outside data processing and software expenses. Both of these categories tend to show some degree of seasonality. The efficiency ratio, which excludes intangible amortization and merger-related expenses from the numerator and securities gains or losses from the denominator, was 53.3% in the recent quarter compared with 53.6% in 2022's third quarter and 59.7% in the fourth quarter of last year. Next, let's turn to credit. Despite the challenges of labor shortages and persistent inflation, credit remained stable. The allowance for credit losses amounted to $1.93 billion at the end of the fourth quarter, up $50 million from the end of the linked quarter. In the fourth quarter, we recorded a $90 million provision for credit losses compared to the $115 million provision in the third quarter. Net charge-offs were $40 million in the fourth quarter compared to $63 million in last year's third quarter. The reserve build was largely due to growth in our C&I and consumer portfolios. The baseline macroeconomic forecast experienced nominal deterioration during the fourth quarter for those indicators that our reserve methodology is most sensitive to, including the unemployment rate, GDP growth and residential and commercial real estate values. At the end of the fourth quarter, nonaccrual loans were $2.4 billion and represented 1.9% of loans, essentially unchanged from the end of the linked quarter. As noted, net charge-offs for the recent quarter amounted to $40 million. Annualized net charge-offs as a percentage of total loans were 12 basis points for the fourth quarter compared to 20 basis points in the third quarter. Loans 90 days past due on which we continue to accrue interest, were $491 million at the end of the recent quarter compared to $477 million sequentially. In total, 74% of these 90 days past due loans were guaranteed by government-related entities. Turning to capital. M&Tâs common equity Tier 1 ratio was an estimated 10.4% compared with 10.7% at the end of the third quarter. The decrease was due in part to the impact of the repurchase of $600 million in common shares which represented 2% of our outstanding common stock as well as growth in risk-weighted assets. Tangible common equity totaled $14.7 billion, up slightly from the end of the period of the prior quarter. Tangible common equity per share amounted to $86.59, up 3% from the end of the third quarter. Now, turning to the outlook. As we look forward into 2023, we expect that inflation and higher interest rates will continue to impact the bank and our customers. We believe we are well positioned to sustain a strong net interest margin and pre-tax pre-provision net revenue to risk-weighted assets with our goal to generate top quartile return on average tangible common equity. As a reminder, the acquisition of Peopleâs United closed on April 1, 2022. Thus, the outlook for 2023 includes four quarters of operations and balances from the acquired company compared to only three quarters during 2022. This 2023 outlook also reflects the sale of M&T Insurance Agency that closed in October of 2022. During the first nine months in 2022, this business recorded revenues of $31 million and the results of its operations were not material to M&T's net income. Additionally, in December, our subsidiary, Wilmington Trust NA announced the sale of its Collective Investment Trust business. Trust income associated with this business totaled $165 million in 2022. And after considering expenses, the results of operations from this business were not material to M&T's net income. Sale of this business is expected to close in the first half of 2023. Since the timing of the closing is uncertain, this outlook includes the full year of the Collective Investment Trust business. First, let's talk about our net interest income outlook. We expect taxable equivalent net interest income to grow in the 23% to 26% range when compared to the $5.86 billion during 2022. This range reflects different rates of deposit balance growth, deposit pricing and loan growth. Consistent with the current forward curve, our forecast incorporates two 25 basis point Fed funds hikes in the first quarter of 2023 and one 25 basis point cut in the fourth quarter. Key driver of net interest income in 2023 will be the ability to efficiently fund earning asset growth. We expect continued intense competition for deposits in the face of industry-wide outflows. Full year average total deposit balances are expected to be down low single digits compared to the $158.5 billion during 2022. In order to offset deposit declines and to ensure a stable liquidity profile, we plan to issue senior debt during 2023. We continue to expect deposit mix to shift toward higher cost deposits with declines expected in demand deposits and growth in time deposits as well as on balance sheet sweeps. This is expected to translate into a through-the-cycle deposit beta in the high 30% to low 40% range. Next, let's discuss the drivers of earning asset growth. We currently plan to grow the securities portfolio by $4 billion compared to the $25 billion balance at the end of 2022 with the addition of longer duration mortgage-backed securities throughout the year. Next, turning to the outlook for average loans. We expect average loan and lease balances during 2023 to grow in the 8% to 9% range when compared to the 2022 full year average of $119.3 billion. This implies total average loan and lease balances in the fourth quarter of 2023 to be flat to slightly up from the $129.4 billion average during the fourth quarter of 2022. Mix of C&I, CRE and consumer loans, inclusive of consumer real estate loans is almost 1/3 each at the end of 2022. We expect this trend to shift slightly as C&I growth outpaces CRE. As we've seen during the second half of 2022, higher levels of interest rates are expected to slow down the growth in our consumer loan book in 2023. Turning to fees. Excluding the $136 million gain on the sale of the M&T Insurance Agency in the fourth quarter of 2022 as well as securities losses, noninterest income was $2.23 billion in 2022. We expect 2023 noninterest income growth to be in the 5% to 7% range compared to 2022. The outlook for 2023 reflects approximately 10 months of foregone income from M&T Insurance Agency as a result of the sale. Overall, mortgage banking revenues are expected to be up 5% to 7% compared to 2022. Commercial mortgage banking revenues are expected to rebound in 2023, and we will return to a gain on sale residential mortgage banking model in 2023. However, with the high level of interest rates, we expect muted origination volumes and thus, anticipate total residential mortgage banking revenues to be relatively stable compared to 2022. We expect service charges on deposit accounts to be 3% to 6% higher than 2022 and anticipate trust income to be 8% to 10% higher in 2023. Turning to expenses. We anticipate expenses, excluding merger-related costs, the charitable contribution and intangible amortization to be up 10% to 12% and when compared to the $4.52 billion we experienced during 2022. Approximately half of this increase reflects an extra quarter of People's United expenses. This outlook also incorporates the impact from the sale of the M&T Insurance Agency. We do not anticipate incurring any material merger-related costs in 2023 and intangible amortization is expected to be in the $60 million to $65 million range during 2023. As a reminder, first quarter expenses will be elevated as a result of our typical seasonal increase in compensation expense. For the first quarter of 2023, we anticipate an uptick in the range of $90 million to $95 million. That amount last year was approximately $74 million. Turning to credit. We expect credit losses to be higher than the strong results in 2022, but to remain below M&T's legacy long-term average of 33 basis points. Provision expense over the year will follow the CECL methodology and will be affected by changes in the macroeconomic outlook as well as changes in loan balances. For 2023, we expect taxable equivalent tax rate to be in the 25% range. Finally, turning to capital. We believe the current level of core capital exceeds that needed to safely run the company and to support lending in our communities. We plan to return excess capital to shareholders at a measured pace. M&T's common equity Tier 1 ratio of 10.4% at December 31, 2022 comfortably exceeds the required regulatory minimum threshold which takes into account our stress capital buffer or SCB. With a solid starting CET1 ratio and the potential to generate additional amounts of capital over the next few years, we don't expect to change our capital distribution plans. We anticipate continuing to repurchase common shares at a pace of $600 million per quarter under our current capital plan. Before we go to Q&A, I wanted to take a moment and reflect back on some comments made at the beginning of the call, where we reference #3 and how he is winning the game of life. Sometimes numbers can be simple with deeper meaning than what meets the eye like the divine proportion. I'd like to take a moment and share what I see with some of these numbers. The first game after #3 went to the hospital. Our team returned a kickoff, the first time it has done so in three years and three months. First playoff game was won by 3 points. #14 and 17 are key leaders on our team. The difference between 14 and 17 is 3. That number seems to come up quite often. If you look at those key leaders and you drop the 1 from 14 and the 1 in front of 7, you're left with 4, 7. 47 is an interesting number. I know you're all thinking about the periodic table of elements. 47 is the atomic number of silver. The Vince Lombardi Trophy is made out of silver. That interesting? But it gets even weirder. The symbol for silver is Ag. If you reverse those letters, you get GA which is the abbreviation for Georgia, the potential site of the AFC Championship. And all of this is happening in 2023. There's that number again. Probably just a set of random coincidences or is it? I guess, sticking with the 3s, I think at one point you talked about a long-term NIM of 3.6 to 3.9. So those 3s involved there and they're divisible by 3. And so why don't we kick it off with that. All right. I guess our outlook for the net interest margin over the long term hasn't changed, Matt. And the question is, what's the long term? And when we look at the structure of an average bank balance sheet and the mix of funding that is deposits or wholesale funding, those costs tend to be pretty competitive, and it's the mix that ultimately drives the margin over the long run. And when you look at where we see our balance sheet going in that of the industry, we think that's -- we're in a unique time right now where pricing has not kept -- deposit pricing has not kept up to rates on loans. And that's ultimately going to close. And so will we see that in 2023, those numbers? Unlikely. But as we go into '24 and '25, will we start to see the margin move back down into those normal historic ranges? We think so. And the most important thing about why we talk about that is, we don't want to set up the bank and the expense structure, assuming that margins like that are going to hold because recent history suggests that's just not likely. If it happens to, that's great. But we don't want to build the bank so that we're counting on those kinds of margins for the expense run rate that we have. Okay. So 3 years, once again, 3 popping up to normalize on the NIM. But did I miss any comments on the NIM for '23? Or most importantly, what you're modeling for the fourth quarter this year? Both on the full year and then most importantly, the fourth quarter of '23, what are you thinking on the NIM? And then I think that would assume both the forward curve and then I think commercial loans tend to reprice a little bit sooner than maybe funds move. So if you have a 4Q '23 estimate and then framing of puts and takes, which it's helpful, including with the repricing earlier the commercial loans? Yes, sure. If you look at the year, based on our current outlook, we think the average NIM for the year stays above 4%. You probably see a little move up in the first quarter just because of the impact of day count. And so you'll see it pop up. But actually, it's quite likely that net interest income in dollars might actually be lower -- will likely be lower in the first quarter of '23 than it was in the fourth quarter of 2022. Taking into account that forward curve that's relatively flat, but starts to see some cuts at the end of the year, we think the margin will be higher in the first half of the year than in the second half of the year and probably heads down towards 4% as we get to the fourth quarter of 2023. And if you could talk a little bit about any efforts here to protect the NIM at that level, particularly as we look at potential cuts in the third pivot anything in terms of balance sheet positioning that we should be considering in terms of what you're already doing to protect the NIM at these levels? Yes. There's a few things John, that we've been working on all this year to start to protect the NIM. First, you've seen us increase the size of the securities portfolio, and we've talked a little bit about growing that a little bit further in 2023. Within there, we also anticipate shifting the duration a little bit. We've taken some duration so far in -- on the balance sheet, in the mortgage portfolio, we'll slow that down and we'll take that duration in the securities portfolio with some MBS -- we'll also be doing -- we mentioned some term funding, which we'll lock that in, which will also help. And then the thing that ultimately is the biggest benefit to maintaining the margin and reducing asset sensitivity is deposit pricing, right? And so it's a little bit painful when it's compressing on the way up, when it's catching up to the loan pricing. But ultimately, the best way to combat declining rates is through repricing of deposits. And so those three things would be the biggest help. We will and continue to have a hedge portfolio that helps reduce some of the asset sensitivity in the short term, might help the NIM of some of the earlier hedges that were put on that are a lower received fixed rate roll off. And so those are kind of the three major things that will have helped us reduce our asset sensitivity, and will help us protect the NIM at these kind of higher levels as time goes on. Yes. We'll see how much we grow from where we are at the end of the first quarter because of the position of the balance sheet and what we'll do will likely not be to add to outstanding notional but to add to forward starting is likely what we would do. Right. Got it. Okay. And then just one other follow-up on the commercial real estate front, could you maybe give us an update on what you're seeing there in terms of credit trends, maybe trends in delinquencies and criticized assets and any time distress in the office portfolio, that would help? Yes, sure. Within -- in the commercial real estate portfolio, the biggest trend that we've had going on for probably the last four quarters is just the reduction in the construction portfolio. And so a large number of construction projects were originated in late '18 and during 2019. And as the pandemic went, they continued but at a slower pace, and those have been coming to completion this year. And as those have come to completion, they've turned into permanent mortgage financing oftentimes not on our balance sheet. And so you've seen the decline in commercial real estate largely being construction related. When we look underneath at some of the major categories and we look at the criticized, we actually have seen hotel criticized balances peak probably about two or three quarters ago. It got as high as about 86% of our hotel portfolio. It's now down below 50%. And if we're seeing remixing in the criticized, there's two categories. One is healthcare, which we've talked about a little bit before, and that's typically assisted living and senior housing. And that's not from a lack of demand that we're seeing some challenges in that portfolio. It's their ability to staff. And so we've seen occupancy rates in these portfolios come up post pandemic but they're not able to get all the way back to pre-pandemic levels because there's not enough staff to adequately care for the folks that want to live there. And then the other place, obviously, we're looking at is office, and we're paying a lot of attention to office. The portfolio, I think, is as of the end of the year, right around 20% criticized, we're watching lease expirations and lease sign-ups. The vast majority of our real estate portfolio has lease expirations out 2024 and later. So far, what we've seen is decent renewing. We are seeing some movement down in price per square foot. But what we've been doing is going through all of the lease portfolios -- sorry, the office portfolios and stressing both vacancy rates and lease rates to see what the debt service coverage ratio is and what making sure that we've got adequate coverage. If we talk about our expectations for charge-offs, in -- as we go into this year. That's the place where we'd have the most concern. When we talk about charge-offs moving up from the levels we've seen in 2022. It will be some of those portfolios that is still a place where we've really got our eye. Hi, Darren. Just wanted to ask about -- just, I guess, a follow-up on the office book. If you could just remind us where that total office exposure is and then specifically the exposure in New York City? Probably you should -- you'll see this when the K comes out. But the office exposure in total is right around $5 billion. When you look at what's in New York City, it's about 15% that would be New York City. It's pretty widespread across predominantly the Northeast. Okay. And then just a follow-up on CRE. In terms of -- I think you mentioned that the permanent CRE book was sort of flattish linked quarter with construction balances rolling off. And it sounded like -- I just want to make sure I understand that for 2023, is the expectation that, that permanent CRE book will grow just to a lesser extent than the C&I book? Or do you still -- are you still looking for outflows in that or thinking about outflows in that CRE book? Yes. Yes. Overall, Frank, we're thinking that the overall CRE book does continue to drift down, but at a much slower rate than what we've seen in 2022. It will be a modest decline -- well, on average, it's actually going to be up because of the People's United. But if you look versus the fourth quarter, the permanent book on average is relatively flat compared to where the fourth quarter was. And most of the decline would continue to be in the construction side of things. Remind you the construction portfolio is the one that -- is one of the ones that tends to carry higher loss rates in the stress test, which is part of the reason why we've been working to obviously support our customers so that they can finish the projects, but then to not add meaningfully to that once those reach their completion and find permanent financing. I guess just maybe on the balance sheet. So you mentioned about $4 billion in securities purchases from $25 billion at year-end. If you don't mind reminding us like what that implies for the cash balance as we think about -- on a steady state, I think cash was about $25 billion over the fourth quarter. Is $20 billion the right place for you or where the bank expects to be? And how much of that might go away from like deposit runoff. So just thought process around that? Yes. There will be some movement, Ebrahim, between cash and securities over the course of the year. If you look at the as-at the end of the year, probably down in the $9 billion range. If you look at the average for the year, probably think in the slightly below $20 billion, between $20 billion and $19 billion is probably the spot. That number is going to move around a little bit, obviously, depending on outflows in deposits, as well as our funding needs to support loan growth as well as to make sure we're managing the bank's liquidity profile. And so those will move around a little bit over the course of the year, but those are kind of round numbers where we're forecasting 2023. Got it. And I'm sorry if I missed it, you talked about issuing some debt. Did you quantify how much in debt do you expect to issue through the course of the year? I didn't mention a number, obviously, that this is dynamic, right? And that the amount is going to be a function of what's happening with deposit funding and runoff and whatnot. But right now, we think it's in the $3 billion to $4 billion range over the course of 2023. And what would be the cost of the debt today given just the shape of the yield curve? I'm just wondering if it's better to lock in term funding relative to short term right now based on the market? Well, it's a great question. There's -- obviously, the rate isn't depending on the tenor, right? And right now, there's a -- you like the opportunity to reprice the shorter-dated notes but they're trading higher than the longer-term debt. And so we think low to mid-5s is the range of yield on that depending on the term. And what we'll be trying to do since we've really brought down the level of wholesale funding at the bank will be to not lock in all-in-one tenor, but to start to build a more balanced maturity profile as we think about the funding of the bank, so that we don't have massive amounts coming due all at the same time. And so I think as you think about it, think about not being all one tenor and one type of but something that starts to build a little bit of a profile that is spread out over the next few years. Got it. And just on a separate note, the CRE book or the CRE office, do you have the debt service coverage ratios handy in terms of where they were at the end of the year? I don't know that I have that right off the top of my -- at the tip of my fingers here. Give me one second and let me see if I can find it. But it has -- in aggregate, that portfolio has still been above 1. And when we look at the LTVs in that portfolio, they still run below 60% on a weighted average basis. Now obviously, there are some above that and some below. But as we look at it right now and we look at the clients' ability to support the asset either with cash flow or with how much equity they have in the property where we feel pretty comfortable with where we sit, but we're watching it. As we've talked about, there's -- it's one of the places where we see the most risk and where we're focusing a lot of our attention from a credit perspective. I was hoping you can break down your loan growth guidance for next year. In the past, you've spoken about the lending synergies from the Peopleâs acquisition and the footprint there. I think you mentioned small business card and equipment finance. So just if you can break down how you see that contributing to loan growth in '23? And how you see that evolving? I guess as we look at People's impact on 2023 from a loan perspective, it's certainly additive. But it's one of those things where the loan balances take a little bit of time to build and to show up in a material way. So when we look at 2023, we continue our focus on C&I, and we expect to see strong growth in the C&I portfolio over 2023. On an average basis, it prints a big number because it's four quarters of Peopleâs and not just three, and so 20-ish percent over the average in 2022. But outside of that, it comes down a little bit more like into the 3% to 5% range. There's a bunch of pieces in there. One of the ones that we talked about that impacted the fourth quarter was our dealer floor plan business. And what we've seen is, is some inventory builds as supply chains open up and consumer purchases slowed down a little bit with rising rates, and so we saw some movement there. We did see some broad-based movement in our core commercial customer. The leasing business where we prefer to call it our equipment finance business continues to show steady growth, which would show up in the C&I balances. And then the other thing where we'll be intensely focused is on building out our small business and business banking segment. That's one of the places where we see a great opportunity in the New England franchise and to deploy our methods of banking. When you look at the other portfolio CRE, we talked about relatively flat to slight somewhat down, the consumer real estate also flat to down, and that's really -- that's the consumer mortgage business, and that's really just a reflection of normal amortization. And because we will stop holding the originations, we will go back to gain on sale. And then we think the consumer portfolio slows down a little bit, again, just because of the interest rates and the pace of activity in terms of car buying as well as recreational vehicle purchases. The one offset there, which is also a People's related thing. But unfortunately, it doesn't grow the balances that much as we expect to launch our credit card into the People's United markets, which will help grow credit card balances. But as I mentioned, they are still relatively small, and so hard to see in the bond growth but nice from a margin perspective. One of the other things that is in the People's franchise, which we like is, we've talked about it before, the mortgage warehouse lending business, but it's a tough part of the cycle for the mortgage warehouse lending business that -- with refinance activity almost not exist and purchase a little bit low, but the balance is there, are likely to still be a headwind. We don't think that they go down materially from here, but they won't go back to where they were in 2020 and 2021 without a decrease in the long-term mortgage rates. That's really helpful. And I think you've also mentioned in the past that C&I is benefiting now because of less capital markets activity. Are you assuming some sort of reversal in your '23 guide? We're just -- we're cautious about the level of economic activity and seeing some slowdown in inflation, in GDP and what that translates into in terms of demand from our clients. It's really not much more than that. There isn't any sign that we see that we're seeing a material slowdown -- or we're not seeing credit concerns, we're just seeing cautiousness while people wait to see how the economy plays out in 2023. And so we're cautious on it as well. Got it. And then just a follow-up on one of the prior questions. On the stress test, you've spoken about the adverse effects of the excess cash balances and of course, the Fed has been stressing CRE more than the other asset classes. Just given that December 31 will be used as a starting point for the next stress test, do you think you've done it now for how well do you think you're positioned going into that? We've certainly made a meaningful shift in the balance sheet this year. Cash balances, we mentioned, are down the better part of $17 billion from where they were at the end of last year. The mix of C&I and CRE when we focus just on commercial balances is almost 50-50, where it was 60-40 before CRE. And when we look at the -- or the construction balances, they're down a couple of billion dollars. And so -- and not to mention the margin is up and so the PPNR start point is higher. Things that we've got our eye on, and we're not -- we're uncertain a little bit is how the merger expenses will be treated in the stress test this year. But once we get through 2023, it should be clean. And so that will be helpful. And then the other question is, what's the Fed scenario, right? We haven't seen it yet. It's very likely that it will continue to focus in the real estate sector. Previously it focused on hotel and retail. Those seem to be doing a little bit better. So it wouldn't surprise us if the new focus is office and healthcare. And so it just depends on where the emphasis is from that perspective as well. But we start from a really strong capital position. We've got the current SCB covered, which is pretty high. And we continue to move the balance sheet in a positive direction, which if it doesn't get us all the way where we want to be in 2023, it should carry us a long ways towards where we want to be in 2024. Darren, on the cost side, you mentioned, obviously, the conversions being passed. Can you give us an update on what proportion of the initially expected $330 million of saves from Peopleâs were in the fourth quarter run rate; and if not fully there, when do you expect to get there? Yes. Ken, the vast majority of the saves are in there through the end of the fourth quarter. We're probably -- if you think about we were targeting 30% of the cost base, weâre like 27% or something in that range, is what we've achieved so far. When you look at it on a percentage basis, we're almost there. When we look at it on a dollar basis, the run rate is actually a little bit higher than we thought it would be because of inflation. When we talk about the percent save, it's still the same. And so, some of that will come out over the course of the year. We're running -- weâre carrying a little bit higher staffing in the branches as we stabilize a little bit higher staffing in some of the call centers. And so those things will normalize themselves over the course of the year. But when we look at where we sit, from my perspective, we pretty much closed the book on the cost saves that we expected to achieve. A couple of other things that have worked out very positive is the onetime expenses turned out to be a little bit less than we thought. We incurred a little bit less in severance expense. We also incurred a little bit less in some contract terminations than we thought at due diligence. And the nice thing is the Peopleâs was an asset-sensitive franchise. And with rates going up, the NII is coming in better than we thought. And so the PPNR is a little bit higher than we expected. So overall, the numbers that we thought we would realize post close and post conversion are in line to slightly better than what we thought, and we're almost back to breakeven on tangible book value. So overall, we're very, very positive about where things sit early on. And as we mentioned before, excited to go to work in New England and bring M&T's branded banking into that new market. Got it. Great. So then one follow-up to that is then if that's the case that you're pretty run rate, then we can all take a look at the kind of implied underlying expense growth off of this fourth quarter and knowing that you have the seasonal step-up in the first. So can you just kind of frame that for us, just what do you think about that organic side, what's driving it in terms of the initiatives that you're focusing the most in terms of incremental expense growth from here? Yes. The biggest driver of that is compensation. And when you look at 2022, we made some meaningful adjustments to our associates' compensation. We raised the minimum wage. We've been dealing with competition for talent like everyone has, and compensation expense is about 55% of our total expense base. And so when you look at the driver of that growth, it's really that compensation cost that's driving it. Outside of that, the other line item, you'll see where we'll be investing and have been is in outside data processing and software, that I think for us and for the industry, you see more and more reliance on purchased software. And with those future software contracts come licenses and maintenance fees, which tend to go up, every year. And the other place, we'll probably see a little bit of growth in advertising and promotion. As we continue to stabilize the franchise and introduce ourselves in New England, we'll see an uptick in that as we go forward and then kind of normalize into what I would describe as a normal percentage of our operating expense over time. I want to start. So looking at this quarter with the second quarter where you funded loan growth with excess liquidity, talking about issuing sub debt, when do you think you'll start growing deposits again? Is this back half '23? And where do you see the loan-to-deposit ratio trending through the year or maybe ending the year? There's always an ability to grow deposits. It's just at what cost, right? And so we're always looking at -- number one, our focus is on customers and customer relationships. And so for situations where we would have single-service time deposits or money market accounts, we may not choose pay rate there because we can fund the bank more efficiently in the wholesale markets. But for customers who are operating account customers, which is our core funding base and part of our long-term strategy, then we're more willing to pay rate. And so we're always making that trade-off. And so to say that it's going to officially end in the second half of the year, I think would be would be a little foolhardy. But our idea is, obviously, there will be a spot you get to where customers maintain balances in their checking accounts, if you're a consumer or your operating account, if you're a business and you kind of hit that floor. And when will that floor hit, I think we start to see it as rates stabilize, and you'll see that as we go through 2023. But also, we know that the deposit pricing lags movements in Fed funds and moves -- lags movements in loans. And so our goal will be to stabilize it as we go through the year. But obviously, making those trade-offs that I mentioned as we work with clients. Oh, sorry. Right. The -- I think over time -- and again, time, maybe, let's call it, 3 years, aha, just to pick on our #3 is, over the long term, loan-to-deposit ratios for us and for the industry will trend back to their long-term average. And when we think about those loan-to-deposit ratios and those long-term averages, that's also part of the reason why we talk about that net interest margin over the long run, normalizing back to where it's been historically. And so we're kind of, we think, maybe around 80-ish a little bit above as we get to the end of 2024 -- sorry, 2023. But it's obviously a function of how we choose to pay and fund the bank. I was going to say, and I know the 3 was in the middle of the call, your stock was up 3%, but now it's up over that, so I can't use that. Well, we appreciate that and the 3 reference. There's something that happens in every call and it kind of seems to run its course. So 3 is this one. There you go. A question for you regarding your comments about the commercial real estate portfolio. When you look at it, particularly for office, there's a concern, of course, with the work-from-home possibly being more permanent and there'll be less space needed, possibly vacancy rates go up in the office space. What do you think is the greater risk? The occupancy rates going higher because of that trend or the refinancing risk where your customers having to refinance because their mortgages are terming out, they have to refinance it and the rates are just so much higher today than when people took down these mortgages maybe 5 years ago? Right. So I think it's hard, Gerard to pinpoint it on one or the other because they work together, right? I mean if occupancy and price per square foot was okay, are holding up, then you probably got the coverage to refinance when your loan is due. I remind you, when we underwrite whether it's multifamily, office or hotel, we underwrite to long-term interest rates and long-term occupancy rates. And so we've got some protection built in with our clients when we underwrite. So there's a little bit of room there. But as we look at it, I think in the short term, it's the refinance risk, it's a little bit bigger. Over the long run, we debate this a lot internally, and we go back and forth with our Chief Credit Officer, that this trend of more remote work, hard to handicap where that's going to end up, right? You can see some changes in the economy. You see some movements with some of the tech firms with employment. That may or may not drive people back into the office, we don't know. But when you see younger people early in their professional career, you can see the benefits to being co-located with their co-workers. And so that trend, I think, ultimately starts to come back. Is it five days a week probably not, but it's not going to be zero, at least this is Darren's opinion. So take it for what it's worth. To me, the bigger issue is when you look long term at the population, there's a big chunk of the population called the baby boomers that are approaching retirement age. They're not enough of them to come in up in the next wave to use all the space that they needed to sit in to be employed. And that's a longer-term cyclical trend, which will affect these things. And so there's going to be some pain in the short term, no doubt. Over time, rates will move up and down and refinancings will happen. There will be some movement in and out. But to me, the longer-term trend is what's happening with the population and the working population and what's the capacity that exists today versus what the likely future looks like, absent any other changes in politics. And I will leave it at that before we get into a discussion I don't want to get into. Sure. As a follow-up question, based upon your experience and your conversations with your colleagues at M&T, what do you think is driving what we're seeing today where the CECL reserve build -- you and your peers obviously have to take a look at the economic forecast. Many people use Moody's, which is weaker this quarter than last quarter, which drove up reserves. But at the same time, I think you mentioned your net charge-off numbers are expected this year to be below your through the cycle levels. Spreads in many areas, high-yield securities or even one of your peers that their corporate loan spreads haven't widened out yet. What's going on where we're not seeing -- we -- I don't think, some metrics telling us we're going to have a tough downturn, whereas the reserve build is pointing to a weaker economy? Yes. I think, Gerard, to me, when I think about the way we all set aside reserves. We've got -- it's weighted heavily on your economic forecast and your R&S period, your reasonable and supportable period, which for a lot of the industry is the first couple of years and then there's a reversion to the long-term average. And so what you're seeing today is the current view where the charge-offs are well below the long-term average. And so the allowance is always going to take that the long term into account. And then you're forecasting and bringing forward those losses based on the assumptions that go into the R&S period. And the expectation for unemployment to go up and for GDP to come down is there. It's in the baseline for Moody's. It's moved a little bit. Most People like us will not just look at the baseline, but look at a more severe economic scenario as well as a better one. And you kind of weight those. And it doesn't necessarily need to be what you see today in the pricing and the spreads versus what's in the forecast. They should be connected, but they're not always, right? And there's always going to be points in time where these disconnects exist. And so we look at it and we think about the provision is keeping the bank safe. It's capital by another form. But as we underwrite business, we're always looking at each individual relationship and its ability to pay back. And the spreads are going to be a reflection of the expectation of that credit risk through the cycle. And so for us, we've had so many long-term relationships where we've seen the behavior of these clients through the cycle and their willingness to step up and many times bring outside resources to help maintain their payments and stay accruing. And so each organization is different, but that to me is a little bit of why you might see a disconnect between what's actually pricing today versus what's in the CECL outlook. And just quickly on the CECL outlook, what was the weighted unemployment rate that you guys came up with in your analysis? You mentioned you used the base case, but you also took into account the more severe case as well. Yes. We're kind of in the 4-1 range on unemployment in the base. And that's during the R&S period, obviously, right? And so you're -- once you get past that, then you're reverting to the long term. We have reached our allotted time for the question-and-answer session. I will now turn the call back over to Brian Klock for closing remarks. . Again, thank you all for participating today. And as always, a clarification of any of the items on the call or news release is necessary, please contact our Investor Relations department at area code (716) 842-5138. Thank you and have a good day
|
EarningCall_1183
|
Good morning, and welcome to the NextEra Energy and NextEra Energy Partners Fourth Quarter 2022 Earnings Call. All participants will be in listen-only mode. [Operator instructions] After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. Thank you, Jason. Good morning, everyone, and thank you for joining our fourth quarter and full-year 2022 combined earnings conference call for NextEra Energy and NextEra Energy Partners. With me this morning are John Ketchum, Chairman, President and Chief Executive Officer of NextEra Energy; Kirk Crews, Executive Vice President and Chief Financial Officer of NextEra Energy; Rebecca Kujawa, President and Chief Executive Officer of NextEra Energy Resources; and Mark Hickson, Executive Vice President of NextEra Energy, all of whom are also officers of NextEra Energy Partners, as well as Eric Silagy, Chairman, President and Chief Executive Officer of Florida Power & Light Company. John will provide some opening remarks and will then turn the call over to Kirk for a review of our fourth quarter and full-year results. Our executive team will then be available to answer your questions. We will be making forward-looking statements during this call based on current expectations and assumptions which are subject to risks and uncertainties. Actual results could differ materially from our forward-looking statements if any of our key assumptions are incorrect or because of other factors discussed in today's earnings news release, in the comments made during this conference call, in the risk factors section of the accompanying presentation, or in our latest reports and filings with the Securities and Exchange Commission, each of which can be found on our websites nexteraenergy.com and nexteraenergypartners.com. We do not undertake any duty to update any forward-looking statements. Today's presentation also includes references to non-GAAP financial measures. You should refer to the information contained in the slides accompanying today's presentation for definitional information and reconciliations of historical non-GAAP measures to the closest GAAP financial measure. As a reminder, Florida Power & Light completed the regulatory integration of Gulf Power under its 2021 base rate settlement agreement and began serving customers under unified rates on January 1, 2022. As a result, Gulf Power is no longer a separate reporting segment within Florida Power & Light and NextEra Energy. For 2022 and beyond, FPL has one reporting segment and therefore 2021 financial results and other operational metrics have been restated for comparative purposes. Thank you, Jessica, and good morning everyone. Before I turn to a discussion of our financial results and the future growth prospects, I'd like to make some comments on the status of our review. As a reminder, we reported last quarter that we were reviewing allegations of Florida state and federal campaign finance law violations raised in media articles and a related complaint filed in October with the Federal Election Commission. Our review of information reasonably available to us is now substantially complete. Regarding the Florida allegations, based on information in our possession, we believe that FPL would not be found liable for any of the Florida campaign finance law violations as alleged in the media articles. With respect to the FEC complaint, you may recall that it was filed by a special interest group and primarily relies on media articles that allege certain violations of the Federal Election Campaign Act by various parties, including by implication FPL. The FEC process is a confidential, civil administrative process with an investigation only commencing if the FEC votes to do so. We plan to file our response seeking dismissal of the FEC complaint in the next few weeks and do not believe it is appropriate for a complaint such as this to move forward. The total amount of contributions referenced in the complaint is less than $1.3 million and we do not expect that allegations of federal campaign finance law violations taken as a whole would be material to us. With that behind us, I would like to now discuss our fourth quarter and full-year 2022 financial results and future growth prospects. Both NextEra Energy and NextEra Energy Partners had a terrific year in 2022 and both businesses have never been better positioned. The cost and efficiency of new renewables have improved significantly over the last two decades, while natural gas prices have seen an increase over the past year with volatility likely to continue going forward. At the same time, landmark renewables legislation was entered into law last fall. After the passage of the Inflation Reduction Act, or IRA, we often said it was transformational for our industry and our business. Before IRA, we largely qualified for two federal incentives: wind production tax credits and solar investment tax credits. We always had the challenge of planning the business with those federal incentives expected to phase down and expire in a few months or years. Some years they were extended, others they were not. The uncertainty changed customer behavior and it changed our behavior. Today, the incentives are clear. They support a broader range of renewable technologies. They are in place for a much longer period of time. And they incentivize a domestic supply chain that will further reduce the cost of renewables that are made in the USA, creating new American jobs. In short, we believe the IRA provides growth visibility for a broad range of low-cost clean energy solutions, in a predictable way and for a long time. We believe that, in this environment, low-cost renewables will help NextEra Energy and NextEra Energy Partners continue to drive long-term value for our customers and our shareholders and unitholders. So today, I am excited to share that we are extending our financial expectations for an additional year at both NextEra Energy and NextEra Energy Partners and I look forward to sharing more details on those expectations in a few minutes. In 2022, NextEra Energy continued its long track record of outstanding execution, delivering full-year adjusted earnings per share of $2.90, up nearly 14% from 2021. As a result of strong operational and financial performance at both FPL and Energy Resources, we achieved the high-end of our adjusted EPS expectations range. Over the past 10 years, we have delivered compound annual growth in adjusted EPS of roughly 10% for our shareholders, which is the highest among all top 10 power companies. NextEra Energy outperformed the S&P 500 Index by nearly 10% in 2022, despite a challenging year in the financial markets. In terms of total shareholder return, NextEra Energy has outperformed the S&P 500 Index and the S&P 500 Utilities Index on a three, five, 10 and 15-year basis. Over the past 15 years, we have outperformed nearly all of the other companies in the S&P 500 Utilities Index and more than tripled the average total shareholder return of the index. Over the same period, we have outperformed 75% of the companies in the S&P 500, while nearly tripling the average total shareholder return of the index. We are proud of our long-term track record of creating shareholder value, but we remain intensely focused on execution at both FPL and Energy Resources and we remain committed to delivering long-term growth for shareholders going forward. We have a long history of executing and delivering on our commitments, even in periods of uncertainty and disruption, and 2022 was no exception. Despite a challenging macro environment, we invested more than $19 billion in American energy infrastructure, while maintaining our strong balance sheet and credit ratings. Overcoming supply chain challenges, we constructed and placed into service roughly 5,000 megawatts of new renewables and storage projects, demonstrating the strength and resiliency of our team's expertise and competitive advantages. While disruption created some near-term challenges, it also created opportunities and I'm extremely proud of our team's execution in 2022 in delivering adjusted EPS growth of nearly 14%. During 2022, FPL successfully executed on its strategic initiatives, while delivering on what we believe is the best customer value proposition in America. Despite inflationary pressures, we further reduced our already best-in-class non-fuel O&M cost per megawatt-hour by approximately 8.6% versus 2021. We also continued our investments in solar generation that can reduce the variable fuel component of our customer bills. We placed into service approximately 450 megawatts of cost-effective solar during 2022 and we anticipate commissioning another roughly 1,200 megawatts of low-cost solar in 2023, bringing our total solar buildout to roughly 1.7 gigawatts within the first two years of our current rate agreement. Our relentless focus on productivity and making smart capital investments for the benefit of customers is a significant part of what has kept our typical 1,000 kWh residential customer bills the lowest among Florida investor-owned utilities and more than 30% below the national average. FPL has also continued to provide exceptional service reliability and was recognized for the seventh time in eight years as being the most reliable electric utility in the nation. Our team responded exceptionally well in response to hurricanes Ian and Nicole. And during a year of high inflation and high natural gas prices, FPL used its strong balance sheet to provide bill relief for its customers. Looking forward, we remain committed to providing clean, affordable, and reliable service to our customers for many years to come. Energy Resources also had a terrific year in 2022, delivering adjusted earnings growth of nearly 11% versus the prior year. With economics driving strong demand for renewables, Energy Resources had a record year of new renewables and storage origination, adding more than 8,000 megawatts to our backlog as we continue to capitalize on the ongoing clean energy transition that is occurring across the United States. With the significant net additions over the last year, our renewables and storage backlog now stands at a year-end record of approximately 19 gigawatts, net of projects placed in service, and provides strong visibility into the growth that lies ahead. Our continued execution, combined with the long-term visibility into clean energy incentives and the strong market backdrop for low-cost renewables, gives us more confidence in our long-term outlook at NextEra Energy. Last June, we laid out our vision and strategy to decarbonize both ourselves and the broader U.S. economy. In August, the IRA helped provide more certainty and flexibility to plan for growth than at any other time in our history. Over the next two decades, we are well positioned to continue our track record of creating long-term value for shareholders through additional renewables and storage investments, expansion into new markets and products that enable even more renewables, and organic growth opportunities to optimize our existing fleet by repowering assets and co-locating storage. At FPL, our plan is to lower costs for customers by accretively deploying capital into low-cost solar, storage and eventually hydrogen. By transforming our generation fleet and continuing our decades-long strategy of fuel-switching, we will not only help customers by keeping bills low but also help the state of Florida achieve energy independence. Our customers have already seen the positive impacts of the IRA on their bills. We estimate that solar production tax credits are expected to save customers roughly $400 million over the term of our current rate agreement. This month, those savings started with a one-time $36 million refund on customer bills for our completed 2022 rate base solar projects. With only about 5% of FPL's generation mix coming from solar today, we are still in the early stages of building out our low-cost solar portfolio. At April, FPL expects to file its annual Ten-Year Site Plan, which will present our generation resource plan through 2032. Last year's plan included roughly 9,400 megawatts of new solar capacity through 2031, including roughly 4,600 megawatts of additional solar after 2025. By incorporating the IRA benefits, we expect the post-2025 new solar capacity in this year's plan will more than double what it was last year. We believe low-cost solar will also provide a valuable hedge for our customers against rising natural gas prices in the future. At Energy Resources, the combination of low-cost renewables, higher natural gas prices and the broader push toward decarbonization across the economy enables our strategy to serve both utilities and commercial and industrial customers with comprehensive clean energy solutions. These comprehensive clean energy solutions are often complex and, in addition to new renewables, can include renewable fuels, hydrogen, and Behind the Meter projects, all of which are expected to ultimately create even greater demand for renewables. Customers are looking for long-term partnerships with customized solutions at a scale unlike anything we have seen in the past. And we believe that no company is better positioned than Energy Resources to serve these complex customer needs in a way that helps them both save money on their energy bills and meet their emissions reduction goals. We are particularly excited about the potential for green hydrogen and the role it will play as a solution to help commercial and industrial customers cost-effectively lower emissions. We are building the algorithms and tools to identify and optimize the best green hydrogen sites around the country and leverage our significant interconnection and land inventory position. We are using the skills and capabilities that we have developed over the decades that we have led the renewables industry to participate in emerging clean hydrogen markets in a big way, and we are already starting to see some of our early efforts materialize. Last week, we signed a term sheet for approximately 800 megawatts of new solar generation, which we have not included in our backlog, that is expected to reach commercial operations in 2026 and is expected to support a green hydrogen-related facility in development in the Central United States. Additionally, Energy Resources is participating in the development of hydrogen hubs in the Southwest and Southeast. Earlier this month, these hubs were encouraged to file full applications for federal funding from the U.S. Department of Energy under its $8 billion program to create networks of hydrogen producers, consumers, and local connective infrastructure to accelerate the use of hydrogen as a clean energy carrier. In the Southeast, our plan is to support a 140 tons-per-day clean hydrogen facility at our Gulf Clean Energy Center that would be powered by FPL solar projects. In the Southwest, our plan is to build a 120 tons per day electrolysis-based clean hydrogen project in Arizona in partnership with Linde, the world's largest industrial gases company and the largest liquid hydrogen producer in the United States, with whom we recently signed a memorandum of understanding. The clean hydrogen produced by this facility would be used to support decarbonization of the West Coast mobility and industrial end-markets. These are just a few examples of clean hydrogen opportunities our team is actively pursuing. We continue to work with various partners on hydrogen solutions and we are excited by both the number and scale of opportunities in front of us. At our investor conference in June last year, we announced Energy Resources development expectations of roughly 28 to 37 gigawatts of new build renewables and storage through 2025. In sizing those expectations, we considered, among other factors, the expiration and phase down of production tax credits and investment tax credits under then-existing tax law. Typically, when tax credits are near the planned expiration dates, we see a spike in demand in the immediate years prior. Then, after tax credits are extended, demand weakens in the short term. Even though tax credits were extended with the IRA, we are continuing to see tremendous demand for new renewables. It is against that backdrop of strong market demand and the continued cost advantages of renewables combined with our unparalleled competitive advantages that today we are extending our development expectations at Energy Resources through 2026. We now believe that we will place into service approximately 32,700 to 41,800 megawatts of new renewables and storage projects from 2023 through the end of 2026. If you compare midpoint to midpoint, our new four-year development expectations at Energy Resources are approximately 15% higher than the previous four year development expectations range that we announced at our investor conference last year. To put these numbers into context, just executing at the low-end of our new development expectations through 2026 would more than double the size of our current renewables and storage operating portfolio, which took us more than 20 years to complete. Due to our long-term visibility into clean energy incentives and the significant growth opportunities at both FPL and Energy Resources, I am pleased to announce that we are extending our adjusted earnings per share growth expectations at NextEra Energy by an additional year through 2026. For 2023 and 2024, we expect our adjusted earnings per share to be in the ranges of $2.98 to $3.13 and $3.23 to $3.43, respectively. For 2025 and 2026, we expect to grow 6% to 8% off the 2024 adjusted EPS range. This equates to a range of $3.45 to $3.70 for 2025 and $3.63 to $4 for 2026. We will be disappointed if we are not able to deliver financial results at or near the top end of our adjusted earnings per share expectations ranges in each of 2023, 2024, 2025 and 2026, while at the same time maintaining our strong balance sheet and credit ratings. As always, our expectations assume our usual caveats, including normal weather and operating conditions. Let me now turn to NextEra Energy Partners, which had another terrific year of execution, while delivering on its commitments to unitholders. For 2022, NextEra Energy Partners grew its LP distributions per unit by approximately 15% year-over-year and delivered more than 20% year-over-year growth in adjusted EBITDA, highlighting the strength of its operating portfolio. This growth is supported by NextEra Energy Partners' outstanding portfolio of clean energy assets, which was further diversified in 2022. During the year, NextEra Energy Partners acquired interests in approximately 1,200 net megawatts of long-term contracted renewables and storage assets from Energy Resources. Our confidence in NextEra Energy Partners' long runway of growth has been further bolstered by the IRA. Against a backdrop that we believe includes at least two decades of clean energy incentives, we expect NextEra Energy Partners' opportunity set for acquiring renewables from both Energy Resources and from third-parties to continue to be robust. NextEra Energy Partners' organic growth opportunities have also expanded significantly, and we are currently evaluating repowering investments for roughly 1.3 gigawatts of wind assets owned by NextEra Energy Partners for 2024 through 2026. Additionally, earlier this month NextEra Energy Partners leveraged its cost of capital advantages to execute early buyouts of tax equity interests on two of its existing asset portfolios for approximately $190 million. These transactions are intended to enable NextEra Energy Partners to take advantage of the IRA's new transferability provisions, which allow for the sale of tax credits to third-parties. With the buyouts and subsequent transfer of tax credits, NextEra Energy Partners can now fully access two cash flow streams for unitholders -- project cash flows and cash flows that result from the transfer of PTCs. Taken together, NextEra Energy Partners expects these early tax equity investor buyouts to deliver an attractive cash available for distribution yield for unitholders. The significant tailwinds provided by the IRA and Energy Resources' future renewables outlook, combined with NextEra Energy Partners' third-party M&A and organic growth opportunities and continued ability to raise low-cost capital, even in a challenging capital markets environment, provide us with long-term growth visibility. As a result, today we are pleased to announce that we are extending our financial expectations for NextEra Energy Partners by another year. We now see 12% to 15% per year growth and per unit distributions as a reasonable range of expectations through at least 2026. We believe that NextEra Energy Partners' distribution per unit growth expectations are best-in-class versus any other company of its kind in the market and that the combination of NextEra Energy Partners' clean energy portfolio, growth visibility and financing flexibility offers unitholders a uniquely attractive investor value proposition. In summary, both NextEra Energy and NextEra Energy Partners have never been better positioned. We anticipate a tremendous acceleration of growth in renewables and storage deployment across the U.S. due in part to the IRA, particularly in the latter half of the decade. And we believe that our substantial competitive advantages will allow us to continue delivering value to shareholders and unitholders for many years to come. Before turning the call over to Kirk, I'd like to talk about the important organizational changes we are announcing this morning. After 20 years with NextEra Energy, Eric Silagy has notified me of his intention to retire from FPL, where he has led the team for 11 years. Eric has been a passionate advocate for continuous improvement and under his leadership, FPL has been transformed into the Nation's largest and most reliable electric utility. Over the last decade, Eric has led the efforts to modernize FPL's generating fleet, making it one of the cleanest, lowest-cost and most fuel-efficient in the country. His commitment to putting customers first is demonstrated every day by FPL's award winning customer service, bills that are significantly lower than the national average and the best reliability in the country. Last year during hurricanes Ian and Nicole, I saw firsthand Eric's dedication and compassion for our customers as he steered the FPL team to quickly restore power and quickly get the State of Florida back on its feet. Over his 20 years of dedicated service to our company, Eric has also been a tremendous supporter of the communities where we do business. His advocacy across the State has helped to foster Florida's economic growth, strengthen our state university system and grow the next generation of Florida leaders, just to name a few of his many accomplishments. I want to thank Eric for his service and wish him and his family all the best on this next chapter in life. With Eric's departure we are excited to welcome Armando Pimentel back to NextEra Energy as FPL's President and CEO. As you know, Armando previously served as NextEra Energy's and FPL's CFO and the President and CEO of NextEra Energy Resources. As a lifelong Floridian, Armando is a proven leader that will be relentlessly focused on serving our customers. He is also a good friend and colleague who I've worked closely with for many years, and I am confident that under Armando's leadership, FPL will continue its long track record of delivering outstanding performance to our customers. Thank you, John. I want to start by saying what an honor and a privilege it has been to work for NextEra Energy. This company's performance has been unprecedented in our industry and I couldn't be more proud of the results we have delivered for our customers, our shareholders and our employees. When I joined NextEra Energy in 2003, FPL relied more on foreign oil to generate electricity than any other utility in America. We knew that we needed to modernize our generation portfolio and we recognized that building a clean, low-cost and fuel-efficient fleet was a great decision for our customers as it would save them money on their fuel bill. Today, that long-term vision has saved FPL customers a cumulative $14 billion over the last 20 years. That's $14 billion that never came out of our customers' pockets and helped them to pay for their kids' education, take their families on a vacation or pay for other family expenses. These efforts began by thinking of ourselves more as a technology company than a utility, finding new and innovative ways to run the grid. And it led to improved reliability, reduced operating costs and a totally different way to approach hurricane restorations. Ultimately, this new way of thinking led to faster restoration times, which has saved the State of Florida billions of dollars. These are just a few examples of how we have transformed FPL into one of America's cleanest, most affordable and most reliable energy companies. While saying Goodbye to such a great organization is always difficult, I know that now is the right time for me to hand over the reins of FPL. The last year has been one of the most challenging of my career given a number of distractions, including two hurricanes and significant supply chain and inflationary pressures, to name just a few. When John became CEO of NextEra Energy last year, I committed to him that I would stay in my role for at least one more year and I've now satisfied that commitment. In April I will mark my 20th anniversary with NextEra Energy at which point I will have led the FPL team for going on 12 years, which is well beyond the tenure of most CEO's. We have two more years of execution before our next rate setting proceeding, which as all of you know is an all-consuming process and that I just wasn't sure that I could fully commit to. So, I feel it's best for the transition to take place now and for new leadership to take the helm of FPL to ensure consistent management heading into a very busy next couple of years. It has been the greatest honor of my career to lead the FPL team, and I cannot thank our nearly 10,000 FPL employees and thousands more of our retirees enough for their hard work, for their dedication and for always putting our customers first. They have served our communities and our state with distinction and always challenged themselves to get better every single day. In my opinion, and I'm a little biased, FPL is the best utility in the world. I am so proud of what our team has accomplished, and it is extremely well positioned to continue to deliver exceptional value to both customers, shareholders and to the state. I wish John, Armando and the entire FPL team all the best in their future endeavors. Thank you, Eric, and good morning everyone. Let's now turn to the detailed results, beginning with FPL. For the fourth quarter of 2022, FPL reported net income of $763 million, or $0.38 per share, up $0.07 per share year-over-year. For the full-year 2022, FPL reported net income of $3.7 billion, or $1.87 per share, an increase of $0.24 per share versus 2021. Regulatory capital employed increased by approximately 11.4% for 2022. We continue to expect FPL's average annual growth in regulatory capital employed to be roughly 9% over the four-year term of our current rate agreement. FPL's capital expenditures were approximately $3.1 billion in the fourth quarter, bringing its full-year capital investments to a total of roughly $9.2 billion. For the fourth quarter, FPL's net income was impacted by a number of factors, including favorable weather as well as an approximately $40 million pre-tax contribution to charitable foundations that will allow us to continue to support the communities that we serve. For the full-year 2022, FPL's year-over-year net income growth of nearly $500 million was aided by favorable weather, increased customer growth, and effective cost management that supported our ability to continue to deploy smart capital for the benefit of customers. FPL's reported ROE for regulatory purposes is expected to be 11.74% for the twelve months ended December 31, 2022. During the fourth quarter, we did not use any reserve amortization, leaving FPL with a year-end 2022 balance of $1.45 billion. Our overall capital program at FPL is progressing well. We continue to advance one of the nation's largest solar expansions and successfully met our solar deployment objectives at FPL in 2022. Beyond solar, construction on our green hydrogen pilot at the Okeechobee Clean Energy Center remains on schedule as it continues to advance towards its projected commercial operation date later this year. Earlier this week, FPL filed with the Florida Public Service Commission its proposed plan to recover approximately $2.1 billion of incremental fuel costs incurred in 2022. Under our proposed plan, FPL utilize its strong balance sheet to spread these unrecovered 2022 fuel costs over a 21-month period beginning in April 2023. Additionally, FPL's proposed plan would further benefit customers by offsetting the 2022 fuel cost recovery by approximately $1 billion this year based on the recent drop in projected natural gas prices compared to FPL's original 2023 projections made in the third quarter of 2022. We believe this proposal is a reflection of FPL's customer-centric strategy to navigate challenging environments for the benefit of customers. Separately, FPL is also seeking recovery of approximately $1.3 billion of storm costs incurred in 2022. Under FPL's proposal, the storm costs would be recovered over a 12-month period starting in April 2023 to reduce the potential customer bill impacts that could result from the simultaneous recovery of charges related to future storms. Taking both proposals together, we anticipate that FPL's typical 1,000 kilowatt hour residential customer bills as of April 2023 will remain well below the projected national average and the projected average for Florida investor-owned utilities. The Florida economy remains strong. Over the last 10 years, Florida's GDP has grown at a roughly 6% compound annual growth rate. The GDP of Florida is roughly $1.4 trillion, which is up approximately 10% from 2021. At the same time, Florida's population continues to grow at one of the fastest rates in the nation. Over the past year, Florida has created roughly 600,000 new private sector jobs, and Florida's labor force participation rate continues to improve at a faster rate than the rest of the country. Although we have seen the growth rate stabilize, three-month average Florida building permits, a leading indicator of residential new service accounts, have outpaced the nation's quarterly growth in new building permits by roughly 6%. Other measures of confidence in the Florida economy have meaningfully improved versus the prior-year, including an 11% improvement in Florida's retail sales index and a roughly 2% decline in mortgage delinquencies. During the quarter, FPL's average customer growth was strong, increasing by nearly 74,000 from the comparable prior-year quarter. FPL's fourth quarter retail sales were up 2.1% versus the prior-year period, primarily driven by a favorable weather comparison. For 2022, FPL's retail sales increased 1% from the prior-year on a weather-normalized basis, driven primarily by continued strong customer growth. Energy Resources reported fourth quarter 2022 GAAP net income of $996 million, or $0.50 per share. Adjusted earnings for the fourth quarter were $402 million, or $0.20 per share. For the full-year, Energy Resources reported GAAP earnings of $285 million, or $0.40 per share, and adjusted earnings of approximately $2.44 billion, or $1.23 per share. The effect of the mark-to-market on nonqualifying hedges, which is excluded from adjusted earnings, was the primary driver of the difference between Energy Resources full-year GAAP and adjusted earnings results. Energy Resources' full-year adjusted earnings per share contribution increased by $0.11 versus 2021. Contributions from new investments increased by $0.04 per share due to continued growth in our renewables and storage portfolio. As we previously highlighted, the Commerce Department's decision to investigate circumvention claims led to delays in the development of renewables, which effectively pushed out the completion of certain projects that we previously anticipated in 2022. As a result, contributions from new investments were negatively impacted in 2022. We anticipate that Energy Resources' adjusted earnings per share contributions from new investments will be much stronger in 2023, when we expect many of these delayed projects will be completed. Our customer supply and trading business increased results by $0.12 versus 2021, primarily due to higher margins in our customer-facing businesses and the absence of Winter Storm Uri impacts. Our existing clean energy assets also increased results by $0.02 per share year-over-year. All other net impacts decreased results by $0.07 year-over-year, driven primarily by higher debt balances reflecting growth in the business. Additional details of our full-year 2022 results at Energy Resources are shown on the accompanying slide. As John mentioned, Energy Resources delivered our best year ever for origination, signing approximately 8,030 megawatts of new renewables and battery storage projects. Since the last call, we have originated approximately 1,700 megawatts of renewables and storage projects, including approximately 300 megawatts of wind, 730 megawatts of solar and 670 megawatts of battery storage. Our origination performance in 2022 reflects continued high demand among all customer classes for clean energy solutions that not only help achieve their renewable energy goals but, perhaps more importantly, allow our customers to save on energy costs by switching to lower-cost forms of generation like wind, solar, and solar-plus-storage. Today, we are extending our renewables development expectations through 2026 as a result of our tremendous progress in 2022, strong continued origination success and the strong market demand for low-cost renewables driven in part by the IRA. Our revised expectations are by far the largest expected four-year development program in our history and reflect our high level of confidence in Energy Resources' ongoing leadership position and the continued acceleration of renewables penetration across the country. The accompanying slide provides additional details on our new expectations and where our development program at Energy Resources now stands. As you know, the industry has faced significant supply chain challenges and disruption over the past year and yet our integrated supply chain and engineering and construction teams demonstrated their resiliency by continuing to execute for our customers, and we have been working for over a year with our suppliers to manufacture wafers outside of China. We believe the Commerce Department's preliminary determination on circumvention of anti-dumping and countervailing duties late last year clarified that solar panels manufactured in Southeast Asia using wafers and cells produced outside of China are not circumventing anti-dumping and countervailing duty laws. We are confident that we can source panels consistent with these guidelines by the end of the two-year waiver period. Finally, we continue to advance discussions to support the domestic production of solar panels. Turning now to the consolidated results for NextEra Energy. For the fourth quarter of 2022, GAAP net income attributable to NextEra Energy was $1.52 billion, or $0.76 per share. NextEra Energy's 2022 fourth quarter adjusted earnings and adjusted EPS were approximately $1 billion, or $0.51 per share, respectively. For the full-year 2022, GAAP net income attributable to NextEra Energy was $4.15 billion, or $2.10 per share. Adjusted earnings were $5.74 billion or $2.90 per share. For the Corporate & Other segment, adjusted earnings for the full-year were roughly flat compared to the prior-year. As John mentioned, we invested more than $19 billion in our businesses in 2022, which we expect will again place NextEra Energy among the top capital investors in the U.S. across all sectors. Capital recycling remains an important part of our financing strategy and this year, we recycled more than $5 billion of capital through asset sales and tax equity financings. Additionally, as we have often highlighted, our underlying businesses generate significant cash flow and in 2022, our operating cash flow grew more than 9% year-over-year, despite FPL being under-recovered for fuel costs and incurring restoration costs for hurricanes Ian and Nicole. As a result of this strong cash generation, we proactively paid down nearly $3 billion in 2023 maturities. Finally, we ended the year with $15 billion of interest rate swaps to manage interest rate exposure on future debt issuances. As a reminder, the current interest rate environment is taken into account in our financial expectations. As John discussed, today we are reaffirming our adjusted earnings per share expectations for 2023 through 2025 and introducing expectations for 2026. Details of our new financial expectations are included in the accompanying slide. We will be disappointed if we are not able to deliver financial results at or near the top end of these ranges. From 2021 to 2026, we expect that our average annual growth in operating cash flow will be at or above our adjusted EPS compound annual growth rate range. We also continue to expect to grow our dividends per share at roughly 10% per year through at least 2024, off a 2022 base. Let me now turn to the detailed financial results for NextEra Energy Partners. Fourth quarter adjusted EBITDA was $360 million, up approximately 12% year-over-year. Adjusted EBITDA growth versus the prior-year comparable quarter was primarily due to new asset additions. Fourth quarter cash available for distribution was $74 million. As a reminder, NextEra Energy Partners' operating expenses and interest expense on project debt are typically higher in the fourth quarter versus the first three quarters of the year. For the full-year 2022, adjusted EBITDA was approximately $1.65 billion, up 21% year-over-year, and was primarily driven by the full contribution from new projects acquired in late 2021. Existing projects added approximately $13 million of adjusted EBITDA year-over-year, with the benefits of higher net generation for both wind and solar partially offset by relatively higher operating and maintenance costs versus 2021. NextEra Energy Partners' cash available for distribution was $634 million for the full-year. Relative to the growth in NextEra Energy Partners' full-year adjusted EBITDA, its cash available for distribution from existing projects was also impacted by relatively higher allocation of production tax credits to investors due to favorable wind resource versus 2021. Over the past five years, NextEra Energy Partners' cash available for distribution has grown at a compound annual growth rate of more than 20%. As a reminder, these results include the impact of IDR fees, which we treat as an operating expense. Additional details are shown on the accompanying slide. Yesterday, the NextEra Energy Partners Board declared a quarterly distribution of $0.8125 per common unit, or $3.25 per unit on an annualized basis, up approximately 15% year-over-year and at the top end of the range we discussed going into 2022. Inclusive of this increase, NextEra Energy Partners has grown its distribution per unit by more than 330% since the IPO. During 2022, NextEra Energy Partners executed several low-cost financings continuing its successful track record of accessing attractive sources of capital to support growth for unitholders. During the fourth quarter, NextEra Energy Partners entered into a new convertible equity portfolio financing for approximately $900 million with a low implied cash coupon of roughly 2.8% for up to 10 years, to be funded by the investor's share of ongoing portfolio cash flows. In December, NextEra Energy Partners raised approximately $500 million in new convertible notes with a 2.5% coupon, which along with the capped call entered into at the time of the financing provides unitholders with dilution protection for up to 50% accretion versus the NEP unit price at the time of issuance. The implied total cost of the convertible notes represents the most favorable spread to an alternative debt issuance in our history. These transactions executed during the fourth quarter were a continuation of NextEra Energy Partners' successful financing execution throughout 2022. In May 2022, NextEra Energy Partners increased the size of its revolving credit facility to approximately $2.5 billion, nearly all of which is currently available. With this available revolving credit capacity and the final funding of approximately $180 million expected from the 2022 convertible equity portfolio financing, NextEra Energy Partners enters 2023 with significant financing capacity to fund future growth. Additionally, NextEra Energy Partners still has $6 billion of Forward Starting Interest Rate Swaps, which is more than enough to cover its corporate maturities through 2027 and will help mitigate the impact of higher interest rates on future debt issuances, whether for maturities or net new issuances. Taken together, we believe that NextEra Energy Partners is extremely well positioned with significant interest rate protection and ample liquidity to finance future growth and to capture a meaningful share of the long-term opportunity set which has expanded as a result of the IRA. This significant opportunity set and NextEra Energy Partners' meaningful financing flexibility provides us with confidence in our ability to continue to deliver long-term value for unitholders over the coming years. From an updated base of our fourth quarter 2022 distribution per common unit at an annualized rate of $3.25, we now see 12% to 15% growth per year in LP distributions as being a reasonable range of expectations through at least 2026, which is an additional year beyond our prior expectations, driven by the partnership's tremendous long-term growth visibility. We expect the annualized rate of the fourth quarter 2023 distribution that is payable in February 2024 to be in a range of $3.64 to $3.74 per common unit. NextEra Energy Partners' run rate expectations for adjusted EBITDA and cash available for distribution at December 31, 2023 remain unchanged. Year-end 2023 run-rate adjusted EBITDA expectations are $2.22 billion to $2.42 billion and cash available for distribution of $770 million to $860 million, respectively, reflecting calendar year 2024 contributions expected from the forecasted portfolio at year-end 2023. As a reminder, all our expectations are subject to our normal caveats and include the impact of anticipated IDR fees, as we treat these as operating expense. In summary, we continue to believe that both NextEra Energy and NextEra Energy Partners have excellent prospects for growth both in the near-term and long-term. Near-term, the progress we made in 2022 reinforces our growth outlook and sets the foundation for continuing to deliver on our financial expectations. Long-term, we believe that the low cost of renewables combined with other clean energy solutions enabled in part by the IRA provides us with unprecedented visibility to extend our track record of delivering long-term growth for our shareholders and unitholders, and we could not be more excited about our future. Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Steve Fleishman from Wolfe Research. Please go ahead. Yes, hi. Good morning. So just a couple questions on the management changes. So you don't appear to be making any connection between the investigation in Eric's retirement. Could you just confirm if that's correct or not? And then I guess secondly, just thoughts on -- often with these successions you'd bring somebody kind of internally up. So maybe thoughts on bringing Armando back who we know well, but just as opposed to the kind of bringing someone internally up? Thanks. Yes, thanks, Steve. First of all, on your first question on connection, we're not making a connection. Eric, when I was first chosen to succeed Jim, Eric, and I had a conversation. Eric said, look I will give you a one-year commitment stay at the company. And we would talk about it at the end of the year. Eric satisfied that commitment to me. 2022 obviously was a year with a lot of challenges. The distractions Eric went through in his prepared remarks. But when you think about all the challenges that that he had to overcome with the hurricanes and with high natural gas prices and inflation and the supply chain and on the media allegations and all those things, I think it took a toll on Eric that that year and gave me his retirement notice. And it's, the way I look at it is it's a little earlier than would've hope Eric, Eric would've wanted to do it. And so we have a very deep bench over at FPL. I'm going to your second question now, a very deep bench at FPL. We have a lot of terrific folks that we could move into Eric's role. We have one individual in particular, Christopher Chapel, he is being promoted to Chief Operating Officer as part of the transition. We're bringing Armando back as well. And Armando has been just a terrific friend to me. I have a lot of respect for Armando. I had the good fortune to work with Armando for roughly 15 years. And I think he will do a great job of bringing Christopher along, who I think in the future will just make an outstanding CEO of FPL. But he, Christopher has been running customer service. He needs to get a little bit more experience on the operations side and on -- and working with the regulatory team. And then on the financial side, getting us ready for the rate case. And I think the combination of Armando working together with Christopher that is a very powerful team, and they will do a tremendous job working together to execute on behalf of FPL. And I think Christopher has a very, very bright future with our company. And all of you will have a chance to get to know him and to meet him in the near future. Some of you have had that chance in the past, and I think that should be a familiar name to some of our investors. Because I'm sure you can appreciate these kind of decisions are never easy, and there's no ever perfect time. As John said, with a transition of leadership last year, I gave John a commitment that I'd be here for at least a year. Didn't have any real hard timeline set, but I've been in the Chair for 11 years. This will be going into my 12th year. And my predecessor had been in the job for 10 years. Jim had been in his job for 10 years, before that Lew Hay had been in his job for 10 years. And as I look forward to, this is the kind of job that you have to plan ahead and we're getting ready to go in another rate case cycle. I mean, that's a multi-year type of approach. And so to go forward longer means I'm really committing through 2026. So a lot of factors come into play. John touched on all of the challenges in 2022. I'm really, really proud of how the team handled them. But it's a 24-hour day job. And there are a lot of challenges that we successfully managed, but it's a decision that is not easy, but I feel good about moving forward and putting -- doing it when the company is in its strongest financial and operational position it's ever been in. With a very strong leadership team, I think that's the right time to do it. Right. Well, I appreciate that color. Thanks. That's the main question we've been getting from people. So just one other thing on the wind -- excuse me, on the backlog, it seems like there's a big increase in wind expectations for the next four years, or the main driver of the higher backlog. Could you just give more color on what's driving? Is that just the extension of the credits or other things leading to more wind expectation through '26? Good morning, Steve. It's Rebecca and I'll chime in on that. It is exactly what John and Kirk highlighted and what we've been talking about for the last couple of months following IRA. With IRA provisions, we now have extensions of incentives now through the end of the decades - well decade plus, but just looking into visibility, it's exceptional now through the end of the decade and likely well beyond that. And it is a big change specifically for wind in this timeframe adding the 100% production tax credit now, obviously through this expectation, windows through it fully. And it's also supported by the backdrop of what I also have highlighted to you all. And John talked about in his remarks about all of the positive follow on effects from strong incentives on renewables and through the introduction of a hydrogen production tax credit. We're starting to see substantial demand and positive engagement around renewables to create green hydrogen and hydrogen-related products thereafter. So our development team is busy having the types of conversations we've never had before, and we can't be more excited about what's ahead. And that's for wind solar storage and the hydrogen products that we're talking about. Hey, good morning team, and congrats, Eric, on your steward career. Armando, welcome back. Feels a little bit like when Maury came back in 2009 here, I must admit. Maybe just related to some of the changes here, just to follow-up on that super quick. First off is Armando committing to the full process here, as you alluded to the rate case cycle being a little bit protracted. And then related to that what is the final timing in terms of this internal process that you guys had underway per the 8-K and is that impacted at all by this pending FEC process that you allude to taking upwards of the balance of the year here? Yes, let me go ahead and take those, Julien. This is John. So first of all on -- with Armando, Armando's committed, he's coming back as our CEO and President of FPL. Armando's committed. So let me just say that. And again, as I said, he is inheriting just a terrific team. I would say easily -- in my own belief, the best team in the industry, and it's a team Eric built and did an outstanding job building, and there's just a lot of strength there. And Armando's has a good fortune of being able to lead that organization. And with Christopher Chapel, as I said too, taking on that that Chief Operating Officer role, I think that's quite a one, two punch that we're going to have over at FPL combined with the existing strength that we already have on the bench there. And the other thing I'll mention is that, Eric, we have the good fortune of Eric staying through the middle of May, which will help ensure a very smooth transition for both Armando moving into to that role. And for Christopher, having a chance to step up, and Eric will do a great job on that transition, and making sure all the right relationships are transitioned as part of that. That's the first piece. The second piece you talked about the internal process and timing. First of all, let me just cover it one more time. I mean, we are substantially complete. On the Florida side, as I said on my comments, we do not believe that FPL would be found liable of a federal campaign finance violation based on our investigation. And second, with regard to the FEC process, let me just say a few words about the FEC process, just so everybody understands exactly what it is. The Federal Election Commission has civil enforcement authority. Anybody in the United States can file a claim with the FEC. And given the political environment that we're in today, I would certainly expect even an uptick in more claims being filed with the FEC, but any citizen can file a complaint. That's where we are right now. A citizen, special interest group filed a complaint. There is no formal legal proceeding or any proceeding with the FEC right now. The FEC will take 12 to 18 months to decide whether or not there is a reason to believe that they should investigate this further. And we will file a motion for dismissal. We think that a claim like this that's based solely on media reports and allegations is not the type of a claim the FEC should take up. If you read the complaint, the complaint details five different scenarios, those, if you add up all the contributions in those scenarios, they don't exceed $1.3 million. And so, when we look at the FEC process as a whole and the FEC complaint as a whole, we do not believe that the federal allegations, taken as a whole, as I said would have a material impact on our business. Got it. And then just super quickly, if I can, just with respect to the originations here, the 1.7 since the third quarter call, this seems a little bit down from the last quarterly call update in the slides. Can you comment a little bit about the trends? Obviously, I'm cognizant of the comments you made about the overall expectations through '26. How do you think about that materializing the pace and just what customer feedback is in putting in orders, "now versus in subsequent period"? Yes, let me take that, Julien. The first thing I would say is the demand for renewables is as strong as ever. When I look at the opportunities that the development organization has right now, they are significant. I mentioned in my remarks the term sheet we signed on the 800 megawatt facility in the Central part of the U.S. for a green hydrogen facility that we didn't even count, for example. And we have a lot of interest around hydrogen right now that's going to fuel a lot of renewable opportunities. The C&I market is extremely strong. We're just seeing a lot of demand across the board. And so I think that's why you see with the revised development expectations, 42 gigawatts on the high end, oh my gosh, I think those of you that have been following the company for a long time, 42 Gigs, that's a 15% uptick on the last four year set that we had, I mean, just to put it in perspective, I mean, FPL's total generation fleet is 27 gigawatts, so to 42 gigs over a four-year period, hopefully that provides a little color and context. Good morning, team. It's actually Constantine here for Shar and congrats on a great quarter, and just wanted to wish Eric the best in the next steps. Certainly, appreciate that. Maybe as a quick follow-up to Julien's question, and maybe just on the -- and you've noted prior impacts of the IRA having some pull and push on the demand for renewables, and maybe just specifically on the details of the cadence of the growth to reach those '26 targets front end loaded, backend loaded, anything there? Yes, hi, Constantine. It's Rebecca. I think the best place to point you to is the development expectations slide that Kirk went through. It's Slide 12 in the materials, and it lays out the ranges by technology for '23 and '24, and then '25 and '26. And obviously there's a significant increase in going into '25 and '26 really for all the things that we're talking about, the significant momentum, also a lot of resolution over the last couple of months and clarity around some of the supply chain disruption that we've seen on the solar side. So it is building and the momentum as John highlighted so well remains exceptionally strong on the development and origination side. So I'm really excited about everything that we see in our traditional businesses as well as the commercial and industrial sector. And then of course, the burgeoning opportunities that we see on the green hydrogen and related products side. Excellent. And on a related note on the kind of upside from repowering opportunities, do you have any thoughts on kind of solar and storage type of repowering? I know that wind is starting to make it into the plan. Just curious on the other side. Yes, we're looking at it and there's, we think there's opportunities over time to repower both battery storage projects as well as on the solar side, there they can be a little bit more complex. And we're certainly looking for some guidance as we go through this year from treasury on this point, as well as others that will be helpful in giving us context. But some of this is also timing. So as you get more mature projects, obviously 10 years on the wind side, five plus years on the solar side will be opportunities then really to expand the horizon for repowering. But as I've talked to our team, every day we're looking at our existing generation portfolio, and I see more opportunities today to enhance the value of our existing portfolio than we've ever seen before. That of course includes repowering, it includes adding battery storage, it includes thinking differently because of the exciting opportunities around green hydrogen about even citing some of those load opportunities, the electrolysis equipment to produce that hydrogen at existing assets. And we're also making investments in transmission across a variety of the integrated system operation markets to be able to add transmission to increase the value of the existing portfolio. So we think there's tons of opportunities and so much more certainty looking forward than we've ever had before because of the clarity around the incentives. Hi, thanks so much for taking my question. I was wondering if you could comment on just your latest experience with access to solar panel supply whether there's any risks that you see for executing on this year's development plan and how the UFLPA law has been impacting projects? Sure. Hi, Dave. This is Kirk, I'll take that. So the last time we spoke, I believe was on the third quarter earnings call. And we shared with you that as our integrated supply chain team had worked and certainly had a challenging year in 2022, but as we highlighted on the earnings call today despite that challenging year, they did a really admirable job. We were able to still put into service 5,000 megawatts. And I think that really speaks to their ability to navigate that disruption. And certainly part of that disruption was you highlighted, which was that the challenges around the ports and trying to work through the panels that had been detained and at the ports. And as I mentioned, the challenges around -- in the third quarter that we highlighted with some of the panels being detained there, what we've seen since the third quarter call is some positive improvement. We've seen some of the panels that had previously been detained, released. And so I would describe it as positive movement. We continue to see each day some positive movement. So we're continuing to monitoring it. We're watching it closely. The team is actively working with our suppliers and continuing to monitor it. But compared to where we were in the third quarter I think we're cautiously optimistic that we are seeing progress and at least from our perspective, we continue to feel like it's something that we can manage in terms of continuing to deliver for our customers. Okay, great. Thanks for that color. And on the renewables development program, I was wondering if green hydrogen is starting to have an impact on the back end of the plan in terms of influencing the renewables demand outlook yet, like in 2026, are you starting to kind of weave in expected demand on renewables from green hydrogen at that point? It's certainly something, it's Rebecca. It's obviously something that we considered when we are setting the development expectations and what we laid out today for you all. I can tell you from a practical standpoint, it very much is starting to show up in the conversations that we're looking at including the 800 megawatt term sheet that we signed in recent weeks for a project that would be expected to COD in 2026. At this point, I think there are a number of folks and ourselves included working hard to put the right development opportunities together. But it is a very active market. We're really excited about opportunities to partner with key folks, Linde among them, as we talked about in the call, but others as well to put forward terrific projects and really bring forward the promise of this technology that we've now been talking about. But it's really coming to reality. I think '26 is probably on the earlier side of what we ultimately will see as a significant ramp-up going into the end of the decade where there's more opportunity to have supply ramp-up for electrolyzers as well as other related equipment for some of the green hydrogen related products as well as working through the development opportunities and establishing the ultimate customers for these products. But everything I see is really exciting and really starting to take shape just now a number of months after the hour provisions were ultimately passed into law. This concludes our question-and-answer session. And the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
|
EarningCall_1184
|
Greetings and welcome to the Microsoft Fiscal Year 2023 Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Brett Iversen, Vice President, Investor Relations. Good afternoon and thank you for joining us today. On the call with me are Satya Nadella, Chairman and Chief Executive Officer; Amy Hood, Chief Financial Officer; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Deputy General Counsel. On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during todayâs call and provides the reconciliation of differences between GAAP and non-GAAP financial measures. On this call, we will discuss certain non-GAAP items. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the companyâs second quarter performance in addition to the impact these items and events have on the financial results. All growth comparisons we make on the call today relate to the corresponding period of last year unless otherwise noted. We will also provide growth rates in constant currency when available as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we will refer to the growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Todayâs call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website. During this call, we will be making forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in todayâs earnings press release, in the comments made during this conference call and in the Risk Factors section of our Form 10-K, Forms 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. Thank you very much, Brett. I want to start with the context I shared with our employees last week on the changing environment and our priorities. As I meet with customers and partners, a few things are increasingly clear. Just as we saw customers accelerate their digital spend during the pandemic, we are now seeing them optimize that spend. Also, organizations are exercising caution given the macroeconomic uncertainty. And the next major wave of computing is being born as we turn the worldâs most advanced AI models into a new computing platform. In this environment, we remain convicted on three things. This is an important time for Microsoft to work with our customers, helping them realize more value from their tech spend and building long-term loyalty and share position while internally aligning our own cost structure with our revenue growth. This in turn sets us up to participate in the secular trend where digital spend as a percentage of GDP is only going to increase. And lastly, we are going to lead in the AI era, knowing that maximum enterprise value gets created during platform shifts. With that as the backdrop, the Microsoft Cloud exceeded $27 billion in quarterly revenue, up 22% and 29% in constant currency. Now, I will highlight examples of our innovation starting with Azure. Moving to the cloud is the best way for any customer in todayâs economy to mitigate demand uncertainty and energy costs while gaining efficiencies of cloud native development. Enterprises have moved millions of calls to Azure and run twice as many calls on our cloud today than they did 2 years ago. And yet, we are still in the early innings when it comes to long-term cloud opportunity. As an example, insurer AIA was able to save more than 20% by migrating to Azure and reduced IT provisioning time from multiple months to just an hour. We also continue to lead with hybrid computing with Azure Arc. We now have more than 12,000 Arc customers, double the number a year ago, including companies like Citrix, Northern Trust and PayPal. Now on to data. Customers continue to choose and implement the Microsoft Intelligent Data Platform over the competition because of its comprehensiveness, integration and lower cost. Bayer, for example, used the data stack to evaluate results from clinical trials faster and more efficiently while meeting regulatory requirements and ASOS chose Cosmos DB to power real-time product recommendations and order processing for over 26 million global customers. Now on to AI. The age of AI is upon us and Microsoft is powering it. We are witnessing non-linear improvements in capability of foundation models, which we are making available as platforms. And as customers select their cloud providers and invest in new workloads, we are well positioned to capture that opportunity as a leader in AI. We have the most powerful AI supercomputing infrastructure in the cloud. Itâs being used by customers and partners like OpenAI to train state-of-the-art models and services, including ChatGPT. Just last week, we made our Azure OpenAI service broadly available and already over 200 customers from KPMG to Al Jazeera are using it. We will soon add support for ChatGPT, enabling customers to use it in their own applications for the first time. And yesterday, we announced the completion of the next phase of our agreement with OpenAI. We are pleased to be their exclusive cloud provider and we will deploy their models across our consumer and enterprise products as we continue to push the state-of-the-art in AI. All of this innovation is driving growth across our Azure AI services. Azure ML revenue alone has increased more than 100% for five quarters in a row with companies like AXA, FedEx and H&R Block choosing the service to deploy, manage and govern their models. Now on to developers. Modernizing applications is mission-critical to any companyâs operations today. And with GitHub, Visual Studio and Azure PaaS services, we have the most comprehensive portfolio of tools to help. GitHub is now home to 100 million developers and GitHub Copilot is the first at-scale AI product built for this era, fundamentally transforming developer productivity. More than 1 million people have used Copilot to-date. This quarter, we brought Copilot to businesses and we have seen strong interest and early adoption from companies, including Duolingo, Lemonade and Volkswagen Cariad Software Group. Now on to Power Platform. Power Platform is becoming an essential digital transformation tool as every business looks to streamline their operations and drive productivity in todayâs environment. We are helping customers realize superior time to value with our end-to-end suite spanning low-code, no-code tools, automation, virtual agents and business intelligence. We are leading in robotic process automation. Power Automate has more than 45,000 customers from AT&T to Rabobank, up over 50% year-over-year. And we are making it easier for anyone to streamline repetitive tasks, introducing new AI-powered features to turn natural language prompts into complex workflows. Now on to business applications. Dynamics 365 is taking share as we help businesses digitize their service, finance, customer experience and supply chain functions. For example, G&J Pepsi-Cola Bottlers is moving from reactive to predictive field service. FUJIFILM is optimizing its operations. Investec is closing deals faster with conversational intelligence. Baylor Scott & White in Texas is using our digital contact center to enhance patient communications. And this quarter, we introduced our new Supply Chain Platform, helping customers like iFit and Kraft Heinz apply AI to predict and mitigate disruptions. Now on to Industry Solutions. Our industry and cross-industry clouds are driving pull-through for our entire tech stack. Our cloud for retail was front and center at NRF last week as we introduced new tools to help retailers manage their day-to-day operations and digitize their physical stores. Polish retailer Zabka has built the largest chain of autonomous stores in Europe with the help of our technology. In Financial Services, our new partnership with London Stock Exchange Group will deliver next generation of data analytics and workspace solutions. And in healthcare, we are rapidly becoming the partner of choice for any provider looking to generate real value from AI. With Nuance DAX ambient intelligence solution, physicians can reduce documentation time by half, improving the quality of their patient interactions. Now on to systems of work. Microsoft 365, Teams and Viva are essential for every organization to adapt to the new world of work. Microsoft 365 is rapidly evolving into an AI-first platform that enables every individual to amplify their creativity and productivity with both our established applications as well as new applications like Designer, Stream and Loop. We have more than 63 million consumer subscribers, up 12% year-over-year and we introduced Microsoft 365 Basic, bringing our premium offerings to more people. Teams surpassed 280 million monthly active users this quarter, showing durable momentum since the pandemic and we continue to take share across every category from collaboration to chat to meetings to calling. Teams has emerged as a first-class platform. Apps from Adobe, Atlassian, Poly, ServiceNow and Workday have each surpassed 0.5 million active users and the number of third-party apps with more than 10,000 users increased nearly 40% year-over-year. There are more than 500,000 active Teams Rooms devices, up 70% year-over-year and the number of customers with more than 1,000 rooms doubled year-over-year. Novo Nordisk will deploy Teams Rooms to 5,000 meeting rooms globally in our largest deal to-date. Teams Phone continues to take share and is the market leader in cloud calling. We have added more than 5 million PSTN seats over the last 12 months alone. With Teams Premium, we are meeting enterprise demand for advanced features like end-to-end encryption and AI-powered recaps. We have seen strong interest in preview and we will make it broadly available next month. With Microsoft Viva, we have created a new market category for our employee experience and organizational productivity. U.S. Bank is using Viva to streamline employee communications and Carlsberg turned to Viva to centralize its digital employee experience for 29,000 employees. In todayâs environment, aligning the entire organization and the most important work is critical. Viva Goals brings objectives and key results directly into the flow of daily work. Viva has also become an indispensable tool for business process. Viva Sales is the super app in Microsoft 365 for sellers. We have seen strong interest since making it generally available this quarter. All up, we continue to see organizations consolidate on Microsoft 365. 80% of our enterprise customers use 5 or more Microsoft 365 applications. And organizations across the private and public sector, including EY, IKEA, NTT Communications, Rio Tinto as well as the state government of Virginia are increasingly choosing our premium E5 offerings for advanced security, compliance, voice and analytics. Now on to Windows. While the number of PCs shipped declined during the quarter, returning to pre-pandemic levels, usage intensity of Windows continues to be higher than pre-pandemic with time spent per PC up nearly 10%. Monthly active devices also reached an all-time high this quarter. And for commercial customers, Windows 11 adoption continues to grow because of its differentiated security and productivity value proposition. We are also seeing growth in cloud-delivered Windows with usage of Windows 365 and Azure Virtual Desktop up by over two-thirds year-over-year. Leaders in every industry from Campari and Grant Thornton UK to Nutrien and Woolworths are using cloud-delivered Windows, including more than 60% of the Fortune 500. Now on to security. Over the past 12 months, our security business surpassed $20 billion in revenue as we help customers protect their digital estate across clouds and endpoint platforms. We are the only company with integrated end-to-end tools spanning identity, security, compliance, device management and privacy informed and trained on over 65 trillion signals each day. We are taking share across all major categories we serve. Customers are consolidating on our security stack in order to reduce risk, complexity and cost. The number of organizations with four or more workloads increased over 40% year-over-year. UK retailer Fraser Group, for example, consolidated from 10 security vendors to just Microsoft. Roku moved identity and access management to the cloud with Azure Active Directory. And Astellas Pharma, Ferrovial and University of Toronto all switched to Microsoft Sentinel because of our integrated XDR and SIM capabilities. Now on to LinkedIn. People and companies continue to look to LinkedIn to connect, learn, sell and get hired. We once again saw record engagement among our more than 900 million members. Three members are signing up every second. Over 80% of these members are from outside the United States. And as the members come to the platform to find and share professional knowledge and expertise, newsletter creation was up 10x year-over-year. Skills are the new currency and people are increasingly investing in their skill-building to keep up with their changing roles in industries. We offer more than 20,000 courses in 11 languages and companies are also turning to a skills-based approach in place of degree or pedigree to identify qualified talent, with more than 45% of the hires on LinkedIn explicitly using skills data to fill their roles. Finally, LinkedIn Marketing Solutions continues to be a leader in B2B digital advertising, helping companies deliver the right message to the right audience on a safe and trusted platform. Now on to advertising. Despite headwinds in the ad market, we continue to innovate across our first and third-party portfolios. Our browser, Microsoft Edge gained share for the seventh consecutive quarter. Bing continues to gain share in the United States and daily users of our Start personalized content feed increased over 30% year-over-year. We are now empowering retailers and expanding our third-party inventory. With PromoteIQ, we are building a complete omnichannel media platform for companies like the Australian retailer, Endeavor, as well as Canadaâs Hudsonâs Bay and Global, the largest Brazilian TV broadcasters chose Xandr to launch a new media buying platform in that market. Now on to gaming. In gaming, we continue to pursue our ambition to give players more choice to play great games wherever, whenever and however they want. We saw new highs for Game Pass subscriptions, game streaming hours and monthly active devices, and monthly active users surpassed a record 120 million during the quarter. We continue to invest to add value to Game Pass. This quarter, we partnered with Riot Games to make the companyâs PC and mobile games, along with premium content available to subscribers. And finally, we are energized by our upcoming lineup of AAA game launches, including exciting new titles from ZeniMax and Xbox Game Studios and we will be sharing details in Gameplay at our showcase tomorrow. In closing, I want to extend my deepest gratitude to our employees for their continued dedication to our mission, customers and partners. We will continue to pursue our long-term opportunity and innovation agenda with urgency while also raising the bar on our operational excellence. Thank you, Satya and good afternoon everyone. Iâd like to start by reiterating Satyaâs thoughts on the changing environment and our priorities, which underpin the decisions communicated in last weekâs announcement. The resulting Q2 charge negatively impacted gross margin by $152 million, operating income by $1.2 billion, and earnings per share by $0.12. Our second quarter revenue was $52.7 billion, up 2% and 7% in constant currency. When adjusted for the charge, gross margin dollars increased 2% and 8% in constant currency, operating income decreased 3% and increased 6% in constant currency, and earnings per share was $2.32, which decreased 6% and increased 2% in constant currency. In our consumer business, the PC market was in line with our expectations, but execution challenges impacted our Surface business. Advertising spend declined slightly more than expected, which impacted search and news advertising and LinkedIn Marketing Solutions. In our commercial business, we delivered strong growth in line with our expectations. However, as you heard from Satya, we are seeing customers exercise caution in this environment and we saw results weaken through December. We saw moderated consumption growth in Azure and lower-than-expected growth in new business across the standalone Office 365, EMS and Windows commercial products that are sold outside the Microsoft 365 suite. From a geographic perspective, we saw strong execution in many regions around the world. However, performance in the U.S. was weaker than expected. Importantly, we continued to see share gains in areas such as data and AI, Dynamics, Teams, Security and Edge. Commercial bookings increased 7% and 4% in constant currency, lower than expected. Consistent execution across our renewal sales motions, including strong recapture rates and growth in Azure commitments on a high prior year comparable were partially offset by the slowdown in growth of new standalone business noted earlier. Commercial remaining performance obligation increased 29% to 26% in constant currency to $189 billion. Roughly 45% will be recognized in revenue in the next 12 months, up 24% year-over-year. The remaining portion, which will be recognized beyond the next 12 months, increased 32%. Our annuity mix increased 2 points year-over-year to 96%. FX decreased total company revenue by 5 points, in line with expectations. At a segment level, FX decreased Productivity and Business Processes revenue growth by 6 points, 1 point favorable to expectations. FX impact on Intelligent Cloud and More Personal Computing were both in line with expectations. Additionally, FX decreased both COGS and operating expense growth by 2 points, 1 point unfavorable to expectations. Microsoft Cloud revenue was $27.1 billion and grew 22% and 29% in constant currency, ahead of expectations. Microsoft Cloud gross margin percentage increased roughly 2 points year-over-year to 72%, a point better than expected, driven by lower energy costs. Excluding the impact of the change in accounting estimate for useful lives, Microsoft Cloud gross margin percentage decreased roughly 1 point, primarily driven by sales mix shift to Azure. Company gross margin percentage was 67%. Excluding the impact of the change in accounting estimate, gross margin percentage decreased roughly 2 points, driven by a lower mix of Windows OEM revenue and sales mix shift from licensing to cloud. Operating expense when adjusted for the Q2 charge increased 11% and 13% in constant currency, about $500 million lower than expected. Operating expense growth was driven by investments in cloud engineering, the Nuance acquisition and LinkedIn. At a total company level, headcount ended December 19% higher than a year ago. Sequential headcount growth was less than 1%. Year-over-year growth included roughly 6 points from the Nuance and Xandr acquisitions, which closed last Q3 and Q4, respectively. Adjusted for the charge, operating margins decreased roughly 2 points year-over-year to 41%. Excluding the impact of the change in accounting estimate, operating margins declined roughly 4 points, primarily driven by unfavorable FX impact as well as a lower mix of OEM revenue. Now to our segment results. Revenue from Productivity and Business Processes was $17 billion and grew 7% and 13% in constant currency, in line with expectations when excluding the favorable FX impact noted earlier. Office Commercial revenue grew 7% and 14% in constant currency. Office 365 Commercial revenue increased 11% and 18% in constant currency, slightly better than expected with healthy renewal execution and ARPU growth as E5 momentum remains strong. Paid Office 365 Commercial seats grew 12% year-over-year with installed base expansion across all workloads and customer segments. Seat growth was driven by our small and medium business and frontline worker offerings, although we saw some impact from the slowdown in growth of new business noted earlier. Office Consumer revenue declined 2% and increased 3% in constant currency, with continued momentum in Microsoft 365 subscriptions, which grew 12% to 63.2 million, partially offset by declines in our transactional business. LinkedIn revenue increased 10% and 14% in constant currency, driven by growth in Talent Solutions, partially offset by weakness in Marketing Solutions from the advertising trends noted earlier. Dynamics revenue grew 13% and 20% in constant currency, driven by Dynamics 365, which grew 21% and 29% in constant currency. Segment gross margin dollars increased 8% and 16% in constant currency, and gross margin percentage increased roughly 1 point year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage decreased slightly, driven by sales mix shift to cloud offerings. Operating expense increased 12% and 14% in constant currency, including roughly 5 points from the Q2 charge. Operating income increased 6% and 17% in constant currency as the 3 points of favorable impact due to the change in accounting estimate were offset by 3 points of unfavorable impact from the Q2 charge noted earlier. Next, the Intelligent Cloud segment. Revenue was $21.5 billion, increasing 18% and 24% in constant currency, in line with expectations. Overall, server products and cloud services revenue increased 20% and 26% in constant currency. Azure and other cloud services revenue grew 31% and 38% in constant currency. As noted earlier, growth continued to moderate, particularly in December, and we exited the quarter with Azure constant currency growth in the mid-30s. In our per user business, the Enterprise Mobility and Security installed base grew 16% to over 241 million seats with impact from the slowdown in growth of new business noted earlier. In our on-premises server business, revenue decreased 2% and increased 2% in constant currency, with continued hybrid demand offset by weakness in transactional licensing. Enterprise Services revenue grew 2% and 7% in constant currency. Segment gross margin dollars increased 17% and 23% in constant currency, and gross margin percentage decreased slightly. Excluding the impact of the change in accounting estimate, gross margin percentage declined roughly 3 points, driven by sales mix shift to Azure and higher energy costs. Operating expenses increased 34% and 37% in constant currency, including roughly 13 points of impact from the Q2 charge noted earlier and roughly 7 points of impact from the Nuance acquisition. Operating income grew 7% and 15% in constant currency as roughly 7 points of favorable impact of the change in accounting estimate was offset by approximately 7 points of unfavorable impact from the Q2 charge. Now to More Personal Computing. Revenue was $14.2 billion, decreasing 19% and 16% in constant currency, below expectations driven by Surface, Windows Commercial and search. Windows OEM revenue decreased 39% year-over-year, in line with expectations. Excluding the impact from the Windows 11 deferral last year, revenue declined 36% on a strong prior year comparable. Devices revenue decreased 39% to 34% in constant currency, below expectations due to execution challenges on new product launches. Windows Commercial products and cloud services revenue declined 3% and increased 3% in constant currency, lower than expected, primarily due to the slowdown in growth of new business and stand-alone offerings noted earlier. Search and news advertising revenue ex TAC increased 10% and 15% in constant currency, a bit lower than expected, as noted earlier. Our Edge browser gained more share than expected this quarter. The Xandr acquisition contributed roughly 6 points of benefit. And in gaming, revenue declined 13% and 9% in constant currency, in line with expectations. Xbox hardware revenue declined 13% and 9% in constant currency. Xbox content and services revenue declined 12% and 8% in constant currency, given the strong first-party content last year. Segment gross margin dollars declined 29% and 24% in constant currency, and gross margin percentage decreased roughly 7 points year-over-year, driven by lower device gross margin and sales mix shift to lower-margin businesses. Operating expenses increased 6% and 9% in constant currency, including roughly 6 points of impact from the Q2 charge noted earlier and 3 points of impact from the Xandr acquisition. Operating income decreased 47% and 40% in constant currency, including roughly 6 points of unfavorable impact from the Q2 charge noted earlier. Now back to total company results. Capital expenditures, including finance leases, were $6.8 billion to support cloud demand. Cash paid for PP&E was $6.3 billion. Cash flow from operations was $11.2 billion, down 23% year-over-year as strong cloud billings and collections were more than offset by a tax payment related to the TCJA capitalization of R&D provision as well as higher employee and supplier payments. Free cash flow was $4.9 billion, down 43% year-over-year. Excluding the impact of this tax payment, cash flow from operations declined 7% and free cash flow declined 16%. This quarter, other income and expense was negative $60 million, lower than anticipated, driven by a mark-to-market loss on a forward share purchase agreement. Our effective tax rate was approximately 19%. And finally, we returned $9.7 billion to shareholders through share repurchases and dividends. Now moving to our Q3 outlook, which unless specifically noted otherwise, is on a U.S. dollar basis. My commentary for both the full year and next quarter does not include any impact from Activision, which we continue to work towards closing in fiscal year 2023, subject to obtaining required regulatory approvals. First, FX. Based on current rates, we now expect FX to decrease total revenue growth by approximately 3 points, COGS growth by 1 point and operating expense growth by 2 points. Within the segments, we anticipate roughly 4 points of negative impact on revenue growth in Productivity and Business Processes, 3 points in Intelligent Cloud and 2 points in More Personal Computing. In our Consumer business, Windows OEM and devices will see continued declines as the PC market returns to pre-pandemic levels. And LinkedIn and search will be impacted as ad market spending remains a bit cautious. In our Commercial business, we expect business trends that we saw at the end of December to continue into Q3. While customers are more cautious in their spend, we also have the opportunity to improve our execution, given our strong position in global growth markets. In commercial bookings, with a declining expiry base and the strong prior year comparable in terms of large Azure contracts, we expect growth to be relatively flat over year. We expect consistent execution across our core and sales motions and continued commitments to our platform will be offset by impact from the slowdown of new business noted earlier and 3 points of unfavorable impact from the inclusion of Nuance in the prior year. Microsoft Cloud gross margin percentage should be up roughly 1 point year-over-year, driven by the accounting estimate change noted earlier. Excluding that impact, Q3 cloud gross margin percentage will decrease roughly 1 point, driven by Azure. In capital expenditures, we expect a sequential increase on a dollar basis with normal quarterly spend variability in the timing of our cloud infrastructure build-out. Our data center investments continue to be based on a near-term and longer-term customer demand, including AI opportunities. Next, segment guidance. In Productivity and Business Processes, we expect revenue to grow between 11% and 13% in constant currency or $16.9 billion to $17.2 billion. In Office Commercial, revenue growth will again be driven by Office 365 with seat growth across customer segments and ARPU growth through E5. We expect Office 365 revenue growth to be sequentially lower by roughly 1 point on a constant currency basis. In our on-premises business, we expect revenue to decline in the mid-20s. In Office Consumer, we expect revenue growth in the low single digits, driven by Microsoft 365 subscriptions. For LinkedIn, we expect mid-single-digit revenue growth with continued strong engagement on the platform, although impacted by the advertising trends noted earlier and the slowdown in hiring, particularly in the technology industry, where we have significant exposure. And in Dynamics, we expect revenue growth to be in the low to mid-teens, driven by continued growth in Dynamics 365, which is now over 80% of total Dynamics revenue. For Intelligent Cloud, we expect revenue to grow between 17% and 19% in constant currency or $21.7 billion to $22 billion. Revenue will continue to be driven by Azure which, as a reminder, can have quarterly variability primarily from our per user business and from in-period revenue recognition depending on the mix of contracts. In Azure, our per-user business should continue to benefit from Microsoft 365 suite momentum, though we expect continued moderation in growth rate given the size of the installed base. As I noted earlier, we exited Q2 with Azure growth in the mid-30s in constant currency. And from that, we expect Q3 growth to decelerate roughly 4 to 5 points in constant currency. FX impact in Azure is about 1 point more than at the segment level. In our on-premises server business, we expect revenue to decline low single digits as demand for our hybrid solutions will be more than offset by unfavorable FX impact. And in Enterprise Services, revenue should decline low to mid-single digits, driven by Microsoft Consulting Services. In More Personal Computing, we expect revenue of $11.9 billion to $12.3 billion. Windows OEM revenue should decline in the mid to high 30s, in line with the PC market. We expect Q3 PC units to be similar to pre-pandemic levels. In devices, revenues should decline in the mid-40s as we work through the execution challenges noted earlier. In Windows Commercial products and cloud services on a strong prior year comparable, revenue should be relatively flat as customer demand for Microsoft 365 and our advanced security solutions will be partially offset by the slowdown in new business noted earlier. Search and news advertising ex-TAC should grow high single digits, roughly 7 points faster than overall search and news advertising revenue, driven by continued volume strength supported by Edge browser share gains and the inclusion of Xandr. And in gaming, on a prior year comparable that benefited from increased console supply, we expect revenue to decline in the high single digits. We expect Xbox content and services revenue to decline in the low single digits as growth in Xbox Game Pass subscriptions will be more than offset by lower monetization per hour and third-party and first-party content. Now back to company guidance. We expect COGS to grow between 1% and 2% in constant currency or to be between $15.65 billion and $15.85 billion and operating expense to grow between 11% and 12% at constant currency or be $14.7 billion to $14.8 billion. Other income and expense should be roughly $200 million as interest income is expected to more than offset interest expense. As a reminder, we are required to recognize mark-to-market gains and losses on our equity portfolio, which can increase quarterly volatility. We expect our Q3 effective tax rate to be between 19% and 20%. And finally, as a reminder, for Q3 cash flow, we expect to make a $1.2 billion cash tax payment related to the TCJA capitalization of R&D provision. Now some thoughts on H2 and the full year. First, in our Commercial business, revenue grew 20% on a constant currency basis in H1. However, we now expect to see a deceleration in H2, given how we exited December. Next, higher energy costs for the full year are now expected to be $500 million compared to our previous estimate of $800 million. Third, as we continue to prioritize our investments and anniversary the Nuance and Xandr acquisitions, our Q4 operating expense growth should be in the low single digits in constant currency. Finally, we remain committed to operational excellence, aligning cost and growth, investing in our customer success and leading the AI platform wave. As a result, when excluding the Q2 charge and favorable impact from the change in accounting estimate, we expect full year operating margins to be down roughly 1 point in constant currency and roughly 2 points in USD, even with the headwinds from materially lower OEM revenue and higher energy costs. In the first half of the year, over 70% of our revenue came from our Commercial business and over 70% of that from Microsoft Cloud. We have a resilient foundation and durable growth markets where we are gaining share. Iâm confident in the ability of our Microsoft team to manage the near-term by continuing to position ourselves for the future. Excellent. Thank you, guys for taking the question. I was hoping we could delve into the expansion of the investment into OpenAI. Satya, I was hoping you could talk to us about, is there any expansion in the scope of what you guys are doing with OpenAI and the commitment that you guys are making in terms of sort of the compute capacity youâre going to be giving to them? And then maybe as from an investorâs perspective, how should we think about when this functionality is going to become â expand beyond just sort of the Azure OpenAI services? And where are weâ going to start to see some of the positive impacts to perhaps Bing or the productivity suite or more broadly across the solution portfolio? Thank you so much, Keith, for the question. So as you know, we started the OpenAI partnership now in 3 years, 3.5 years ago. And weâve been actually working very hard on a lot of elements of this partnership over the last 3 years. And so I think the way for our investors to see this is we fundamentally believe that the next big platform wave, as I said, is going to be AI and we strongly also believe a lot of the enterprise value gets created by just being able to catch these waves and then have those waves impact every part of our tech stack and also create new solutions and new opportunities. So whenever we think about platform opportunities and platform shift opportunities, thatâs how we come at it. How can we essentially ride the wave for everything that we have today and make it more expansive and then what new can be created. So, if you take that lens, the core of Azure or what is considered cloud computing fundamentally changes in its nature and how compute storage and network come together. Thatâs, in some sense, under the radar, if you will, for the last 3.5 years, 4 years, we have been working very, very hard to build both the training supercomputers and now, of course, the inference infrastructure because once you use AI inside of your applications, it goes from just being training-heavy to inference. So, thatâs sort of, I think core Azure itself is being transformed for the core infrastructure business, itâs being transformed. And so you can see us with data beyond Azure OpenAI services even, think about what Synapse plus OpenAI APIs can do. We already have in Power Platform incorporated capability. You could prompt - I mean one of the reasons why we are the leaders in robotic process automation and workflow automation today is because of some of the AI capabilities that we have in there. GitHub Copilot is in fact, you would say, the most at-scale LLM based product out there in the marketplace today. And so, we fully expect us to sort of incorporate AI in every layer of the stack, whether itâs in productivity, whether itâs in our consumer services. And so we are excited about it. But I think that we are also excited about OpenAI zone innovation, right. So, they commercialize their products. We are excited about the Chat GPT being built on Azure and having the traction it has. So, we look to both, there is an investment part to it and there is a commercial partnership. But fundamentally, itâs going to be something thatâs going to drive, I think innovation and competitive differentiation in every one of the Microsoft solutions by leading in AI. Thanks. Satya, can you give us your overall macro view? There were some comments you had made that concerned, I think many about the state of the U.S. spending environment. I am just curious if you could comment and follow-up on what you are seeing there just from a spend environment throughout the year. I think many came away with that perceiving that you were saying itâs getting worse, not better. Can you just give us a little more color on that? Thank you. Thank you, Brent. And first of all, I was making a comment which was sort of a global comment, not just a specific U.S. comment. I mean there is only â I always sort of subscribe to that there is only one law of gravity that I think all of us are subject to, which is inflation-adjusted economic growth in the world. And then how many times that do we grow, because as I have said in my comments, Brent, I fundamentally believe tech as a percentage of GDP is going to be much higher and on a secular basis. So, the question is how many times is it given the overall inflation-adjusted economic growth. So, thatâs kind of how I look at it. Given that, I think the two things that we see, we commented on that even in the last quarter, and itâs even in the outlook, which is the thing that customers are doing is what they accelerated during the pandemic. They are making sure that they are getting most value out of it or optimizing it and then also being a bit more cautious on given the macroeconomic headwinds out there in the market. So, given those two things, the point is at some point, the optimizations will end. In fact, the money that they save in any optimization of any workload is what [Indiscernible] into workloads. And those workloads will start ramping up. And so one of the key things we are watching for, Brent, is to make sure that we are gaining share in this space through our value propositions, so and even build loyalty with our customers so that long-term, we are well positioned for share gains. So, thatâs sort of fundamentally how we view it. And then the other aspect I would also say is simultaneously investing in this new AI trend, because I donât think any application start that happens next is going to look like the application starts of 2019 or 2020. They are all going to have considerations around how is my AI inference performance, cost, model is going to look like, and thatâs where we are well positioned again. So, thatâs how I view it. The market, you all are better readers of, quite frankly, whatâs happening out there. We can tell you what we see. What we see is optimization and some cautious approach to new workloads and that will cycle through, but we do fundamentally believe on a long-term basis, as a percentage of GDP, tech spend is going to go up. Thank you very much. I would like to follow-up a little bit on this question relating to optimization. I know we saw some slowing this quarter. You are guiding to some slowing next quarter in Cloud and Azure. How much of that is â do you believe at this point is truly people optimizing what they have already bought and stepping that before that versus how much of that is due to macro factors themselves specifically impacting demand? I would say two things, and then Amy, please feel free to add. One is, it absolutely is, starts with workloads that they have at scale just because of the visibility one has on whatâs driving essentially the consumption meters. And there is real guidance that we ourselves [Indiscernible] the product to say, here are the things that you could do optimize your billing. And so â so, thatâs sort of what is the fundamental thing, when we say do more with less and how can we help, thatâs sort of the first place customers go to. And then the next piece, really, I think is going to be about how they take the optimization that they get and the savings they get along workload and what new project starts. And thatâs where I think there is a reprioritization, when should we start the new project. And those are the two things that are happening simultaneously. They donât perfectly match, but one of the things is they are looking to back some savings on some workloads and then start. So, thatâs where I think a little bit of what has to happen is the cycle time where the optimization cycle finishes, the projects start and then the projects ramp. And I think that, thatâs what at least on the cloud consumption side you are seeing. And on the per user side, itâs slightly different, which is in per user also, there was real acceleration when it comes to purchases of per user licenses, whether it is for knowledge workers or frontline workers. And again, they are all now making sure that they are all getting used and the usage is going up. Like when we look at our Office 365 usage, all those numbers are pretty up year-over-year in a substantial way. Like I gave you some of the Teams numbers, in fact, one of the things was what will happen to the Teams usage after the pandemic, guess what, theyâre up. And so those are the good news. And now once we cycle through that again, the seats will get added and premium, like I am very, very excited about Teams Pro coming out in a couple of weeks. And those are all the things that people will be able to sort of use to ensure that the ARPUs are also going up with value. And Mark, because I do think itâs actually quite hard to separate from a driver perspective how much is optimization versus macro. Itâs all related when you start to say whatâs the best ROI I can get on every budget dollar I spend in our job as a partner to so many of these customers is to help them do that. So, Satya has talked a bit about Azure. Let me talk a little bit about the per user where the way it showed itself is we had very high renewal rates and very good suite performance at renewal, meaning what we tend to call internally recapture. While we had some more challenges on maybe a standalone sale of a new product where the cycle is going to be a little longer, right, and you are going to have to show that cost savings. But the suite sale, the value in that showed itself in terms of strong E5. You can see the ARPU growth and you can see the consistency potentially in both renewal rate and in, frankly, the Microsoft 365 performance. Thank you very much. Satya, I am curious if you could talk about how long the cycle time for optimization lasts. Are we talking a couple of quarters, few quarters or multiple years, because I do take your comment about tech spending as a percentage of global GDP going higher? So, if that were to happen, this â how do you frame the duration of this optimization thatâs happening in the industry? Thank you so much. I mean I think that you can â you have a workload, you optimize the workload and you start a new workload. So, the thing that I would say is when you are done with optimizing a workload is when you are done with the cycle. So, I think if you sort of say, when did we enter this, we accelerated existing [ph] workloads during the pandemic over a period of 2 years. So, we are optimizing. I donât think we are going to take 2 years to optimize, but we are going to take this year to optimize. And then as we optimize the new projects start and the new project starts donât start instantly at their peak usage. They start and then they scale. And so those are the two cycles that will happen where there will be a time lag. Got it. So, itâs a temporary adjustment before we start to get the full effect of the next set of workloads. Good to get that. Thank you. This one for Amy. Amy, given the obviously tough environment, it sounds like reaching that full fiscal year 20% constant currency commercial revs guide would be tough. Is that also true for the soft guidance for 10%-plus total revenue growth for the year? And if I could just sneak in a clarification, Amy, just because itâs an important metric. When you talk about a 4-point to 5-point decel in Azure, thatâs off of the 38% reported for December, right, not off the 35% exit rate? Thank you. Itâs all â Karl, let me just â the first half of your question, give me a second. On the second half of your question, which is the guide of the exit rate â itâs off the exit rate on Azure of four points to five points, just to make sure that is clear. In terms of thinking about total year revenue, right, I did not comment on full year revenue as we continue, I think really just to watch the Windows PC market as it returns to pre-pandemic levels. Outside of that, as you can see, the trends are relatively consistent. So, in some points, itâs important because if you look at the operating income margin guidance that I talked about, the fact that we are guiding to really only one point of margin deceleration for the year on a constant currency basis with probably over $2 billion of headwind from the OEM business from what we had anticipated heading into the year, the focus on margins, the focus on prioritization, the focus on putting our investments into where we know they have high return, I actually feel quite good about the place that puts us in as we exit the year in terms of â and the right energy, right, or leaving the year in Q4 on leverage. Great. Thanks very much. Amy, I wanted to ask about the expense actions that you announced last week, obviously, not a decision that you would take lightly. How are you thinking about headcount for the remainder of the year and the possibility for further expense actions, if necessary? And what criteria do you consider in making these decisions? Thanks. Brad, listen, thanks for that question. Obviously, as we think about the Q4 guidance around low-single digit operating expense growth, we start to, as you know, sort of lap certain real acceleration points that we had last year. And we lapped the acquisitions both of Nuance and of Xandr. So, by the time that we get to the end of Q4, you will see very moderated headcount growth on a year-over-year basis in addition to some of the prioritization decisions we have made. And you are right. We take decisions like the one we had to make to get our cost structure more in line with revenue just incredibly seriously because we have lots of very talented people who were impacted by that. And so I do think that we feel confident in that exit rate. And as I have said, it will certainly imply that year-over-year growth as we lap some of the investments that we have made will be quite small. Great. Thanks very much. On Office 365 Commercial, with you guys approaching 400 million seats and the E5 business really starting to accelerate here on that consolidated sort of expense ROI that you are putting forth, should we think about the growth there more evenly balanced between seats and ARPU going forward or still to continue to favor seats? Thanks. Yes. Thatâs a good question, especially because this quarter you started to see a little bit more of that ARPU influence. And as you might have gathered from your question and I will just reinforce it, as we see some of this moderating seat growth, whether thatâs some of the new SKU weakness that we had talked about, some of the standalone stuff, you are starting to also see E5 ARPU happen at the same time. So, it does create some stability in that Office 365 Commercial revenue number. So, we are seeing still good seat growth, still growth across all workloads. And as you are pointing out, we are getting further into the E5 health, where we have seen, I want to say, four or four really good quarters of E5 adoption. The value there is just very high for customers in this environment between analytics, security, and I think we have given some, I think good security data points in terms of adoption. And voice, this is a place where customers can save money by moving to this suite. And I do think you are starting to see some of that ARPU help. And we are also investing in outside of Microsoft 365 in other per user workloads. We were being a new suite, Power Platform on its own and even standalone offers like even Teams Pro and what have you. So, there is a significant amount of work we want to do besides sort of the suites that we all sort of have at scale. Yes. Thanks for taking the question. I wanted to ask just about how your visibility has changed in terms of some of the larger Azure customer ramps. Could you just comment on, to the extent those large customer ramps or if any of those projects are getting put on pause? And then is there any way to just kind of quantify the AI potential contribution or maybe GPU-powered contribution that Azure that you are expecting over the coming quarters? Thank you. And on the second piece, I think itâs too early to sort of start somehow separating out AI from the rest of the workload. I mean even the workloads themselves, AI is just going to be a core part of a workload in Azure versus just AI alone. So, in other words, if you have an application thatâs using a bunch of inference, letâs say, itâs also going to have a bunch of storage and itâs going to have a bunch of other compute beyond GPU inferencing, if you will. So, I think over time, obviously, I think every app is going to be an AI app. Thatâs I think the best way to think about this transformation. On your characterization of the large customers, whether there is any changes in their trajectory, I would say I would point back to, I think some of the commentary around every large customer is looking to optimize the workloads that they have at scale today and plowed some of that money back that they save into new project stock. So, thatâs sort of what the classic pattern of large customers is. Sometimes you have ISVs who are different, right. So, if an ISV is optimizing, they are optimizing and say, what is the [Technical Difficulty] That wraps up the Q&A portion of todayâs earnings call. Thank you for joining us today and we look forward to speaking with all of you soon.
|
EarningCall_1185
|
Good morning. Thank you for attending todayâs First BanCorp 4Q 2022 financial results conference call. My name is Alexis, and I'll be your moderator for todayâs call. [Operator Instructions]. I'll now like to pass the conference over to the Corporate Strategy and Investor Relations Officer. Ramon Rodriguez. You may proceed. Thank you, Alexis. Good morning, everyone and thank you for joining First Bancorp's conference call and webcast to discuss the company's financial results for the fourth quarter and full year 2022. Joining you today from First Bancorp are Aurelio Aleman, President and Chief Executive Officer; and Orlando Berges, Executive Vice President and Chief Financial Officer. Before we begin today's call, it is my responsibility to inform you that this call may involve certain forward-looking statements, such as projections of revenue, earnings and capital structure, as well as statements on the plans and objectives of the company's business. The company's actual results could differ materially from the forward-looking statements made due to the important factors described in the company's latest SEC filings. The company assumes no obligation to update any forward-looking statements made during the call. If anyone does not already have a copy of the webcast presentation or press release, you can access them at our website at fbpinvestor.com. Please turn to page four to discuss the highlight for the quarter. We got a solid return of 158%. We earned $73.2 million or $0.40 per share in net income achieve, or $122.2 million in pretax provision income and reached an efficiency ratio of 48% even lower than the prior quarter. The margin expanded by 6 basis points, while on the other hand, net interest income decreased by $2.3 million primarily related to increasing in the interest expense portion. A stable credit trends continue, supporting asset quality improvement with non-performing assets decreasing by $14.1 million to $129.2, which is a decade low at 69 basis point of total assets. Also good news from the early delinquency side which also improved during the quarter and still below pre pandemic levels. In terms of capital deployment, we continue our plan. During the fourth quarter we repurchased 3.5 million shares of common stock for the total purchase price of $50 million and paid $22 million in common stock dividends. Our consistent earning generation capacity discipline and sales management have definitely allowed us to continue returning capital while allocating resources to organically grow. Letâs move on to the balance sheet Page 5, to discuss on deposit trends. On the asset side, total loan leases grew by $254 million. Now the portfolio stands at $11.6 billion during the quarter. And this really happened across all business segments commercial consumer and actually residential. This was actually our strongest quarter in terms of loan portfolio performance. Excluding PPP belongs which are almost finished now. Commercial and construction grew by $141 million or 3% linked quarter. Total originations, including renewals and credit card related activities was very healthy at $1.4 billion up 15% versus the prior quarter. That is our priority deployed capital to achieve profitable loan growth and capitalize on market share across all the lending segments, is really the core principle of our plan. We're encouraged by the trends that we see in the main market and also by the pipeline that we have today for 2023. In line with industry trends, core deposits decreased by $250 million or 2.3% during the quarter, which was actually slightly better than the local market trend for the quarter. I suspect that we continue to see excess liquidity gradually tapering off within household balance sheet. However, our deposit balances for both retail and commercial customer remain above pre pandemic levels. We are focused on leveraging our expanded sales distribution channels and digital channel to grow our market share on the deposit market and the products and services related to it. That said, liquidity levels remain high with a ratio of cash plus liquid securities to total assets above 19%. Let's move to page six to discuss the high level the full year. You know, we're really very proud of the work that the team performed during 2022, over the course of 2022 that teams work very hard to deliver outstanding results for the franchise. We raised our organic loan growth of $762 million when we have two PPP loans on the strategic reduction of residential mortgage, earned 5 million in net income and achieved a record pretax pre-provision income of 475.3 which is up 21% when compared to 2021. And reach a decade low non-performing asset ratio of 0.69%. In terms of the franchise, we continue our investments in people, technology, process improvement. We made great progress by moving forward our omni channel outreach strategy with investment in data service self-service platforms to optimize the execution capabilities and products. When we look at some of the metrics, continue to improve data engagement, retail banking, registration were up 4% during the quarter, 17% during the year. Offshore of our newly launched business digital banking applications continue to increase. Our new Visa digital lending functionality has improved our penetration to a smaller medium business and SBA segments. And also we continue to capture over 40% of all deposits to this channel. All these milestones have been achieved within the context of a more efficient traditional branch network. During 2022 we also consolidated five additional branches, including two during the fourth quarter. Moreover, our efficiency ratio reached a historic low of 48.3 during the year, highlighting our ability to execute ongoing capital investments in technology, improve digital channels, best in class talent, all without compromising the operating leverage of the organization. Definitely these all translated into one of our best performing years on record for the franchise, while you know strongly supporting our communities, our colleagues, and returning approximately 363 million or 119% of â22 earnings to our shareholders, to both common stock buybacks and the payment of a very competitive common dividend. Our strong capital position enable us to continue delivering value to our shareholders while at the same time providing poor loss absorption capacity in the event of an economic downturn. Please, let's move to Page seven, to discuss some highlights on the outlook of our macroeconomic environment? Definitely, global expectations points to our economic slowdown in the U.S. But we remain cautiously optimistic on economic conditions in our main market in Puerto Rico. Labor market performance continue to sustain on our trend based on employment reaching a decade high in November 22 or 4% year over year. And economic activity index, our only indicator of that tracks the economy closest a quarter 2021 levels, even when accounted for the impact of [indiscernible] in September, which disrupted the market for a couple of weeks. Most importantly, our growth thesis continued to be sustained by the large amount of Federal disaster relief funds, still planning to be disbursed. Over 45 billion disburse obligated funds have been earmarked to support broad based economic development and rebuilding initiative designed to improve the airline infrastructure and overall capital stock. Public data showed that disbursement reached $3.2 billion during the 11-month period ending in November. With this actually 96% above what was raised during 2021. The rollout respond of the fund is expected to gradually increase over the next decade, with the most recent estimates reflecting approximately 5 billion are the estimates for 2023. That will be great. The timely disbursement of these funds coupled with a government improvement fiscal position. A focus on economic development is really what is driving the tailwind that we're seeing. Finally, and most importantly, this year we commemorate our 75th anniversary for the institution, proud of our people and all that we have accomplished over this period. I look forward to many more years of collaborating to protect our clients and communities and growing their franchise. We do have multiple initiatives to celebrate this accomplishment and show our gratitude to the community's employees customers. I will now turn the call to Orlando to go more detail on the financials results. Thanks to all for your support. Thanks, Aurelio. And good morning, everyone. As Aurelio mentioned net income for the quarter was 73.2 million. That compares with 74.6 million last quarter. Our earnings per share in the quarter were $0.40, which is the same as we had last quarter. What we saw in the quarter its benefit on interest income from the increase associated with the award repricing or variable rate loans, along with the higher average balances in the loan portfolios for the quarter. But as anticipated, we have also continued to see an acceleration on deposit betas, which is driving deposit costs higher. In addition, we did increase the level of wholesale funding in the quarter, which combined with an increase in the cost, it's ultimately resulted in a reduction in net interest income. The provision for credit losses in the quarter was 15.7 billion, which is basically the same that we had last quarter. But our allowance for credit losses increased by 2.5 million. And I will touch upon that a little bit later. Just to mention for allowance, we continue -- for determining the allowance we continue to use two scenarios, we weighed them baseline scenario, and a downside economic [technical difficulty]. In terms of net interest income, which as you all know it's a challenge this time with interest rate movement. The net interest income was down 2.3 million from 207.9 million in the third quarter to 205.6 million this quarter. Interest income was up $11 million, but interest expense grew by $13 million. In interest income, commercial loan interest income grew $8.2 million, $8 million resulted from repricing during the quarter and we also had about $1.1 million associated with higher loan balances. But on the other hand, we had a $20 million reduction in average balance on PPP loans, which resulted in a reduction of $1.3 million on interest income on loans. The yield on the commercial and construction loans grew by 63 basis points in the quarter. In the case of the consumer portfolio, interest income grew by $3.7 million, mostly related to the increase of average balances, we had $111 million increase in average balances. The yield on this portfolio grew 11 basis points as you know that it's basically a fixed portfolio. So yield improvement comes in -- pricing on new originations. On interest expense. Just looking at the balance sheet, interest expense grew $11 million, 45 basis points increase from 37 basis points we had last quarter to 82 basis points this quarter. Approximately 60% of this increase in interest expense was related to public fund, deposit costs increases. Deposit betas for the quarter for the dollar portfolio was approximately 32%. Core deposits was about 18%, but this increase in betas was mostly driven by the betas on public deposits, which was about 75% for the quarter. We do expect that betas on public deposits to remain high. And these rates obviously are going to move up or down depending on where the market is moving. In addition, in the quarter we did have $2 million increase in cost of borrowings, $700,000 relates to repricing of loan great debentures and the other 1.4 million it's basically increasing and the size of the borrowing portfolio FHLB advances and repose. Margin increased six basis points in the quarter from 431 to 437. The change was primarily a change in asset mix. The average balance of cash and investment securities which are lowered yielding decreased by $600 million. While loans increased $146 million for the quarter. Looking forward, we see interest income growing from the repricing of loans that will happen during the year and from loan growth. For example, you look at balance as at the end of the year loans were $187 million higher than the average balances for the quarter. So that should give us a pickup in the first quarter on interest income. And we also have approximately $130 million in commercial loans that reprice now in January. Some of them are quarterly repricing loans. However, we do expect net interest income pressure to continue in the near term as rates on deposits continue to increase. With some normalization later in the year based on the expectation that rates will start to come down towards the middle of the year. If you just look at our current balance sheet structure, our expectation is that net interest income for the next couple of quarters should remain at close to current levels, with improvements in net interest income coming from the growth in future growth in the loan portfolios. In terms of non-interest income, it remained relatively similar to last quarter. The improvement -- we had improvements in credit and debit card transaction fee based on seasonality, but that was offset by lower mortgage banking income. We also during the quarter -- we also reverse our $700,000 of previously recognized fees on non-sufficient funds as far as some changes on fee structure that are being implemented just towards the end of the year. In terms of expenses for the quarter $112.9 million which compared to $115.2 million in the third quarter, a $2.3 million decrease. The decrease primarily reflects a $1.5 million increase in net gains on OREO operation. Excluding OREO expenses for the quarter were $115.5 million which compared to $116.3 million last quarter, also excluding the OREO impact. This reduction includes reduction -- $700,000 reduction in occupancy, mainly energy costs, and $700,000 decrease in payroll expenses as all bonus accruals and incentives were finalized based on results. These reductions were partly offset by some increase -- $500,000 increase in business promotion, sponsorship and public relation activities that we had during the quarter. The expenses in the quarter were very much in line with our estimates of $115 million and $116 [ph] million, which excluding OREO obviously. And our efficiency ratio, the efficiency ratio continues to be very low at 48%. Looking at the first quarter, we do expect some increases in expenses. Payroll taxes go up in the first quarter as all limits are reset. That increases payroll expenses by good clip in the first quarter. Also, during the quarter we during the at the end of the year, we have seen significant increases in -- or some increases in contract renewals, with inflation glasses, some of the removals are coming up. And there are several technology improvement projects that we have on the way that are picking up speed in this quarter. Based on this, if we exclude OREO expenses, we believe expenses for the quarter for the first couple of quarters should be closer to the $120 million range. In terms of asset quality, as Aurelio made reference, we continue with a very stable asset quality, non-performing decrease $14 million in the quarter, stand at $129 million which is 69 basis points of assets. That reduction, included $9.3 million non-accrual commercial loan reductions, $5 million loans that was restored to accrual status. And we also had a $7 million, that's what drove mostly the reduction in the commercial side. And we had a $5 million reduction in OREO properties based on increase in sales of repossessed residential properties in the Puerto Rico market. Inflows for the quarter increased $3.8 million to $24 million, mostly consumer portfolio that grew $2.6 million based on size. Early delinquencies, again defined as 30 to 89 days continues to be good by $9 million in the quarter with reductions across all portfolios, basically. In terms of net charge offs for the quarter were $13 million, which is 46 basis points of loans compared to 31 basis points last quarter, mostly related to a consumer portfolio. We also had a $1.7 million charge off that we took on in the fourth quarter on the sale of anniversary classified commercial loan participation in the quarter. Consumer loan charge offs were 144 basis points of loans in the quarter, and 107 basis points for the year and this figures are significantly lower than pre pandemic levels. As you can see on prior filings. The allowance for credit losses at the end of 2022, was $273 million, which is $2.5 million higher than the third quarter. And it's about $7 million lower -- I mean, I meant to say $2.5 million lower than the third quarter -- higher than the third quarter and $7 million lower from last year. I'm sorry about that. The ACL was -- on just loans was $260 million, which is $2.6 million higher than last quarter. The ACL reflects the increase in the portfolio's we had in the quarter as well as some less favorable outlook that we have on the models for several macroeconomic components. The ratio of the allowance for credit losses on loans and finance leases to total loans held for investment was 2.25% as of the end of the year compared to 2.28% on the third quarter. On the capital [technical difficulty] just stay with what Aurelio mentioned already. We continue with the execution of the plan. We repurchase during the year 19.4 million shares for $275 million and we paid during the year $88 million in dividends. Our capital ratios continue to be very strong again, basically a small reduction in Tier-1 and an improvement in the leverage ratio. Tangible book value per common share increase from 6.46 to 6.93 in the fourth quarter related to $60 million or so improvement in the other comprehensive loss adjustments as the fair value of the investment portfolio improved in the quarter. And our tangible common equity ratio stands at 6.81 compared to 6.55 last quarter. If we were to adjust for the OCI impact, our non-GAAP tangible book value per share would be about 11.30. And tangible common equity ratio would be approximately 10.6%. So, those were -- those are strong numbers. And again, as we have mentioned in the past, we believe this impact is temporary since we do have the ability to hold the securities through the end of the maturity process. Securities continue at similar pace, we have approximately $40 million to $50 million cash flow coming from the investment portfolio. So we will continue to see some of that cash flow redeployed to the lending side or compensating for funding needs. Hi, good morning. Thanks for the questions. I wanted to follow up on the NII guidance, just to make sure I got it clear. Did you say that you're expecting some level of pressure here in the near term, but for to remain your current levels? Yes, there will be some pressure is still on deposit pricing. And that's going to offset some of the impact from loan growth and or loan already on the portfolio and repricing of loans already in the portfolio. So with those two components, we were expecting net interest income to be sort of similar to this quarter, and improvements will come from the movement in the loan portfolio going forward for the growth on the portfolio. That's what's going to drive improvements in net interest income in the near term. Okay, understood. And then just looking again at the balance sheet in the third quarter securities, cash flows were used to fund deposit outflows and some loan growth in the fourth quarter, you opted to go with borrowings and assets actually increase for the first time and over a year. How should we think about the funding of future deposit outflows to the extent that there's any and the funding of 2023 loan growth? Are you going to be looking to lean on borrowings a little bit more heavily in support of the balance sheet? Or should we still expect much of that funding to come from the bond books? Well, again, the securities portfolio, it's given us somewhere approximately $150 million per quarter in cash flows. So that clearly it's going to be used for funding growth and or deposit implications. We -- during the fourth quarter, we lost deposits at a higher clip than the $150 million. And we did grow the loan portfolio so we ended up taking some additional funding. So clearly, it's a function of what happens on those two components, how much we originate with based on the pipeline, we feel strong about it. And the trends in deposits going forward, which have been a little bit more inconsistent, we -- obviously we see rates, changes in 2023 probably being or we expect them to be less than the significant [technical difficulty] 2022. So that is create some stability on deposit movement. But there is still volatility in the market that we need to be cautious. So there could be some increases in wholesale funding based on that. I'm sorry, sorry, I can see you're saying that. We do have the cash flow coming from the management portfolio, but we also can use the portfolio for repos or advances. Right. Okay. And then just looking at deposits and understanding that it's hard to put a number on the remaining balances of commercial accounts or dollars that are potentially at risk for leaving for higher rates, but can you try and kind of ring fence, the remaining deposits that are still at risk? And then as we think about the overall size of the balance sheet, are you expecting to keep it here at current levels, again using a wholesale to kind of bridge the gap? Or could we still see some decline in the balance sheet here over the first half of 2023? No, we feel the balance sheet, it should stay at similar levels. In reality, we do expect growth in the loan portfolios going forward. And again, that's going to be offset with some reductions on the investment portfolio side. We don't it's tough to answer that one of the positives. Clearly there was excess liquidity that has been redeployed for different things people are using, and obviously the market rate movement, move some, disposable money into very high cost kind of treasury or high yielding kind of treasury securities. And so, with rate expectations movements are being lower now for the first half of the year. That should slow down. But it's tough to say. Thanks for the question. Good morning. Are there any pick up on the loan side? We've had really strong growth this quarter. And that seems to be one of the factors that helps offset some of the other areas of pressure that we've been talking about. Can you speak to your pipeline how demand has been holding up as we've gotten quite a few rate hikes now and kind of the outlook for growth and color around categories would be helpful? Yes, if you look at by segment obviously residential mortgage, we don't expect any growth, I started with the portfolio thing called being. And if we saw last quarter, we have a slight growth, it's really a mix of repayments and origination at the end of the day, because you know how the market -- the currency market is performing, obviously, the more conforming rates go down, we'll be moving a little bit better, the non-government body will move to that. So weâre forecasting that segment to remain flat. We continue to see strong demand for the consumer in auto businesses, credit card, and we continue -- and the pipeline for construction and commercial remains very strong, actually probably very similar to the prior quarter that we started. Some of the Delta, one quarter versus the other depends on the consumer, what we did last year close to 10%. While within the commercial was less than that, it depends on the more chunky deals. I will say it on a blended basis, for the year, we should think about 5% to 6% mid-single digits, as a closest estimate, based on what we see today, what we have, and that could be some larger chunky deals that we're not including here, that could be participation in some of the public private partnerships that the government is structuring, to be able to refine the timing of those, it's quite complex in terms of predicting when they will be finished and close, but some of those are floating around are part of the fiscal plan, and they've been in the negotiation with different bidder. So some of that could help [technical difficulty] banks to which I'm sure, most of the bank locally will participate as part of our support to the infrastructure and the economy. So that I will say, Kelly, the closest estimates are all mid-single digits here. Got it, that's helpful. And to circle back on NII and NIM, as we -- you think about it potentially expanding in the latter part of the year, how should we be thinking about the churn in threshold of NII reaching the bottom? Or should we be anticipating a similar level of deposit pricing pressures this quarter, is a potentially heating up. And if you could give any numbers around the core deposit base, excluding the government deposits and how betas are trending on that that would be helpful in understanding this? Okay. This quarter, we do expect, still some pressure. Remember that obviously, you were seeing average impact in the last quarter of what happened with rates movement throughout the quarter. But obviously, the ending number in the quarter is higher than the average that we had, because of it. Clearly a lot of -- it's a push on a more volatile government component that had a very large beta. And that we expect that to have some impact in the second quarter, although future impact because of rates, expectations are not necessarily going to be at the same pace. On the rest of the path. As I mentioned, the average cost of all the other deposits was 40 basis points in September and the September quarter, it was about 66 basis points in the fourth quarters. The beta there was a little bit over 18%. And we're not seeing dramatic movement, it's probably going to be somewhere between 18% and 22%. It's what I expect from that portfolio. Obviously, the government side will stayed at similar levels that we saw, or what I mean government public deposits in general, that we saw there in the quarter. Got it. Thank you. I turn to the expenses and then step back. I appreciate the guidance of about $120 million of expenses? I understand you had some OREO gains this quarter, excluding that it looks like you would have been more around like $115 million so that implies a $5 million step up. Just in terms of the cadence do you think, in the next quarter or two, there's going to be a build towards that one funny or should we anticipate with the moving parts you laid out in your prepared remarks, that we're going to enter 2023 with 120 and kind of build on that number? Well, you have -- a large components what I mentioned on payroll taxes, all the all the thresholds are reset, we see immediate impact on that, on the first couple of quarters, that tapers down towards the end of the year as some of the limits are reached. So we do see lower impact on that one. But on the other hand, we do have federal technology projects going on that we're trying to get to completion during the year, and that kind of compensate. That's why the 121 20 it's the number we're expecting based on the immediate impact from that payroll implication. And we've also seen, because of the of the inflation components of some of the contract renewals, obviously, are yielding higher increases that we saw a couple of years ago in terms of a contract renewals. So we're starting to see that -- we saw that in the last quarter, and we had several -- and we are seeing that in the first quarter. So that's why we feel that 120 should be like a benchmark on going -- on the next couple of quarters. Good morning, guys. Just going back to deposits quickly. Can you just remind us if there's any seasonality that we should be thinking about over the next couple quarters, or if you have any line of sight on some deposit wins, maybe early in '23, related to taxes or anything along those lines? Well, you always have a little bit of movement at that season, by people using the money, but it's never going to -- it's never been a significant component on the movement of deposits under bank -- at the institution. So it wouldn't -- I wouldn't say any seasonality, it's going to drive a lot of movement over the year. It's more of the other factors. And then, with respect to the buyback, you get the $125 million, which I think is good until June, if I'm not mistaken. How are you thinking about using that today? Some banks are saying they're seeing more uncertainty, and other banks are saying they're getting back in the market. So I'm just curious how you're thinking of things. And if we should expect additional commentary in April, which had been your cadence over the last two years for capital return? Yes, the answer -- question number one, definitely. As we said, before, we would like to give the optionality. And we've been doing that and we adjust, how much we do a recorder based on several factors while we see including macro uncertainty. At this stage, we continue to execute, we probably, I will say the most probable number for this quarter is similar to last quarter, based on what we see today, that can be adjusted, things that they became a concern to the market. On the other hand, we don't have a limit to when to use a 125. So, we can do it now, or do it in three quarters or do in two quarters, there's no expiration. On the other hand, answer to the question number two, yes, our cycle two to three, basically, the capital plan, we're on a three step. See the numbers and decide finally, how much more we're going to do forward? It's going to be April. So yes, we do expect to make an updated announcement on capitals during April, that is correct. Okay, great. Thanks for clarifying that. And then, as you think about credit and net charge offs and provisioning, I think we're all trying to figure out what the new level of a normalized level of charge offs are for you guys. I'm just curious, if you have any more insights, clearly charge offs have been running much lower than what you had probably thought would be a normalized range and if whether or not 46 basis points kind of getting closer to what you consider normalized or how you see that shaking out. We are -- I think there's levels of normalization, we use pre pandemic as a metric, but things have change. The unemployment rate is better is lower. We see more activity in the economy in different sectors. So, we -- when we say normalize, to be honest, it has to be a number between where we are today, and where we were in 2019, not sure, if we're going to reach the 2019, it doesn't look like based on early indications. So, obviously, early delinquencies is a great indicator or classified asset is a great indicator. And NPAs are a great indicator, you know, so far, so good. And it's something that we monitor very, very closely, especially performance. We have a large consumer segment, we have a material portfolio, and a diversify commercial portfolio. I don't, -- all of them are performing well, and you see the asset quality metrics. We are very disciplined in not accumulating classify assets. And every time we see something that we're like, we got to take too long to solve, as we did this quarter, we're moving out so that create some noise in the charger rate, but not necessarily itâs a trend. The key components as Aurelio mentioned Alex that are very stable at this point. So we don't proceed as early unless there is a dramatic change on expectations that trends will change too much from the most recent ones. Pricing, I think it's reasonable is being adjusted by the funding costs and by the curve and by the forward curve. Commercial CRE in the mid-six. And when you go to other large segment or multivariable, you move to mid 7s, when you go to the middle market, probably closer to eight. And when you do look at a blender consumer products are already approaching mid-9. So, I think competition has been fair adjusting what we're all suffering from, which is definitely increasing the cost of funding. So, obviously, the timing is like, some of this, but, I think -- we don't see pressure, we see more competitive pressure on deposit pricing now within the loan pricing. Okay. And then just final question for me on fees. You alluded to some change in the fee structure during the fourth quarters, is that something that's going to have a material impact in '23? No, because of the different changes don't create -- some are coming down and some are going up. So at the end, the end result, it's more of a normal kind of fee based on deposits, itâs a function on deposit size, more than anything. Thank you for your question. The next question comes from the line of Brett Rabatin with Hovde Group. You may proceed. Hey, good morning. I wanted to follow back on credit for a second and just talk about auto and it seems like auto is really continuing to perform fairly well but your charge offs related to consumer or up can you maybe strip a part in the consumer bucket, the auto net charge offs, and then how you kind of think about the normalization, if you want to call it that in auto net charge offs over the next year? I don't have a specifically order here, but the reality -- there is a relationship with size. The portfolio has continued to come up Bret, and we have grown the portfolio by a good clip over the last couple of years. So you start seeing some increases in charge off, which we know are going to happen. The auto portfolio typical charge offs in the market, remember, the deals in the market are much higher, we're on the low 2s to meet 2s, way back. That number is less than half of that today. And we don't see dramatic changes on those numbers at this point. Again, remember that in Puerto Rico, we still have a very poor public transportation system, and the auto becomes a very big necessity. Okay. And then wanted to circle back on the securities portfolio and see if you had any color, Orlando, maybe on how much in maturity you're expecting this year to, to give you some flexibility with either loan growth funding or the deposit base? Thanks. The cash flow has been fairly consistent over the last few months, it's -- we are expecting, like $45 million a quarter between 40 and 50, it's would we have seen -- a month I'm sorry. So we're talking about somewhere between $500 million and $600 million of cash flow coming from the investment portfolio that can be used or will be used for loan funding. We don't perceive doing any movement on the portfolio right now. But it's been fairly consistent over the last few quarters. And we don't see any significant change on that. And then lastly, for me, you mentioned in the Q&A briefly, technology spending, and it seems like all three of the Puerto Rico banks are spending money on technology, digital channels, et cetera. Can you talk maybe a little bit more about the tech spend that you have going on and what you hope that to accomplish in the next year or so? Well, some of the some of that is competitive data, but from an investment amount basically moving more things to the cloud -- is similar to prior year levels, probably a little bit higher this year is, which some of these things amortize, so you donât see the full investment in one year. We continue to move things to the cloud more digital processes internally, more of that processes to the client. So, those are the three categories. Reducing the size of any data centers that we have, in house, and moving to a more efficient hardware environment with less maintenance on operating risk. So, that is in general, it's being a priority, which for our last five years, it was a little bit this interrupted by making by the integration that we have to focus on that, but we never stop doing it, itâs just the speed and we did very well rollout, very important products during 2022. And we continue to adding functionality to these products, as we call it is an omni channel strategy, the branch is important, the call center is important, and that is the channel is very important. So we continue to invest in all channels to optimize and improve the level of services that we can provide to our clients. Thank you for your question. We now have a follow-up question from the line of Kelly Motta with KBW. You may proceed. Thank you. We now have a follow up question from the line of Timur Braziler with Wells Fargo, you may proceed. Hi, thanks for the follow-up. Again, on the security book, it seems like for the last couple of quarters now, the average balances have been pretty meaningfully higher than the period end balances. I'm just wondering what's driving that dynamic mid quarter. Well, you have to be careful because of valuation. The reality is that the balances have been coming down. But obviously the OCI valuation has changed. And for example, if you look at balances this quarter, they came down by over 140 something million, but it went up by about 60 million of the valuation. The other component that you have in there is that as we draw on Federal Home Loan Bank advances, we are required to invest in Federal Home Loan Bank stock. That's part of the requirements. So that was about $40 million in the quarter. So if you segregate that, in reality that portfolio was down 140 something million during the quarter. Thank you for your question. There are currently no further questions waiting at this time. [Operator Instructions]. There are no further questions. So Iâll now pass the line back to Ramon Rodriguez for closing remarks. Thanks to everyone for participating in today's call. We will be attending Bank of America's financial services conference in New York on February 14, and KBW's conference in Boca on February 16. We look forward to seeing a number of you at these events and we greatly appreciate your continued support. At this point, we will end the call. Thank you.
|
EarningCall_1186
|
Good morning, and welcome to the Umpqua Holdings Corporation's Fourth Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there'll be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. Thank you, Catherine. Good morning, and good afternoon, everyone. Thank you for joining us today on our fourth quarter 2022 earnings call. With me this morning are Cort O'Haver, the President and CEO of Umpqua Holdings Corporation; Tory Nixon, President of Umpqua Bank; Ron Farnsworth, Chief Financial Officer; and Frank Namdar, Chief Credit Officer. After our prepared remarks, we will take questions. Yesterday afternoon, we issued an earnings release discussing our fourth quarter 2022 result. We have also prepared a slide presentation, which we will refer to during our remarks this morning. Both these materials can be found on our website at umpquabank.com in the Investor Relations section. During today's call, we will make forward-looking statements which are subject to risks and uncertainties and are intended to be covered by the Safe Harbor provisions of federal securities law. For a list of factors that may cause actual results to differ materially from expectations, please refer to Slides 2 and 3 of our earnings presentation as well as the disclosures contained within our SEC filings. We will also reference non-GAAP financial measures alongside our discussion of GAAP results. We encourage you to review the GAAP to non-GAAP reconciliation provided in the earnings presentation appendix. For the fourth quarter, we reported earnings available to shareholders of $83 million. This represents EPS of $0.38 per share compared to the $0.39 reported last quarter and $0.41 reported in the fourth quarter of last year. On an operating basis, which excludes a number of interest-rate driven items and merger expenses that Ron will review, EPS of $0.46 compared to $0.47 last quarter and $0.44 in the fourth quarter of last year. For the variance between 2022 and 2021 fourth quarter EPS was minimal, the components shifted dramatically as higher interest rates and 16% loan growth during 2022 drove a 31% increase in net interest income, Q4 to Q4, leading to a 25% increase in pre-provision net revenue despite the dramatic decline in mortgage banking revenue. Over the past year, we have made a number of structural changes within the mortgage banking segment, intended to reduce expenses, limit the impact of MSR changes to the income statement and moderate portfolio mortgage growth. Additional actions planned through this quarter will continue this work. Mortgages remain an important product for the bank and for our customers and we remain committed to serving our communities throughout the West. However, we are shifting our mortgage operations towards a retail bank model and we expect a smaller gross and net impact to financial statements and under our prior operating model. Turning now to our pending merger with Columbia Banking System. We announced earlier this month that we received FDIC approval and intend to close at the end of February. Our teams are focused on closing and core system conversion scheduled for this quarter alongside a heightened level of customer outreach. We are laser-focused on execution and we look forward to providing you with an update on next quarter's call when we are officially one team. As you know, there are a lot of moving parts over the next couple of months and our near-term focus is on achieving targeted cost savings, providing high-touch service to our customers as we complete the integration process and giving our teams and our associates the tools to drive the revenue synergy opportunities that we have been discussing for over a year now. Back in October of 2021, we never imagine there would be over 16 months between announcement and close. However, there has also been significant upside to this timeline. We have been waiting but we have not been idle. The joint culture work, which was originally planned to occur post-closing has touched the majority of Umpqua associates and Columbia associates and it has set a framework that enables us to be one team on day one. The planning, prepping, and the brainstorming that has taken place over a year has enabled the development of synergistic products and tools and we are excited for our combined teams to use them immediately. Further and perhaps more importantly, the earlier decoupling of our integration planning from legal day one enable us to maintain our originally scheduled core conversion date this quarter, despite our targeted February 28 closing date. I want to take this opportunity to thank our dedicated associates for the countless hours and incredible effort that they have put into their work. I'm impressed and humbled by your dedication. I joined Umpqua Bank at 2010 and have been honored to lead this outstanding organization for the past six years. While it may be bittersweet to pass the reins, I know I am placing them in capable hands. And as Executive Chair, I look forward to watching the combined organization service customers and it's communities throughout the West of providing enhanced shareholder return. Okay, thank you, Cort and for those on the call, I want to follow along. I'll be referring to certain page numbers from our earnings presentation. Starting on Page 9 of the slide presentation, which contains our performance ratios both on a GAAP and operating basis. The adjustments to our internal operating measures include various fair value changes from interest rate volatility along with merger and exit disposal costs, which are detailed in the appendix on Slide 30. Our NIM continued to strengthen up 13 basis points in Q4 to 4.01%. Our GAAP PPNR ROAA was 1.82%, while our operating PPNR ROAA was 2.1% and operating ROTC increased to 16.2%. Turning to Page 10, which contains our summary of quarterly P&L. Our GAAP earnings for Q3 were $83 million or $0.38 per share. On an operating basis, we earned $99 million or $0.46 per share. For the moving parts as compared to Q3, net interest income increased $17.9 million or 6% representing continued earning asset growth combined with the recent Fed rate increases. We had a provision for credit loss of $34.9 million with the increase driven primarily by slight deterioration in the consensus economic forecast. Noninterest income increased mainly related to changes in the nonoperating fair value marks as detailed later in the appendix and noninterest expense increased $17 million mainly from merger expense and nonrecurring increase in other expense. As for the balance sheet on Slide 11, loans were up $650 million and deposits increased $250 million. This difference, net of the decrease in spring cash was funded with short-term borrowings and the lift in investments AFS related primarily due to a lower unrealized loss. Our total available liquidity including off balance sheet sources ended the quarter at $12 billion represent 38% of total assets and 44% of total deposits. As noted on the bottom of Slide 11, our tangible book value increased in part due to the lower AOCI rate mark on AFS investments. Slide 13 highlights net interest income building the increase to $306 million in Q4 resulted from the recent rate increases along with continued strong loan growth. From a rate volume standpoint, increase in rates led to $16 million of the $18 million increase with volume and mix, making up a $2 million difference. Following that, on Slide 14 of the presentation are the trends for our net interest margin. Again our NIM increased 13 basis points in total to 4.01% in Q4. It represent a waterfall on the margin change on the right of the page, knowing that our loan and cash yields more than offset rising funding costs and key for me here is following the 125 basis point increase in the federal funds rate during Q4, our NIM for the month of December was 4.02%. The next slide includes information on the repricing and maturity characteristics of our loan portfolio noting no significant change in the repricing mix this past quarter. And following that, on Slide 16, on the upper left, we have included our projected net interest income sensitivity for future rate changes in both ramp and shock scenarios over two years. This is a simulation we run in back test quarterly and assumes a static balance sheet. The upper right shows our sensitivity from last quarter and comparing the two, even though we've taken steps this quarter to reduce sensitivity and will continue to do so in future quarters. The deposit beta used in the current simulation is 53% on interest-bearing deposits for future rate changes. The table on the left shows our deposit betas from the current rising rate cycle while on the right we show them from the last rising rate cycle for comparison. Our beta then was 42% on interest-bearing deposits. Our cost of interest-bearing deposits increased from 23 basis points in Q3 to 77 basis points for Q4. Our cumulative data for this cycle to date is now 18% on interest-bearing deposits. The spot rate at year-end was 107 basis points. We expect interest-bearing deposit costs to increase again in Q1 but stay well below our model level. Next on Slide 17. We detailed our consolidated non-interest income trends, netting continued weakness within our mortgage banking segment was mostly offset by a positive fair value change on loans carried at fair value. Turning to Slide 18 on expense. Majority of the increase this quarter related to merger expense for our upcoming combination with Columbia. In addition, we had an increase in state and local taxes along with other expense which I didn't not view as recurring. The next two pages include the segment disclosures on a GAAP basis. The core banking segment on Slide 19 and the mortgage banking segment on Slide 20. The operating non-GAAP stats by segment are later on Slides 32 and 33. Suffice it to say the core banking segment continues to benefit from rising rates and continued loan growth, while Mortgage Banking reported a second consecutive quarterly loss. Cort mentioned plans underway earlier within Mortgage Banking. And a couple of final ones before I turn it over to Frank. On Slide 22, we've included the quarterly loan balance roll forward. Quarterly loan growth was driven by $1.3 billion in new originations in net advances offset by $0.6 billion in payoffs and maturities. We've intentionally slowed down non-relationship lending production, given continued pressure with industry-wide deposit outflows following continued tightening by the Fed. Slides 23 and 24 provide additional statistics and composition on the portfolio and there is no significant changes in the quarter. Next, let me take your attention to Slide 25 on CECL and our allowance for credit loss. As a reminder, our CECL process incorporates a life of loan reasonable and supportable period for the economic forecast for all portfolios with the exception of C&I which is a 12-month reasonable and supportable period reverting gradually to the output mean thereafter. We use the consensus economic forecast this quarter updated in November. Overall, the forecast reflected continued high expected inflation and interest rates with a slight uptick in peak unemployment rates. With this, we recognized a $32.9 million provision for credit loss with $7 million of that for the quarters' loan growth and $26 million for the slightly deteriorating economic variables. This page shows the commercial and leasing portfolio driving the majority of the increase for their most sensitive to the unemployment rate forecast, which again increased slightly on peak from 4.1% to 4.5% over the horizon. The ACL increased to 1.21% at quarter end, up from 1.16% in Q3. Lastly, I want to highlight capital on Page 27. Moving that all of our regulatory ratios remain in excess of well-capitalized levels, our Tier 1 common ratios was 11% and our total risk-based capital ratio was 13.7%. The Bank level total risk-based capital ratio was 12.9%. We declared a $0.21 per share dividend on January 11, payable on February's fixed to holders of record as of January 23rd and equivalent to the fourth quarter's level. Given our targeted February 20th closing date for our merger with Columbia, we expect the next dividend action to be determined by the combined Board. Turning back to Slide 26, our nonperforming assets to total assets ratio of 0.18% was relatively steady with past quarter's levels. And our classified loans to total loans ratio of 0.73% was similarly stable. Our annualized net charge-off percentage to average loans and leases was 19 basis points in the quarter, up 8 basis points from the third quarter's level as net charge-off activity within the FinPac portfolio increased as expected. Following elevated charge-offs and strategic credit tightening implemented during the pandemic, charge-offs in the FinPac portfolio were notably below the historic 3% to 3.5% range for several quarters. As we have discussed on past calls, we have anticipated a gradual migration to historical norms within the portfolio and accordingly, FinPac net charge-offs increased to 2.84% in the fourth quarter. The uptick from 1.36% in the third quarter reflects an increase in net charge-offs primarily within FinPac's transportation portfolio. On a risk-adjusted basis, the FinPac portfolio which is 6% of our consolidated loan portfolio remains the most profitable segment of our loan book with an average risk-adjusted yield in the 10% range. It can also serve as an early warning indicator of trends that may shift to the overall portfolio. However, we do not see any associated weakness in the bank portfolio, which had a charge-off level of just 1 basis point in the fourth quarter. For context bank charge-offs of $550,000 for the fourth quarter and only $2.7 million for all of 2022 is a near de minimis level of activity on a portfolio nearing $25 billion. We continue to be very pleased with our credit quality metrics. We remain confident in the quality of our loan book as we continue to continue to pursue high-quality loan growth balanced with effective and active risk management practices. Yes. Maybe looking at the jumping-off point here for margin as we go into the year, we've great yields on loans, looks like maybe you've benefited from some spread widening and beta is performing better than earlier expected. Do you think with that starts to revert to a more normalized level both spreads and maybe data quickly at the beginning of '23? Or do you have optimistic -- are you optimistic that that could -- those benefits will stay with us longer? Hi, Jared. This is Ron, good morning. We talked about the spot rate on deposit -- in spring deposits being 107 bps at the end of the year. So we do expect to see a continued increase in spend deposit costs into Q1. We will also get the benefit though almost an extra 100 bps on earning asset yields if you take the quarter amount versus the December amount looking forward. So, I feel good about the margin staying around current levels, moving into the nice quarter definitely not dropping back to where it was pre from that standpoint. Hi Jared, it's Tory Nixon. On the spread front, I think, we've been pretty fortunate that spreads have kind of stayed level for us for the most part in our C&I business in our real estate business. The one difference is we got spread increases in some of the construction business, so we feel pretty good about that. I know that there are other places where that's contracting, but for us we seem to be holding pretty steady. I think it's kind of a mix of our customer base. Okay, great. That's a good color. Thanks. And then, just as a follow-up, when we look at the mortgage banking business and some of the restructuring that you're going to do there, what should we be thinking mortgage banking revenues look like as a percentage of fee revenue once that model sort of fully reflected in integrated across the broader franchise? Hi, Jared, it's Ron. I'd say obviously lower from that standpoint but also volumes and expand some profitability or contribution to bottom line will also be lower. So the key on that is much less volatility and we've got the hedging on the MSR asset at this point, but hard to say what a specific percentage would be, will definitely update you as we get through the balance of the changes here over the coming quarter. Talk about in April and July as we look out for the balance of the year on a combined basis. Thanks. Good morning. Just a question on the expense side, I think you've got operating expenses at 181, wanted to get a sense for any further cost saves versus I don't know if it's sold NextGen stuff for versus growth and kind of meld the banks. Just thinking about that 181 number, is there any give to go lower than that or is that a pretty if we're modeling side into the combination. That's a pretty good number to use. I'd say probably less than that, especially with what's happened on the home lending side, right? So, sorry I don't have the -- 181 is on operating basis. We also talked about, there's about $5 million of I'd call it non-recurring state tax adjustments actually show up expense -- other expense net income tax expense. So you can easily knock it down by that plus another $3 million, $3.5 million to get to the rents that would be in the low 170 range and that's before continued reductions in home lending looking forward. Okay. So that tax true up or whatever that figure was that was included in your 181 operating meaning that should back out. Got you. And then on loan growth, I heard the comments from Frank and Cort in terms of sort of looking at risk out there and it doesn't appear to be spreading outside of the FinPac portfolio. I was kind of thinking about loan growth for '23, I think just high-level where you see a growth rate, what seems doable? Hi, Jeff, this is Tory Nixon. I think we remain very active in the prospecting side of the house on the sales side of the house. The customer base of the company has shifted quite significantly over the last several years and we will continue to look for full banking relationships in the C&I space, in particular. So I see growth there continuing for the company and we continue to hire folks and we continue to kind of work on the product side. And I feel good about loan growth for us over the coming year. I think demand is certainly down from 2022. Pipelines are down a little bit, but there's still really good activity, especially in the C&I space. And I feel comfortable in the mid -- low to mid-single-digit loan growth number and I'm excited to see a current set of bankers continuing to work with our customers and continuing to find prospects that we want to bank. Yes. So I wanted to get a sense of what your assumptions are for deposit mix shift so in the quarter that were outflows from DDAs into interest-bearing, I saw there's uptick in CD deposits. So I just want to get a sense of what your assumptions are there in your current CD strategy? No, just like where do you see -- do you see continued further remixing of DDA accounts into interest-bearing accounts going forward? Got it. Yes, I would -- it's hard to say, a specific percentage from that standpoint. What we saw here in the fourth quarter is, like on the consumer about two-thirds of the decline in DDA was on the consumer side, about a third on the business side with the consumer side, it was simply the [ACH] trends incomes were relatively flat but outflows were up 10-ish percent. And so you'll see that decline. So it's hard to say if that's going to continue at that level. I think there will still be pressure on deposits and the industry as the Fed's tightening on the commercial side, it's probably a little bit of mix and some sparing. I would expect, we have used some exception pricing from a pricing just hold-on to larger balance more cost-sensitive deposits. I would expect that would continue here into Q1 as well. So net-net, you probably should see an increase in more interest-bearing and it's the trends on the ACA side continue in the industry that's specific just two aspects. But we see continued pressure on DDA mix. Got you. And-- if the current CD strategy to kind of term out these time deposits, are you looking for more shorter-duration funding. On the CD side it would be generally between six and 12 months in that standpoint. On the borrowing side, we've been in the two to four month range, just given LCR considerations. Okay. And then wanted to dig a little deeper into loan growth multifamily has been a key contributor for a while now. Just curious what the outlook there is for multifamily growth in as far as how demand is looking and then also in consideration of other banks kind of seems like there might be pulling back from this space given concentration concerns. Yes, Brandon, this is Tory. I think the multifamily business for us is -- it's pretty complicated. In this regard, we do a lot of multifamily lending in our real-estate group, and then we have a specific multifamily division. And that specific multifamily division is where you saw, we've seen a lot of growth over in 2022. We have-- that's really demand for that. It's very interest-rate sensitive, so demand for that product is much less than it was historically in 2021 and 2022. So it's relatively flat for us. We continue to be active in this space where we can and we continue to be active in the multifamily space in our real estate division. So larger projects. And I see the outlook there to be relatively flat for over the coming six to nine months. Hi, good morning. Maybe you can go back to just the DDA balances specifically on kind of the consumer side. I would be curious as you look at kind of consumer accounts that your bank, if balances today still remain elevated compared to pre-COVID levels, I'm just trying to get a sense of if there still kind of any surge deposits remaining in the bank or any type of analysis you've done there. Andrew, this is Ron. It's difficult to give a specific beat on it. Just given the trends and outflows, but obviously they lower. Just hard to identify, just given the cash is fungible right, let's still considered surgery was not. I would say this though, when you think back to where the bank was five years ago, 10 years ago, three great recession, obviously much lower DDA mix. but one of the key items here that, keep in mind, and while I don't expect the mix to revert back to those levels over-time, it's just a significant business mix shift and changes that Cort and Tory made over the last decade. So, much higher-level of commercial balances within the deposit book today which will give us some stability. I think right now what you're seeing is, just real instantaneous reactions just with the Fed tightening and inflation on the consumer side, so that continues. I expect that also continue in terms of outflows in DDA. But overall, nowhere near where it was decades plus back, just given the mix-shift with the customers. Yes. That's a good point. I appreciate that. And if I can maybe go back to just the mortgage commentary for a moment. I realize it's probably tough to think about the go-forward kind of mortgage contribution as a percentage of fees or revenue but can you just maybe talk about specifically, post some of the actions that you're going to take. And maybe shifting towards the more retail mortgage business. I guess, just structurally, how does that change the profitability within your mortgage business going-forward. Hi, Andrew, it's Cort. So traditionally, until 2022, we had operated mortgage group home lending as we call it, it's more of a traditional first mortgage operation company, if you will. And obviously with rates doing what they did and with the movement we saw, we're going to transition to more of a retail model, what do we mean by that are in-place mortgage lenders and retail locations operating in support of their local communities and the branches. That's what that generally has traditionally met which is a change for the way that we have served our local markets. To your point, it's hard at this point to give any indication of where we think volumes are going to be and it has a lot to do just with just volumes in the communities and under themselves alone, where we get with staffing. Staff, I'll Tory comment a little bit on where you think staffing will settle out. And this is all done, we're making these moves right now, actually since the beginning of the year. We'll make them during the quarter. So, Tory some guidance on FTE. Yes, thanks, Cort. I would -- certainly the industry itself is contracting and demand is significantly less than what it was and we're responding to that. I think at the height of our home lending business, which was phenomenal during the pandemic, we were at about 650 or so associates. I think that today is in the high 300s and we are actively moving that down south and I think we'll land somewhere in the 2 to 250 range in terms of people making sure that as we, as we pivot to this new and different model, we continue to serve our customers and our retail customers, our private bank customers and our commercial customers and we continue to serve our communities. And so that's the direction that we're headed in over a little bit of time and we'll get there. I just one follow-up, just to make sure because other people listening to this call, not just the analyst community. This does not mean like I mentioned in our opening comments, we are not committed to first mortgage finance, we are. We've made a strong commitment and our CBA agreement for our work on our merger to provide low to moderate income finance, low to moderate-income communities, which we are firmly committed to and we've created a group inside mortgage lending to serve that community. So I just want to make sure it goes on the record. This does not mean we are pulling out of mortgage. It has been a big part of this bank for as long as I've been here longer than that and it will continue to be a key part of our business as we continue to serve when we double in size here in about six weeks. Andrew, this is Ron, I'm just going to add in on Cort and Tory's comments. Obviously, the goal is going to be, to have a profitable mortgage business within the redesign we talked about earlier. So, but it's hard to get a beat on specifically the metrics sale margin minus expense just nonetheless positive compared to last couple of quarters. The other thing I'll also add is going forward, given the size, we expect it to move to, it will no longer be a separate segment. So we'll talk about it, just in terms of fee income changes and expense level changes. Okay very good. I appreciate all the color. If I could sneak one more in, just maybe now that there is a closing date set for the acquisition, which was good to see. Any thoughts on kind of pro forma capital levels or updates to the fair value marks or just kind of wait until deal close. Andrew, this is Ron again. I'd say, let's wait till deal closes just given the volatility rate changes, so much. But that's also one of the reasons why we have excess capital going into this to be able to utilize that. And I guess I'd also point out that, wherever that ends up that will also turn into additional capital accretion over time pretty quickly from that standpoint. So there is obviously we'll talk more about that in April. Good morning, thanks for the questions. Just first one on to clarify on the noninterest expense run rate standalone, low '170s stripping out the tax accruals -- unusual tax accrual this quarter, lower mortgage expense, I guess, does that low '170s run rate consider your typical non-mortgage comp kind of merit increases for the year or not. Hi Matthew, this is Ron. Merit increases generally hit towards the end of Q1. Very early part of Q2. So it's in the run for this past year which you look ahead over first couple of quarters of '23, you will see an increase in tax rate right et cetera -- like sub generally in the first quarter, you see that, and then it tails off over the balance of the year, then the merit comes on in Q2, will also have the added benefit with the combination on the combined basis the cost saves by Q4 next year and that too it get something will provide much more updates on as we get to close, and for sure, with outpost close with outlooks on that front. Okay. Got it. Okay, great. And then just circling back to the margin. I'm not sure if you mentioned in your earlier comments, but the average monthly NIM in December do you have it. And I think you mentioned -- Okay, great. And then just on the pro forma capital and kind of assuming it maybe shakes out to a level where you have some nice excess capital. Can you just remind us around the process to be able to repurchase stock given your negative retained earnings and whether or not, you still be constrained by that on a pro forma basis. Sure yes. We will -- that will carry forward just given this combination and the accounting acquirer. So our balance sheet will continue forward, as is the fair value of the Columbia balance sheet. The process that was pretty straightforward. It's a quarterly non-objection process with the state and the FDIC based on legacy, banking loss from decades ago, which were driven by credit losses. And this is goodwill which is excluded from capital. So, but still we have to go through the process, work well with [indiscernible] FDIC. We do that today on the dividends from the bank to the Holdco which support the definition of Holdco like the shareholders at the same process we follow on share repurchase with an outlook on base forecast and stress forecast and the capital -- excess capital doing it. I will point out that about a year and a half back we did repurchase stock from that standpoint. So we came course as the combination came together. But nonetheless pretty straightforward process and I would expect no change to that in the future. Other than, it will be much quicker runway to get to positive retained earnings on the outlook. Just based on where rates are today where the March will be in that accretion over time. Great, thanks for the question. In terms of just -- Ron, maybe just for you the balance sheet, you've obviously got this opportunity to make some tweaks if you need to. So I guess I'm interested just getting your head a little bit about what you might be thinking about perhaps from the securities portfolio also from lending concentrations. I think you talked about FinPac came about 6%, obviously that will get diluted down but any broad high level comments on any tweaks to how we should think about the balance sheet. Yes, I mean we'll talk more about it in April, but pretty consistently in this environment it's a function of reducing sensitivity. So within the bond portfolio will be looking to extend duration [indiscernible] longer out and funded with two to four month advances will help reduce sensitivity depending on where rates go in the future. So that's probably the primary one from that standpoint. And then just be manager -- matter of managing the borrowings to the extent the Fed continues to chime in. Okay. Let me add on to that too. Sorry, let me add on to that too, the second part of your question was our loan concentrations, no plan -- no need to adjust anything on the lending side, we've got a great mix, we've got the capacity to continue to full tilt on any given vertical from that standpoint including FinPac. Got it. Okay. Thanks, Ron. And on credit, I guess I totally get the distinction between FinPac and the rest of the book. If -- you're sitting down for the '23 outlook and the economy is pretty uncertain, where besides FinPac are you spending most of your time in terms of looking for problems. Hi, Frank Namdar. I would say in the CRE space probably centered around office just because that remains an area that's still a big unknown as to where that's all going to shake out into the future and risk people like me don't like unknowns and don't like surprises. So we try to figure it out ahead of time, but as we sit here today, I mean we do not have one office property that is a -- a special mention or classified assets. It remains very stable and strong at this point, but that would be the one space that that we're keeping a close eye on. Thank you. And there are no other questions in the queue. I'd like to turn the call back to management for any closing remarks. This is Jacque Bohlen and we would like to thank you for your interest in Umpqua Holdings Corporation and participation on our fourth quarter 2022 earnings call. Please contact me if you would like clarification on any of the items discussed today or provided in our presentation materials. This will conclude our call, goodbye.
|
EarningCall_1187
|
Good day, and thank you for standing by. Welcome to the Nasdaq Fourth Quarter 2022 Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Neil Stratton, Investor Relations. Please go ahead. Good morning, everyone, and thank you for joining us today to discuss Nasdaq's fourth quarter and full year 2022 financial results. On the line are Adena Friedman, our Chair and Chief Executive Officer; Ann Dennison, our Chief Financial Officer; John Zecca, our Chief Legal Risk and Regulatory Officer; and other members of the management team. After prepared remarks, we will open the line up to Q&A. The press release and presentation are on our website. We intend to use the website as a means of disclosing material, non-public information and complying with disclosure obligations under SEC Regulation FD. I would like to remind you that certain statements in this presentation and during Q&A may relate to future events and expectations and as such, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from these projections. Information concerning factors that could cause actual results to differ from forward-looking statements is contained in our press release and periodic reports filed with the SEC. Thank you, Neil, and good morning, everyone. Thank you for joining us. My remarks today will focus on the following areas: Nasdaq's fourth quarter and full year 2022 financial and business performance. The progress we have made to advance Nasdaq along our strategic journey, and our enterprise-wide ambitions and priorities for 2023 and beyond. I will also provide comments on the current market and regulatory environment before turning the call over to Ann for a deeper look at our financial results. We continue to deliver solid growth in 2022, even with an uncertain macroeconomic backdrop and following a very strong 2021. 2022 was also a year of milestones, strategic firsts and market-leading innovation for Nasdaq. I'm proud of the Nasdaq team and the resiliency of our business as well as the trusted relationships we have with our clients. Before I turn to our financial performance, I want to remind everyone about our new corporate structure that we implemented during the fourth quarter. When we gathered at our Investor Day in November, we noted how the alignment of our business across three new divisions, Market Platforms, Capital Access Platforms and Anti-Financial Crime, allows us to capitalize on mega trends shaping the financial system to unlock new growth opportunities for our company. These trends include the modernization of markets where we continue to deliver innovation that powers the world's economies and enhances the underlying infrastructure, the development of the ESG ecosystem where we help companies and investors successfully navigate increasingly complex reporting frameworks, access more seamless roots to capital and achieve their net zero or sustainability objectives, and the increasing need for advanced anti-financial crime technology, where we can enhance the integrity of the financial system through emerging technologies, including cloud and AI. Our financial results today reflect the new divisional alignment, and we look forward to continuing our journey as we deliver world-leading platforms that improve the liquidity, transparency and integrity of the global economy with our long-term goal of becoming the trusted fabric of the global financial system. Now let's turn to our results. I'm very pleased to report Nasdaq's financial performance for the fourth quarter and full year of 2022. First, regarding the fourth quarter, Nasdaq achieved $906 million in net revenues, a 2% increase compared to the prior year period and a 5% increase on an organic basis, excluding the impact of changes in FX rates and acquisitions and divestitures. In the quarter, we delivered 5% organic growth across our Solutions businesses even with an 11% drop in our Index revenues. We also delivered 4% organic growth in our Trading Services business in the fourth quarter on top of a very strong trading performance in the fourth quarter of 2021. For the full year of 2022, net revenues of $3.58 billion increased 5% from 2021 and 7% on an organic basis. Our Solutions businesses generated 10% annual organic revenue growth despite a fast-changing market environment, and our Trading Services revenues increased 1% on the back of very strong performance in 2021. Our annualized recurring revenue, or ARR, ended the year at $2 billion, an increase of 8% year-over-year. Annualized SaaS revenues increased 13% to $725 million in the fourth quarter of 2022, representing 36% of total company ARR. For the full year, non-GAAP earnings per share of $2.66 increased 6% from 2021. Our strong performance in 2022 against a challenging macroeconomic backdrop illustrates the strength of our diversified business and our ability to deliver against our longer-term objectives. Next, I'm going to turn to specific divisional highlights, which reflect the new corporate structure, focusing mainly on the fourth quarter results. In our Capital Access Platforms business -- division, we delivered $420 million in total revenue in the fourth quarter, a 2% increase in organic growth. Revenue in our Data and Listing Services business increased by 3% from the prior year period and 6% organic growth. primarily due to an increase in annual listing fees and growth in proprietary data revenues driven by higher international demand, partially offset by a decrease in initial listing fee revenues. In 2022, Nasdaq maintained its position as the leading U.S. exchange for IPOs for the tenth consecutive year with 87 operating company listings for a 92% annual win rate. In Europe, our Baltic, Nordic and First North exchanges combined welcomed 63 new listings in 2022, including 38 IPOs. For the second consecutive year, Nasdaq Stockholm remains the most successful listing venue in Europe. In our Index business, we saw revenue decrease by 11% versus the prior year period, primarily due to lower average AUM and exchange-traded products linked to Nasdaq indices, partially offset by higher revenues related to futures trading linked to the NASDAQ 100 Index. Year-over-year average AUM for the fourth quarter declined by 19%. The fourth quarter presented a particularly challenging market backdrop on both a year-over-year and quarter-over-quarter basis. Ann will provide more details on the AUM and trading dynamics that drove the fourth quarter revenue decline. Focusing on the full year performance, our Index revenues for the full year of 2022 increased 6% versus 2021 due to higher net inflows and futures volumes. Net inflows into exchange-traded products totaled $34 billion in 2022, and we saw demand grow for our new offerings with 44 ETPs tracking Nasdaq indexes, accumulating $3.5 billion in AUM during the year. In our Workload Insights business, which include our Corporate Solutions as well as our Investment Analytics business, our fourth quarter revenues increased 8% from the prior year period or 10% organically, reflecting deepened client engagement and strong client retention. Turning next to our Market Platforms division. We delivered $403 million in total revenues in the fourth quarter, a 3% increase from the prior year period or 5% organic growth. Our Trading Services business, which includes our transactional and U.S. paid plan data businesses, delivered combined total revenue of $253 million for the fourth quarter, an increase of 4% organically from the prior year period. This is primarily due to higher U.S. equity derivatives trading revenues, reflecting higher revenue capture versus the prior year period and higher industry volumes. Cash equities trading revenues were lower year-over-year, primarily driven by lower European cash equities revenue, partially offset by modest growth in the U.S. cash equities business. During the fourth quarter, we were incredibly pleased to announce the migration of Nasdaq MRX, 1 of our 6 U.S. options exchanges, to the cloud in partnership with Amazon Web Services. The new cloud-enabled system delivers -- continues to deliver ultra-resiliency to our market participants while improving latency performance by 10%. As the first exchange to put a major market in the cloud, this marks a significant milestone in our journey to build the next-generation technology infrastructure for the world's capital markets. This success has also reinforced our credibility with our technology clients. As illustrated by Bolsa Electronica de Chile's agreement earlier this month to migrate their current on-premise Nasdaq trading technology to our cloud-based marketplace services platform. We are thrilled that BEC has chosen us to help manage this next phase of their cloud journey. And lastly, in our Marketplace Technology business, we delivered $150 million in revenues during the fourth quarter, of 5% increase versus the prior year period. Growth in revenue was primarily due to increased demand for connectivity, driving a record year for our Trade Management Services business as well as higher SaaS-based market technology revenues. Order intake in our Market Technology business totaled $106 million for the quarter and $264 million for the full year, which compares to a record of $304 million in 2021. We had strong order intake across both existing and new clients with over 90% of our new clients signing up for SaaS solutions, an encouraging indicator of growth returning to the technology business post pandemic. We signed 12 new technology clients and completed five implementations in our Market Technology business in 2022. We continue to make good progress with our post-trade implementations, taking two of our largest clients into live operation during the year. Over the past 18 months, we've seen increased demand for our technology solutions with many current and new client conversations focused on market modernization initiatives encompassing both cloud delivery and SaaS. Before I conclude my remarks regarding our Market Platforms division, I want to offer brief comments here on the SEC's equity market structure proposals, which the commission published in December of 2022. We're encouraged that the proposals address many of our recommendations from a paper that we published last year on optimizing markets. While we believe that the equity markets work well now, we acknowledge that there are always opportunities for improvements. Accordingly, we support the SEC's efforts to modernize and enhance equity market structure to improve trading efficiency, bolster competition, increase market transparency, strengthen best obligations and ultimately, achieve better outcomes for investors. In proposing to introduce significant changes to markets that are already highly complex and interconnected, we think it is critical for the commission to strive to avoid unintended consequences by proceeding incrementally, methodically and collaboratively. There are also a few areas where we differ with the SEC's approach, and we plan to recommend improvements, modifications and or alternatives during the comment period. Finally, turning to our Anti-Financial Crime division. We delivered $82 million in total revenue during the fourth quarter, a 21% organic increase from the prior year period and 14% when adjusting for the impact of the deferred revenue write-down. The revenue increase was driven by strong demand for our fraud detection and anti-money laundering solutions or what we call our FRAML [ph] solutions in addition to modest growth in our surveillance solutions. Regarding our FRAML solutions specifically, revenue grew 23% when adjusting for the impact of deferred revenue in the prior year period. The business saw continued growth in new clients across small to medium banks with 98 new SMB clients signed during the quarter. In addition, the business signed its first two clients to its crypto anti-financial crime platform in 2022. This is an exciting offering that allows crypto companies to identify crime, ensure regulatory compliance and prevent losses. We also continue to see momentum following several proofs of concepts with a number of Tier 1 and Tier 2 banks, including signing a Tier 2 bank for our enterprise fraud solution during the fourth quarter. Feedback on the proof-of-concept results has been very positive, and we anticipate signing additional clients in 2023. I want to take a moment here to acknowledge our leadership appointment that took place this month in our Anti-Financial Crime division. Brendan Brothers, a co-founder of Verafin and the division's Head of Strategy, has been appointed interim Head of our AFC division. He succeeds Jamie King, who's retiring from Nasdaq. We're grateful for Jamie's tremendous contributions to Verafin, and we wish him very well in his next chapter. And we're excited to have Brendan step in to his role as we continue to execute against our AFC road map. As I mentioned at the start of my remarks today, Nasdaq has made notable progress against our broader strategic journey. With the year ahead now in focus, I'd like to share our enterprise priorities for 2023 and beyond. First, we will strive to realize the benefits of our new divisional alignment. We aim to unlock the growth opportunities that our new structure provides us. We intend to deliver an enhanced client experience by delivering more unified solutions through a One Nasdaq approach to our clients. We will have a focused capital allocation strategy across our three divisions, and we will increase our go-to-market agility by integrating related software development and marketing talent into each division, which would facilitate streamlined decision-making. Second, we want to remain positioned for success amid a dynamic market environment. With macroeconomic uncertainty likely to persist as we continue into 2023, we want to demonstrate the value of our mission-critical solutions in an environment where businesses know that they need to keep investing but are increasingly focused on quick time to value and strong return on invested capital. And third, we want to continue advancing our long-term cloud and AI strategy across the Nasdaq franchise by optimizing our agile development and leveraging machine intelligence across our solutions to unlock more opportunities to deliver innovation to our clients. Within market platforms, as we deploy our new data-centric system architecture, combined with the scalability and the analytics engines that are offered through the cloud infrastructure, we believe we'll be able to develop new AI-based order types and we'll offer more advanced capabilities to our market participants connected into our ecosystem. These capabilities will also become available to our exchange technology clients as we work collaboratively with them to deploy cloud-based market infrastructures in their home markets. Beyond market platforms, we're already well positioned with our cloud-based SaaS solutions across many of our solutions businesses, and we're on our journey to bring more of our solutions into the cloud. In 2023, we're currently migrating our clients onto our next-gen cloud-based governance platform and trade surveillance platform. As our anti-financial crime solutions demonstrate, having a cloud-based data lake unlocks enormous potential in applying advanced AI algorithms and self-reinforcement learning engines to our solutions. And with new step function improvements in AI that are coming to market, we're extremely excited to apply those technologies to more of our solutions in 2023 and beyond. We look forward to updating you on our progress on these priorities in the quarters to come. Before I wrap up, I would like to address the current market environment. Uncertainty still lingers across the global economy and market-driven headwinds. And if they persist throughout the year, that could impact our near-term growth outlook across listings and index in 2023. We are also seeing a modest elongation of sales cycles for certain of our solutions, notably our IR solutions and our asset owner solutions, which is part of our Analytics business. We are viewed by our IR and asset owner clients as a trusted partner to help them manage through the challenges that the markets have presented. But we are finding, particularly in more hard-hit sectors, that clients are going through more internal gates to approve investments in IR and portfolio management solutions. More generally, across our broader Nasdaq platform, client demand remains strong. Despite the macro uncertainty, we believe 2023 will be marked by how well businesses continue to adapt to the digital transformation of the economy through investments in technology. Nasdaq benefits from that digital transformation given our range of technology and analytics solutions. Building on our foundation of solid client retention, competitive success and deepened engagement with clients, we have confidence that our clients' investments in technology and cloud-based SaaS solutions will continue to be a priority. Therefore, we maintain our conviction in the investments we're making to deliver modern world-class solutions to our clients. We have a very resilient and diversified value proposition and are well prepared to guide our clients and our companies through this dynamic environment. We are entering the year with a continued focus on achieving our revenue growth outlook over the medium term as we navigate a complex 2023, and we remain confident that our longer-term investments across market modernization, ESG solutions and anti-financial crime technology will create value for our clients and shareholders alike. As I wrap up, I will summarize by saying that our fourth quarter produced solid results for Nasdaq, completing a very successful 2022 for our company. Looking ahead in 2023, we enter the year focused on realizing the benefits of our new corporate structure to amplify growth across our key pillars of liquidity, transparency and integrity as we look to advance towards our goal of becoming the trusted fabric of the global financial system. Thank you, Adena, and good morning, everyone. My commentary will primarily focus on our non-GAAP results and all comparisons will be to the prior year period unless otherwise noted. Reconciliations of U.S. GAAP to non-GAAP results can be found in our press release as well as in the file located in the Financials section of our Investor Relations website at ir.nasdaq.com. As a reminder, on Slide 4, our financial reporting reflects the new corporate structure that we announced last quarter. Additionally, in order to better align our financial reporting with our internal management structure, we also recast the U.S. cash equity and options tape plan revenues into the Trading Services business within Market Platforms division from the Data and Listing Services business within the Capital Access Platforms division. Investors can review an updated supplement on the IR website with historical time periods reflecting this change. I will start by reviewing fourth quarter 2022 performance beginning on Slide 11 of the presentation. The 2% increase in reported net revenue of $906 million is the net result of organic growth of 5%, including a 5% organic increase in the Solutions businesses and a 4% organic increase in Trading Services, partially offset by a 3% negative impact from changes in FX rates and the net impact of an acquisition and divestitures. Moving to operating profit and margins. Non-GAAP operating income decreased 1% while the non-GAAP operating margin of 49% was down from 51% in the prior year period. For the full year 2022, the non-GAAP operating margin totaled 52%, a decrease of 1 percentage point from 2021. Non-GAAP net income attributable to Nasdaq was $317 million or $0.64 per diluted share compared to $328 million or $0.64 per diluted share in the prior year period. Turning to Slide 12. As Adena mentioned earlier, ARR totaled $2 billion, an increase of 8% from the prior year period, while annualized SaaS revenues totaled $725 million, an increase of 13%. I will now review quarterly division results on Slides 13 through 15, starting with the Market Platforms division. Revenues increased $10 million or 3%. The organic increase was 5%, and there was a 2% negative impact from changes in FX rates. Trading Services' organic growth totaled 4% with the increase primarily due to higher U.S. equity derivatives and U.S. cash equity revenues due to higher capture and higher industry volumes, partially offset by lower European cash equity revenues due to lower industry volumes. Within marketplace technology, we had strong performance in our Trade Management Services business and delivered another quarter of organic growth in the Market Technology business, driven by higher SaaS revenues and strong order intake during the period. This builds on the positive organic revenue growth in the third quarter of 2022 and, is a further encouraging proof point that the programs and initiatives implemented by the leadership team are moving the business forward. ARR totaled $503 million, an increase of 5% compared to the prior year period. The division operating margin of 52% in the fourth quarter of 2022 and 54% in the full year of 2022 both decreased 2 percentage points from the prior year period. The change primarily reflects increased expenses associated with the continued investment in our people and our businesses, including our digital asset strategy. Capital Access Platform revenues were unchanged, reflecting organic revenue growth of $7 million or 2% as well as a 2% negative impact of changes in FX rates. Organic revenue growth during the period reflects positive contributions from the Workflow and Insights and Data and Listing Services businesses, partially offset by an organic decline in Index revenues. Spending a moment on Index. Overall Index revenue declined by 11% compared to the fourth quarter of 2022. When examining the key drivers of the financial performance, our asset-based licensing revenues declined 21% compared to the prior year period, partially offset by a 25% increase in futures-related revenues linked to the NASDAQ 100 Index. Average AUM during the period, which is used to calculate our asset-based revenues each quarter, decreased 19% from the prior year period and trading volumes in futures linked to the NASDAQ 100 index increased 21% from the prior year quarter. To assist analysts and investors going forward, we are updating our public disclosures to provide average AUM each quarter in addition to the end of the period, which will be -- which will better align our key disclosures with our key revenue drivers for the business. One additional note looking forward to the first quarter of 2023. Trading activity of instruments linked to our indexes achieved certain annual thresholds during the second quarter of '22 that resulted in an increase in licensing economics during the remainder of the year. As we begin 2023, the economics of certain agreements reset for the new year. We estimate that this will lead to approximately $9 million of lower revenue in the first quarter of 2023 compared to the fourth quarter of 2022, assuming similar trading activity and product mix in the two periods. ARR for Capital Access Platforms totaled $1.19 billion, an increase of 7% compared to the prior year period. The division operating margin of 50% in the fourth quarter decreased -- the fourth quarter of 2022 decreased 3 percentage points from the prior year period. The operating margin for the full year 2022 was 54.4%, up 60 basis points from 53.8% in 2021. Anti-Financial Crime revenue increased $14 million or 21%, with $4 million of the increase due to the impact of the deferred revenue write-down on Verafin in 4Q '21. Organic growth was 21% in the period or 14% when excluding the impact of deferred revenue, reflecting healthy demand for fraud detection and anti-money laundering solutions as well as SaaS-based surveillance solutions. Fraud detection and AML solutions revenues grew 23% compared to 4Q '21, excluding the impact of the deferred revenue write-down. ARR for Anti-Financial Crime totaled $312 million, an increase of 16% compared to the prior year period. Signed ARR, which also includes ARR for new contracts signed but not yet commenced, totaled $338 million, an increase of 17% versus the prior year period. The Anti-Financial Crime division operating margin was 32% in the fourth quarter of '22 and 26% in the full year of '22. Turning to Page 16 to review both expenses and guidance. Non-GAAP operating expenses increased $26 million to $460 million. The increase reflects a $45 million organic increase, partially offset by a $20 million decrease from the impact of changes in FX rates and a $1 million decrease from the net impact of an acquisition and divestitures. The organic expense increase is primarily driven by higher compensation and benefits expense and general and administrative expense. The higher compensation reflects our continued investment in new employees to drive growth, including a 10% increase in the team over the past 12 months; and annual merit increases, which were higher than prior years due to inflationary pressures on compensation. The higher general and administrative expense primarily reflects higher travel versus the prior year period as we returned to a more normalized level of travel in 2022. During the fourth quarter of 2022, we initiated a divisional alignment program with a focus on realizing the full potential of our new corporate structure. As a reminder, we did this to focus our business more sharply on three megatrends: modernizing markets, ESG and anti-financial crime. The structure change not only increases our focus but will also bring commercial teams closer together, put technology and marketing resources closer to our products and redefine how we engage, attract and retain clients across products. As a result, we expect to incur $115 million to $145 million in pretax charges, approximately 40% of which will be non-cash charges. The program will be open for two years and has three main components: one, asset impairments and contract terminations; two, employee-related costs to support the divisional realignment; and three, onetime consulting and other spend designed to help us unlock revenue synergies. We are targeting benefits in the form of combined annual run rate operating efficiencies and revenue synergies of at least $30 million by 2025. Costs related to the divisional alignment program will be recorded as restructuring expense. We are initiating our 2023 non-GAAP operating expense guidance to a range of $1.77 billion to $1.85 billion. The midpoint of the expense guidance range reflects an increase of just over 5%, including an increase of 1% related to our digital asset strategy and primarily reflects our continued investments to drive growth across ESG, anti-financial crime and market modernization. We expect the 2023 non-GAAP tax rate to be in the range of 24% to 26%. Turning to Slide 17. Debt increased by $27 million versus 3Q '22, primarily due to net issuances of $465 million of commercial paper and $164 million increase in Eurobond book values caused by a stronger euro, partially offset by repayment of $600 million of 0.445% senior unsecured notes at maturity. Our total debt to trailing 12 months non-GAAP EBITDA ratio remains at 2.7 times as compared to the third quarter of 2022. With record free cash flow, excluding Section 31 fees of $1.5 billion in 2022, our weighted average cash cost of debt of 2.2% and no long-term debt maturities until 2026, we have positioned the company to minimize the impact of rising rates and to provide flexibility to support our growth strategy. During the fourth quarter of 2022, the company paid common stock dividends in the aggregate of $98 million. As of December 31, 2022, there was an aggregate $650 million remaining under the Board-authorized share repurchase program, reflecting an increase in authorization approved by the Board in December. Turning to Page 18 of the presentation. I would like to highlight some of the significant progress we have made, executing on our sustainable strategy. For the seventh consecutive year, we were named to the Dow Jones Sustainability North America Index, one of the most prestigious environmental, social and governance ranking benchmarks. Nasdaq was 1 of 8 diversified financial services companies selected for inclusion in the 2022 index. In addition, we were only -- 1 of only 283 companies out of 15,000 evaluated and named to CDP's 2022 Climate Change A list. In closing today, Nasdaq's fourth quarter of 2022 results reflect a continuation of the company's ability to consistently perform well across a wide range of operating environments. [Operator Instructions] And I show our first question comes from the line of Richard Repetto from Piper Sandler. Please go ahead. Yes, good morning, Adena, and good morning, Ann. I didn't quite get those restructuring charges, but I think I'd like to keep my question broader. Adena, you talked right at the conclusion in your prepared remarks about sort of the outlook for '23. And I think we all get if the markets are down, the index business, the listing business, et cetera. But I'm trying to see what businesses might flourish, or is there any businesses that might make progress if we get -- with this macroeconomic uncertainty? Because investors look at exchanges to be a little bit countercyclical. And might attach with that, that this sort of outlook, I know it's early on, but the Reg NMS changes, just on balance, they're not going to happen this year. But if they -- the whole balance, whether the fee -- cap fees versus the higher volumes, how you look at the balance from the proposed changes. That's okay. No, no, that was good. Okay. So in terms of outlook for 2023, I think the general view inside of Nasdaq right now is that we continue to have really strong client interactions across all the businesses that comprise our annualized recurring revenue. So that's our Anti-Financial Crime business, our -- what we call our Corporate Solutions business, our investment analytics capabilities and particularly in our analytics and our data businesses and in our Marketplace Technology business. We still see really good client demand, client interactions, progress against our strategy. I feel our ESG services had double-digit growth and we continue to see really great capabilities and opportunities there. Our anti-financial crime technology continues to show really strong growth. And I think that the market modernization efforts are really impact -- having a positive effect on our engagement with our market tech clients as they're thinking about modernizing their infrastructure. So what I would say, the long-term trends that we're really driving towards feel good as we go into 2023, and we feel really great about the client engagement. The market backdrop, obviously, we're not immune to it. No company is. But I would agree that exchanges have a really resilient -- we're a resilient platform because we have this underpinning of trading, we have this underpinning of our listings and listing fees. We have an underpinning of data that really help keep us really strong and quite resilient in -- across all different market environments. But there are a couple of areas where we have market beta. So certainly, listings revenues won't grow as fast if we don't have listings come out to the market. We have 200 companies on file looking to tap the NASDAQ and hopefully, if the markets open up as we go through the year. But as you know, it takes 2 to tango. So we've got the supply the demand really comes for investors feeling confident underwriting new deals. And I think if we can see interest rates kind of top out and we kind of know where that ends up, we see inflation continue to come down and we have a more certain economic underfooting, we could actually see activity pick up, particularly in the latter half of the year. And we're hopeful for that. And that will help, obviously, with '23 growth but also help with '24. I think with the Index business, it's obviously subject to market beta with our AUM. And we were able to withstand a lot of changes in market values last year. But the fourth quarter, you could see, had a big impact. So the AUM dropped a lot. We didn't have as robust inflows in the fourth quarter to counteract that. But as we go into 2023, we're leased off to a better start. We'll have to see how that evolves, and that's an area where we will have market data through the year. So we'll have to see that goes. But if I were to sum it up, though, the areas where we have recurring revenues and we have our SaaS revenues, we feel really good about how we're engaging with clients. We do have some elongated sales cycles across IR and analytics. But generally speaking, really strong demand. The trends that we're underwriting, we feel really good about and investments we're making there. And I think the markets will be the markets, but I think we've been able to demonstrate really strong performance across different market cycles. Lastly, you asked a question about Reg NMS and the fees and volumes. It's really early, Rich. It's an initial proposal from the SEC. There'll be rounds of comments, there'll be probably revisions in the proposals. And so it will be several years before we kind of see the impact of that. But you're doing the same tactics that we're trying to do, which is we see more opportunity to bring more retail volume onto lit venues, and that's obviously going to benefit us. But we also see a change in the tick sizes and the relevant access fees, and that's where we have to kind of look at that, the kind of what I'll call the different dynamics that that will result in. And so we actually kind of net-net are generally positive on what the SEC's proposed. But we obviously want to make sure we're calibrating the tick sizes and the access fees appropriately for what they're trying to achieve there. Good morning. And thanks for taking the question. I wanted to dig in a little bit on Verafin. I was hoping you can update us on how the sales environment and pipeline is evolving. And you mentioned some proof of concepts that are undergoing right now. I was hoping maybe you can elaborate on how many you have with Tier 1 banks, and historically, what's been the time to conversion with those historical clients signing over to becoming paying customers? Thank you. Sure. Yes. Thanks, Michael. So generally, if we look at all of AFC, so you've got anti-financial crime, so you've got the FRAML business which is kind of the Verafin capabilities, and then you have our trade surveillance, which is really the surveillance technology we offer to trading firms and we have market surveillance, which is the technology -- the surveillance technology we offer to markets. In Verafin, as I mentioned, we continue to see really nice strong demand there, and client -- especially with small and medium banks, the conversion has been quite consistent, finding a lead to getting them to become paying clients. And we had, I think it was 98 new clients in the quarter. And we had really strong dynamics there. And it's -- I have to say, I think what we offer is a great product and it shows up in the sales. As we go upmarket, that's where we're kind of -- we, as Verafin, are facing some new unchartered waters, right? We're getting up to the top of the top of the banking universe. And I think that what we're seeing is Tier 2 banks, we're getting them signed up and lined up slowly but surely. The proof of concepts are showing a significant reduction in false positives and a better ability to identify real fraud. And so I think that's really -- the proof points are really helpful in getting to convert a client. Tier 2 banks, you're talking more like a, I would say, anywhere from a 6 to 12-month sales cycle there. And then you get up to the large Tier 1 banks. And that's where, again, we have several proofs of concepts that are completed now, and I think that we're showing really strong results in terms of improvements in lower false positives, better fraud detected. But the contracting cycles there are really long because they go through a really deep review internally. We go through, obviously, cyber review. We go through a lot of different things. And those sales cycles can be anywhere from, I would say, kind of 9 to 15 to 18 months. So we are really hopeful because we completed some of those proof of concepts in the first half of last year that we should be able to convert them this year. And I can only say, Michael, we're not giving specific numbers, but it's a good number of proof of concepts that we've completed. It gives us an opportunity to show that we can get into the Tier 1 banks as we go through '23. And so we're confident we'll be able to show those proof points as we go through the year. Yes, good morning, everyone. This may be a little bit of a snippy question but I'm going to ask it anyways. It's about the recast. So obviously, you just in November resegmented and rolled out new targets for solutions 7 to 10. But then obviously, you just recast something today to basically move a no or shrinking business into the non-solution segment. So if my math is right, it's about 60 basis points of positive impact to organic growth to Solutions in the fourth quarter. So I guess my question is, should we hold you accountable for higher targets now? Was it 7.5% to 10.5%? Or how should we be thinking about it? Because, again, you did a nice job recasting and really moving Solutions to be non-trading, and now you're changing that around again? Thanks. Yes. So Alex, thanks for the question and it's not snippy. So -- but I would say this. We actually made that change, so what happened was we used to have the options tape revenue sitting inside the Market Services business, and we have the equities tape revenue sitting inside of Market Data. And -- but what we did with the realignment was we actually moved the management of the equities tape into the Markets team because of the fact that the revenues associated with the equity tape are more -- they ebb and flow with market share and other dynamics in the market as opposed to just pure client demand. And so we decided, and so when we first redid -- went into the new divisional alignment, we actually moved the options tape into data as opposed to moving the equity tape into the markets. And we -- as we went through the fourth quarter and we really thought about kind of aligning the business with the management, we actually decided to make a switch. So we kind of moved the options and equities tapes now into market platforms because that's where the team that supports them are moving into the Market Platforms division, are being managed by the Market Platforms team. So we did not do it intentionally to kind of recast targets or anything like that. We're not changing our medium to long-term outlook across our Solutions businesses. 7% to 10% is the target and the outlook that we expect to be able to achieve over medium to long term. But we did want to move those products just into the group that's managing them. That's really the only catalyst. Good morning. Thank you for taking my question. So on the expense outlook, could you please talk about the area that you will invest in ESG and Anti-Fin Crime? Is there any specific examples you can give to us? And how should we think about the new product launches or even incremental revenue potential from these investments? Thank you. Sure. I'll start. Hi Owen. So when we think about -- I guess, just coming back to the guidance, we've got that midpoint of our guidance is at 5%, which is when you look at our 4% to 7% medium-term outlook, we're just below the midpoint of that which would be 5.5%. When we think about what comprises that 5%, substantially all of our growth is to support, like you said, the -- our growth initiatives across ESG, AFC and market modernization. And I would characterize them as the investment we need to continue building out the long-term opportunities for those business to support the revenue growth we have in our outlook over the medium term. And so I think it's really about that 18% to 23% medium-term outlook on AFC and then our capital access platform medium-term outlook to support the growth there, ESG being the biggest or a high -- growing off a small base but a high-growing portion of the Workflow and Insights portion of the business. Yes. And I think, Owen, one thing we did point out because embedded in that 5% annual growth in expenses is about, 1 percentage point of that is really the continued investment we're making in our digital assets business. As we kind of get closer to launching that business, hopefully in the first half of this year. So that's one concentrated investment that we've called out as we went through and discussed the outlook. I think beyond that, when we look at the remaining 4% growth, as Ann said, the majority of that growth really just comes from making sure we're making the right investments across the three key pillars. We're not kind of quantifying investments in each one of those pillars. But they're all -- you have to think about it this way. The growth outlook of one of those businesses, if there's a higher growth outlook, it's likely that we're putting more investment dollars or at least on a percentage basis, putting more investment into those businesses. So like our AFC business. If we have a medium to long-term growth outlook of 18% to 23%, we're investing in the R&D and the go-to-market and the sales capabilities to make sure we support that growth. And so that would have a higher level of investment than something that's growing 5%, let's say. But I also think that -- as a general matter, we feel like we're making the right choices of where to invest our capital to make sure we can sustain our growth and make sure we achieve this on the medium to long-term outlook. Good morning, everyone. So I had a question on the pretax charges from the divisional alignment. I was wondering if you could provide more detail behind the employee-related costs. And what does this really mean in sort of simple terms? Is it layoffs, new hires? And where are you increasing headcount and where are you potentially reducing headcount? Okay. Thanks, Craig. I can get started on that question. So if we think about just overall the realignment program that we've launched, the objective of the program is really tied very, very closely to our restructure of the -- and realignment of the divisions themselves. So when you think about the employee costs that are embedded in that range of 115 to 145, they're really complementing our divisional realignment and not broad-based. We're not looking at anything sort of from a broad-based company perspective, but really the effect of looking at location and functional strategy within the alignment of the divisions. And then also migrating some of our tech to optimize the power of the combined divisions. And we think about those costs coming in over the next two years and with an expected return on those costs of an annualized run rate savings and revenue synergies of about $30 million a year sort of fully baked in by 2025. And I'd say that $30 million estimate, right now, the majority of that is on the expense side. Thanks, good morning. I wanted to follow up on the Anti-Fin Crime. The 14% growth ex the deferred revenue this quarter, trying to bridge that to the 3 to 5-year outlook of 18% to 23%, and you've clearly talked about a lot of momentum. But is in the -- but the long sales cycles, do you need -- should we think about 2023 as being within this, the higher end? Or is it going to ramp as we kind of get and maybe exiting that -- exiting '23 or beyond to get to those higher numbers? Sure. Well, I think that as we look at our kind of our medium- to long-term outlook, that 18% to 23%, we feel is well supported by the sales opportunities, the pipeline and the overall continued investment in the actual products so that we can continue to expand our capabilities. I thought I'd give you just a little bit more detail on how we look at the dynamics. And I mentioned -- as I mentioned before, we have our FRAML solutions. And that obviously, that's our Verafin asset, and that was delivering more than 20% growth in the quarter and continues to have really strong growth potential even as it continues to scale. And so I think there, Dan, we definitely think that the Tier 1, Tier 2 -- we're not dependent on Tier 2 and Tier 1 banks to support that growth rate in the short term. But as we continue -- as we move upmarket and we are able to attract this Tier 1 and Tier 2 banks, the ticket sizes are much, much higher. So over the longer term, showing momentum across that will be important to continue to maintain the strong growth trends that we're showing in that business. The other two parts of the business, trade surveillance, that continues to have kind of high single-digit, low double-digit growth, and it has for a long time. That's providing surveillance solutions to trading firms. And there, we're continuing to drive that growth by expanding the types of modules that we offer, like our crypto modules as well as more -- bringing more asset classes onto the platform and really continue to globalize the clientele there. We have gotten to the point where we become an enterprise provider of surveillance across large banks, and that continues to be a good growth opportunity to support that kind of high single digit, low double digits. The one area that is actually has a low -- I would say flat to low growth profile is our market surveillance business where it's the smallest part of the division. But it's a harder one to grow a lot because the overall base of client opportunities is smaller. That's where we provide surveillance to markets and regulators. And there, that business was largely flat for the year and continues to have a low growth profile. So that's -- I think certainly in 2022, that has created a little bit of kind of a lower growth view. And as we go into '23 and '25 or '23 to '24, '25, '26, we hope to find new ways to catalyze some growth there, but we will expect that to be a low grower in the years to come. So hopefully, that just gives you a little more context. Good morning. Thanks for taking my question. Maybe just one confirmation just on the divisional alignment program, the 115 to 145. I just want to make sure that's those expenses are not included in the non-GAAP guidance. So just a clarification on that. And then more broadly, just in terms of the Solutions growth for this year, I realize 7% to 10% remains your longer-term target. But given the headwinds that you're describing this year from the elongated sales cycles and of course, the pressure on index licensing, should we be thinking of a near-term 2023 as being sort of lower than that? And then the initiatives that you're investing in would potentially then raise that in '24? So kind of a slowdown and then a reramp of that Solutions revenue. Sure, Brian. So on the first part of your question, the divisional alignment program, the cost associated with those will be booked on the restructuring line, and they will not be included as part of -- they are not part of our non-GAAP expense guidance that we released for 2023, yes. Yes. And then with regard to the overall outlook for the business, I think that -- I would say it this way, I think, Brian, that in general, we feel really good about how we're delivering on the growth of our Solutions businesses across, as we mentioned, AFC as well as the investment analytics, so insights and workflows for the corporates and I know market tech business. And I think we continue to see really good client demand. There are some elongated sales cycles and that could bring the growth down a little bit for the year. But I think the one area that we do have some dependence on the market backdrop is in our listings business and our Index business. And there, we are hopeful that we'll see some improvement across index values, market values, which will then, of course, support bringing more companies to market, and that will help us manage through the year and be consistent with how we are looking at our targets. But those areas could create more of a challenge if we don't see an improvement in the overall market environment for this year. I think that's why we like to keep those targets as kind of medium to long term as we look at an average over multiple years just because of the fact that there are years where you have a tougher market backdrop. I would point out, though, that even with the tough market backdrop that we had in 2022, we were able to deliver 10% organic growth across our Solutions businesses. And we had 8% improvement -- increase in our ARR and 13% increase in our SaaS. So even with a really challenging market environment from last year, I think we were able to show a consistent story across Nasdaq. Good morning, Adena and Ann. I wanted to just spend a second on Puro.earth and the long-term opportunity there. I know Puro.earth presented at COP 27 and the trading certificates increased 250% in 2022. Can you talk about the potential earnings contribution from this business in the future? And is there an opportunity to sell Puro.earth directly to your corporate clients that are across the U.S. and Nordic businesses? Sure. Yes. Actually, we do. So what -- I love talking about Puro.earth. So just as a reminder, Puro.earth a carbon removal marketplace where we have a minority position in partnership with a company called Fortum in Finland. And we are really excited about the opportunity that Pure Earth provides to us and, frankly, to our clients. So we do already tap our corporate clients as clients. So they come in directly and buy carbon removal credits through the Puro.earth platform, and we leverage our corporate relationships to really continue to grow the demand for those credits. I think that what's holding that market back today, and it's very small, so I just want to enforce off on everyone that, that is a small business today. It did grow, as you said, actually, I think it was like 250% to 300% year-over-year but from a tiny base, it sits in our Market Platforms business. It supports our ESG strategy and that mega trend. But what's really holding that platform are all -- that whole marketplace back is supply. So we are really focused on high-quality industrial carbon removals. We do diligence on every supplier we put on the platform. We have -- we work with an advisory committee to determine which scientific methods we're willing even to put on the platform. We're very, very discerning in how we bring supply onto the platform. And given the fact that it's still a pretty nascent industry, we're really hamstrung by small supply today. So over the next three to five years, we actually expect a lot of investment to come into the carbon renewal space. We think that will really bolster supply. We're replatforming Puro.earth to have a really advanced blockchain based registry that we can then leverage across multiple trading venues. And we're working with some market makers to help create -- they're going to buy up from removals and start to create a secondary market, so that we can also have trading activity start to develop on the platform. But I want to say this. I think Puro.earth is kind of like a 5 to 10-year strategy. It's a very small investment for us as of right now. It's a small but mighty team. But we are really, really excited about what it can become, but just recognize it's a long-term strategy. Good morning. Thanks for the question. I was hoping we could dig into some of the interplays in the kind of legacy listings business and the Corporate Solutions business. I guess, on the one hand, I was curious if you could help frame the revenues that could be at risk from stocks delisting over the course of this year, and then on the flip side, opportunities you guys might see from some of the discounts on the Corporate Solutions services that you provided to IPOs that listed over the last couple of years, those coming off and the probability of them starting to pay for service? Great. Yes. Thanks, Alex. I mean the SPAC revenue represents just over about 1% of total revenue for Nasdaq. So it's a small part of our revenue stream. We are seeing SPAC combined, but we're also seeing a number of SPAC decide to provide the money back to their shareholders. So it's a small part of our revenue. And -- but we're -- but we also recognize that the environment has changed a lot for SPACs, and so we would anticipate some reduction in revenue coming from the back of SPAC ultimately not finding combinations. So I think that's something that will probably have more of an effect in 2024 than in 2023, but it's something we're watching pretty closely. But as I said, just to size it, it's a little more than just 1% of the revenue. I think with regard to Corporate Services and Solutions, which is our IR and our ESG solutions to support corporates, you are right. We have a lot of clients who come on to our platform. We've been supporting them through the IPO package for the last two years. And so as we get particularly into 2024, we're going to see the opportunity for us to turn them in and convert them into paying clients. And so that is obviously -- that part of our outlook for that business is how we convert those clients to paying customers. We've also upsold those clients even during the IPO package period where we might sell them into some of our ESG packaged solutions and into a deeper set of IR solutions. So we do have them some of them as paying clients now. And I think that obviously, even bolsters our view that they'll continue to want to use our services beyond the IPO period. But I just want to say, I think that's more of a '24 opportunity than '23, but we're very optimistic about that. We have strong retention of clients as we convert them. Good morning. Maybe a question on the BEC migration from your on-premise solution to your cloud-based platform. Could you just remind us of the revenue and margin impact for Nasdaq from this type of on-premise to cloud migration? I'm just trying to put some numbers around the impact so we have a better understanding of kind of the larger opportunity if we see more similar type announcements over the coming year or two? Yes. I think that we'll probably need to come back to you to give you a little bit more of that view. I can't sit there and use one client and extrapolate it to the whole business. But when we do sign a client on to more of a SaaS-based market tech contract, there are two benefits. One is just it becomes an annualized recurring revenue as opposed to an implementation revenue, which has much lower margins, followed by a service and maintenance and license agreement which has a higher margin. So you have like more steady revenue and a more steady margin throughout the length of the contract. But I don't think we've given you a view yet into like what's the margin differential. And so I kind of feel like we probably need to come back and give a little bit more of an insight into that specifically as we gain more traction in getting our clients to sign on to cloud-based, particularly cloud-based solutions. So let's come back to you on that, but I just don't want to give you kind of a wrong answer right now. Thank you. That concludes our Q&A session. At this time, I would like to turn the call back over to Adena Friedman for closing remarks. Great. Thank you very much. Well, as we conclude today's call, I want to reiterate that our leadership team remains very focused on executing our strategy to deliver for all of our stakeholders, and we look forward to continued discussions throughout the year on the progress we aim to make against our strategic priorities. So thank you very much, and have a great day.
|
EarningCall_1188
|
Ladies and gentlemen, welcome to the Hanmi Financial Corporation's Fourth Quarter and Full Year 2022 Conference Call. As a reminder, today's call is being recorded for replay purposes. [Operator Instructions] Thank you, Doug, and thank you all for joining us today to discuss Hanmi's fourth quarter and full year 2022 results. This afternoon, Hanmi issued its earnings release and quarterly supplemental slide presentation to accompany today's call. Both documents are available on the IR section of the company's website. I'm here today with Bonnie Lee, President and Chief Executive Officer of Hanmi; Anthony Kim, Chief Banking Officer; and Ron Santarosa, Chief Financial Officer. Bonnie will begin today's call with an overview and Anthony will discuss loan and deposit activities. Ron will provide details on our financial performance and then Bonnie will provide closing comments before we open the call up to your questions. Before we begin, I would like to remind you that today's comments may include forward-looking statements under the federal securities laws. Forward-looking statements are based on current plans, expectations, events and financial industry trends that may affect the company's future operating results and financial position. Our actual results may differ materially from those contemplated by our forward-looking statements, which involve risks and uncertainties. Discussion of the factors that could cause our actual results to differ materially from those forward-looking statements can be found in our SEC filings, including our reports on Forms 10-K and 10-Q. In particular, we direct you to the discussion of certain risk factors affecting our business contained in our earnings release, our investor presentation and in our Form 10-K. Thank you, Larry. Good afternoon, everyone. Thank you for joining us today to discuss our third quarter 2022 results. 2022 was a year of solid execution and record earnings for Hanmi. We continue to strengthen and diversify our business by executing our well defined strategies, enabling us to finish the year with a strong momentum. This strategic model, coupled with our ongoing dedication to customer service, underscores our proven ability to navigate dynamic macroeconomic conditions and deliver strong results. For the year, we generated record net income and loan production and an improved net interest margin, all while diligently managing our operating expenses and improving our asset quality. Let me review the highlights. Net income for the year was a record $101.4 million, or $3.32 per diluted share. Loans grew by 15.7% in 2022, driven by record new loan production of $2.1 billion. Net interest income for the year increased by 21.8% as a result of a higher average earnings assets and a 42 basis point increase in our net interest margin to 3.50%. Our deposits grew by 6.6% for 2022, which helped fund our loan growth, and the mix of non-interest bearing deposits remained strong at 41.2% of total deposits. We managed our non-interest expenses diligently. They increased by less than 5% for the year, and we recorded a full year efficiency ratio of a 47.93%, a 608 basis point improvement from 2021. Importantly, asset quality improved significantly in 2022 as we continued our focus on high quality loans, disciplined underwriting and vigilant credit administration practices. As a result, nonperforming assets declined 29% to $10 million or 0.14% of total deposits. Criticized loans were down 20%, and net charge-offs were negligible over the course of the year. Last, our 2022 return on average shareholder equity was strong at 14.83%. We increased our shareholder dividend twice this past year 25% year-over-year in recognition of our improved performance and our capital ratios remained very strong, positioning us well for continued growth in a safe and sound manner. Our team delivered meaningful progress on each of our strategic growth initiatives. We further diversified our loan portfolio, strengthened our relationships with existing customers, expanded our customer base, bolstered our core deposit franchise. Our commitment to exceptional customer service is the hallmark of our community banking approach, and in tandem with our focus and hard work, enabled us to achieve these results. As we have discussed in the past, diversifying our loan portfolio has been a key priority over the last two years, and we made excellent progress in 2022. For example, our residential mortgage loan production was a record $421 million for the year and represented approximately 20% of our total loan production, well exceeding our ramp-up targets of 10% to 15%. Our SBA group also generated another strong year of production originating $209 million of loans for the year, driven by a keen focus on expanding market reach and securing new talent and we continue to gain solid traction with our Corporate Korea initiative, where both loans and deposits grew meaningfully. As a reminder, this initiative focused on the needs of US divisions of South Korea-based businesses and serves to diversify our portfolio with high quality loans. Here, loan balances were up $145 million or 23% for the year, and deposit balances grew $230 million or 59% and now representing just over 9% of our total deposits. In addition to the diversification achieved in our loan production and loan categories, nearly 12% of new commercial real estate and C&I loan production for the year came from outside California, up from 7% last year. We saw strong growth in Texas in our Eastern region, reflecting both the healthy market conditions as well as our continued success in attracting new customers in these markets. The results are clear; our loan diversification strategies are working. Our asset quality remains very strong as we have been proactive in communicating with our customer about their businesses. We want to understand the challenges they may see on the horizon and work together to help them navigate this uncertain macroeconomic environment. Communication with our customers is a critical part of our approach, both in gaining new business and in maintaining existing relationships. With that, I'll turn the call over to Anthony Kim, our Chief Banking Officer, to discuss fourth quarter loan production and deposit gathering in more detail. Thank you, Bonnie. I'll begin with additional details on our loan production where fourth quarter volumes were $474 million, down modestly from the third quarter and, we believe, reflecting the current environment of higher interest rates and economic uncertainty. We achieved higher sequential production in commercial and industrial, SBA and equipment finance and while our residential mortgage production was down from its record volume in the third quarter, we originated $107 million of loans during the fourth quarter, a very good result in a challenging mortgage environment. Our focus in the residential mortgage division is on the non-QM market, and our correspondent lenders in this market remain active. A large portion of our production continues to be for home purchases rather than refinances. The purchase market remained relatively healthy in the fourth quarter as many homebuyers were eager to close on their homes and lock in their rates. However, we do expect mortgage originations to moderate in 2023 as higher interest rates are having an impact on both the purchase and refinance markets. C&I funding was $138 million during the quarter. Total commitments on commercial lines of credit increased to $1 billion at quarter end, up $56 million or 5.7% from the prior quarter and up 34% year-over-year. Outstanding balances on these lines increased by 6% between quarters, resulting in a fourth quarter utilization rate of 40%, consistent with the third quarter. Equipment finance production was strong again at $89 million for the fourth quarter, up from $86 million in the third quarter. And SBA 7(a) loan production was $53 million for the fourth quarter and continues to perform in line with our expectations. Our investment in loan production personnel over the last year and half has enabled us to continue to service this key market. With respect to our Corporate Korea Initiative, as Bonnie mentioned, we delivered strong loan growth for the year, which was driven by $187 million of new production. We did see a decline in production for the fourth quarter given the higher level of economic uncertainty that is impacting our customers. However, we remain optimistic about this important line of business and expect 2023 to be another good year for us. Our Corporate Korea portfolio is well above the level we had expected for this business as loan balances were $781 million at year-end, representing 13% of our total loan portfolio. The average rate on all new loan production for the fourth quarter was 6.85%, up 130 basis points from the third quarter. Payoffs were $121 million for the quarter, down from $140 million for the third quarter. The average rate on loan payoffs was 6.27%, up 101 basis points from our third quarter payoffs. This is the second quarter in a row where new origination yields have exceeded the yields on loan payoffs, which should benefit our future average loan yields. In summary, our efforts to further diversify our loan portfolio by industry, geography and loan type is working, which we believe will drive incremental growth and profitability. Now turning to deposits; excuse me, deposits remained relatively stable during the fourth quarter, down less than 1% from the prior quarter. We did see a shift in the composition of our deposits during the quarter, as some deposits in DDAs, money markets and savings accounts moved understandably into time deposits given the rapid increase in interest rates. Notwithstanding these moves, noninterest-bearing DDAs represented just over 41% of our total deposits at year-end, which we believe validates our strong customer service and local market expertise. We also had continued success with our deposit gathering efforts with our new and existing Corporate Korea clients as those deposit balances grew modestly in the fourth quarter. At year-end, our Corporate Korea deposits were $575 million, up 59% from the prior year and represented just over 9% of our total deposits. And now I'll hand the call over to Ron Santarosa, our Chief Financial Officer, for more details on our fourth quarter financial results. Thank you, Anthony. Beginning with net interest income at $64.6 million for the fourth quarter, we saw a 2.3% sequential growth from the third quarter. This increase primarily reflected the increase in average loans, while the increase in the cost of interest-bearing deposits essentially offset the increase in average loan yields. Average loans reached $5.88 billion for the fourth quarter, up 3.2%. The cost of interest-bearing deposits rose 92 basis points to 1.7% and the yield on loans was 5.21%, up 54 basis points. Turning to our net interest margin, which was 3.67% for the fourth quarter and up one basis point from the prior quarter; we saw the increase in loan yields benefited our net interest margin by 48 basis points, while the increase in the cost of interest-bearing deposits reduced that benefit by 46 basis points and there was a negative one basis point differential between the increase in yields on other interest-earning assets and the cost of borrowings and debt. During the fourth quarter, we saw a 125 basis point increase in the federal funds rate, 425 basis points for all of 2022 and extraordinary acceleration of interest rates in a very short period. Expectedly, the interest rates offered on our loan and deposit products have also increased and as we saw, depositors renewed their interest in time deposits. Turning to our various betas for the fourth quarter; our interest-bearing deposit beta for the fourth quarter was approximately 62%, while our loan beta was approximately 37%. As we have previously noted, the beta in any particular quarterly period can vary significantly given the amount of the change in the federal funds rate for that period as well as differing market conditions for that period. As such, we continue to remain cautious as to the quarterly trajectory of the net interest margin given the current uncertainty in interest rates and the economy. That said, we are very pleased with the performance of our net interest revenues and net interest margin through this stage of the rising rate cycle, especially given the support from our high level of noninterest-bearing demand deposits. Moving on; noninterest income was $7.5 million for the fourth quarter, down from $8.9 million for the prior quarter, due primarily to a $600,000 decline in other operating income and a $300,000 decline in our SBA gain on sales. The decline in other operating income was primarily due to a $500,000 decrease from the third quarter where we had a gain on the disposition of a lease residual. The volume of SBA 7(a) loans sold for the fourth quarter decreased modestly to $40.9 million, and trade premiums, as expected, declined 10% to 5.99% for the quarter. Last, we recognized a $300,000 valuation adjustment to our bank-owned life insurance asset. With respect to expenses, noninterest expenses for the fourth quarter were up $600,000 from the third quarter, with some categories increasing and others declining. Salaries and employee benefits increased by $900,000, reflecting primarily adjustments to incentive compensation from our strong loan production and financial performance, changes in activity levels contributed to the $500,000 increase in professional fees and a $200,000 decrease in advertising and promotion. Occupancy and equipment expenses was $1 million lower in the quarter, largely due to adjustments to real property taxes on leased and owned premises. In addition, other operating expenses were higher by $300,000 due to a valuation adjustment on our servicing assets. As a result, our efficiency ratio for the fourth quarter increased slightly to 46.99%. We recorded a provision for credit loss expense of $52,000 for the fourth quarter, down from $600,000 for the third quarter. Fourth quarter expense reflected a positive loan loss provision of $200,000 and a negative off-balance sheet provision of $100,000. The allowance for credit losses was $71.5 million at year-end, representing a coverage ratio of 1.2%. Compared with the third quarter, our specific allowances increased $1 million, while the allowance for quantitative and qualitative considerations decreased by $1.1 million. In summary, we delivered another strong quarter with net income of $28.5 million or $0.93 per diluted share, a return on average assets of 1.56% and a return on average equity of 15.9%. For the full 2022 year, our return on average assets was 1.44% and our return on average equity was 14.83%. The company and the bank exceeded minimum regulatory capital ratios, and our ratio of tangible common equity to tangible assets was 8.5%, up from the prior quarter because of net retained earnings for the quarter as well as a positive adjustment to the unrealized after-tax loss on our securities portfolio arising from a decrease in longer-term interest rates. Consequently, our tangible book value per share was up 4.8% from the third quarter to $20.54. Thank you, Ron. I believe this past year and in the years before that, we have demonstrated our ability to navigate volatility, and we'll continue to do so with a keen focus on the execution of our strategic plan. We entered 2023 with a strong balance sheet. Looking ahead, we anticipate that loan production will moderate from the levels we saw in 2022 due in large part to the current elevated interest rate environment and uncertain macroeconomic backdrop. We are approaching this dynamic environment with caution and discipline. We remain vigilant in our underwriting and credit administration. We remain focused on growing our core deposit base by continuing to win customers and expand our existing corporate relationships. And we remain committed to our communities and the Hanmi team, all with the goal of delivering attractive returns to our shareholders. With that, I want to thank the entire Hanmi team for their exceptional work this past year. We just celebrated our 40th anniversary, an important milestone for our company. Our teams reflect the communities we serve in enabling them to bring a deeper understanding of our customers' needs. They are our competitive advantage and with them, we look forward to many more decades of delivering personalized relationship-based service with a continued commitment to helping our customers reach their financial goals. This is how we intend to continue generating positive results for our customers, our communities and our shareholders. Hi. Good evening. Thanks for the question. I think I'll start with the deposit side. We've seen a few of your peers report so far, and betas are clearly accelerating, but you were still able to keep your margins pretty flat this quarter, which is great. Just wondering if you could provide some commentary on maybe spot deposit rates at 12/31 as well as what you're expecting for betas and vis-Ã -vis how that should read through into the margin in the next couple of quarters here. Well, thank you, first of all. And I just want to acknowledge the hard work of Anthony and the team in managing our deposits, not only in their growth, but in the rates that we pay. It's a very competitive marketplace and I think our beta reflects the discipline and determination that Bonnie had mentioned. So with that, I can plainly tell you that the cost of our interest-bearing deposits through January, for the month, are about 70 basis points higher than the quarterly average that we experience. So how that translates into a beta, I truly don't know. We're going to be up against perhaps two more rate increases. What I can say is that I think we've demonstrated again over the past few quarters that we take to heart what our depositor needs are, but also what our financial performance needs are and we navigate the best we can through those hurdles and when we meet again in the first quarter, I'll let you know what our beta is. Thanks Ron. Just stepping back on deposits, just at a high level; noninterest-bearing, you had some runoff this quarter, but they're still over 40% and pre-pandemic, you were more around 30%. Just on a high level, anything like structural that would dictate having a higher level of noninterest-bearing? Maybe it's Corporate Korea or -- and those sorts of initiatives, but just wondering on what you view as kind of the run rate of noninterest-bearing deposits as part of your mix here with what you've done in the past couple of years. And how much do you anticipate kind of sticking around as liquidity post COVID starts to run through? Thanks. So let me try to answer that. So definitely, last couple of quarters, we did see outflow of DDA going into the interest-bearing deposit category. And I still think that speed of -- the velocity of the outflow will slow down. And our strategy has been very consistent that we go after -- we target market and the corporate deposit accounts, and we've been very successful, whether that has been Corporate Korea Initiative or corporations within the US. So that strategy will continue to stand. Hey. Good afternoon. Thanks. Maybe first just on running out the margin outlook discussion; Ron, if you had the average margin in the month of December? Okay. Got it. And then maybe shifting to loan growth, held up pretty well this quarter and I know, Bonnie, you mentioned that you fully expect it to slow, which is not a surprise. But can you speak to the pipeline and then also, what drove the strength in C&I production this quarter with rates in the low 7s? Just trying to get a bit of better feel for the types of credits you might be booking in this environment. Sure. In terms of our strong production in the C&I, which has been -- diversification has been one of the key strategy. So in the 4Q, the contribution was from the new commercial lines of credit to the corporate type of customers. And then in terms of industry, it's fairly broad various industries, including manufacturing companies that we extended the C&I. Okay. Great. And then maybe just on the SBA outlook. Premiums continue to come in. What's your expectation around premiums and production and your comfort level with originating SBA 7(a) going through a recession? Sure. I think in terms of production, first of all, production, I think we are expecting about $45 million to $50 million per quarter. And then I think that has been fairly consistent. In terms of the premium market, I think it's been -- this quarter -- past quarter was a little shy of 6%, 5.99%. So I think it's pretty much holding at that rate. So thanks to some of the new markets that we went into and then the additional marketing people that we hired, that we were able to have a really good production. And hopefully, that momentum stays throughout 2023. Okay. And then just on the -- maybe for Ron on the noninterest expense run rate. I think there's a couple of moving parts this quarter. It sounded like there was an MSR adjustment that hurt a little bit. But just your overall thoughts on expense growth in terms of that run rate and with wage inflation and all the other things we need to consider. Yes. We're clearly prepared for the pressure that we will see probably starting the second quarter with wage inflation. That's in the marketplace. We will address that prudently. So I would look at noninterest expenses just subject to general inflationary pressure with, as we pointed out, which is just a function of a period, we seem to be fortunate with activity levels in certain categories going up and down, offsetting each other. But generally so, inflationary pressure I would just think about. Okay. And then last one for me. Just any updated thoughts around buyback activity. Capital turned a corner here. Obviously, rates have helped. But just your appetite to maybe reconsider the buyback given your -- where your stock trades and obviously a recession on the horizon. I think we've been patient with capital, which I think has served us well, particularly through this volatile rate environment that we've had here in the second half of 2022. So we'll continue to be patient. There's a lot of things that have yet to play out in the interest rate side of life. And then I think you'll see -- I think we're all anticipating, I'll say, a pent-up expectation of how will economic activity actually play out in this new environment. So we'll continue to be patient. My first question is about the new CDs that were brought on in the quarter. I'm wondering if you have kind of what the average rate on those were and what the average life of those are. I would just say I think what I would look to in the earnings release slide deck, we show the CD maturities. And so you'll see about $1.2 billion, if I remember correctly, that will mature 4 quarters forward. And the average rate of that was 3.83%. Okay. Great. Yes. Sorry. Okay. And then my next question is kind of looking at your loan-to-deposit ratio, is your expectation that you'll be funding the loan production off of deposit growth? Yes. Certainly, gathering deposits going forward, this environment will be a challenge. But we feel that whether it's a Corporate Korea Initiative and as well as expansion -- successful expansion into outside of California regions, that we can bring the additional deposits into -- to fund our loans. So we are mindful, and we are looking at those numbers very closely when we build our loan pipeline. Okay. And then just a -- so we have heard from a number of competitors the last couple of days. And they've been talking about significant headwinds to margin expansion in 1Q and perhaps even first half of 2023. Do you think you're immune to those headwinds or maybe just not going to face them at the same strength of those -- your competitors will? Not at all. We're not immune whatsoever. So again, you saw a magnificent 1 point expansion. So I know a conversation previously about are we at the apogee yet? We tried to signal in the third quarter, looking back at our second quarter earnings, that it's probably going to happen. We'll continue to debate that. But at what point differential right now, I think we might be cresting. So my questions were largely asked and answered already. But just in terms of the tax rate, Ron, bounced around a little bit. It was lower this quarter. Where do you project at this point the full year tax rate for '23? Yes. I think for the full year of 2022, we ended up on the, I'll say, the low end of 28%. And the year prior, we were at the high end of the 28%. So I still think the 29% is about right, spot me plus or minus, like 50 basis points, if you will. But I feel comfortable for judgment matters to use 29%. Okay. And then just one more question on that Slide 14 that you just referenced a moment ago on the NII sensitivity. On the deposits where you've got the footnote #2, that cost of CDs as of December 2022 was 2.68%. I assume that's the average for the month of December as opposed to the period end because the period end seems like it will be over 3%. Correct? This is Matthew Erdner on for Jason. Good quarter all around. It's good to see that credit quality is holding up well. But loans 30 to 89 days past due was up 52% quarter-over-quarter. Can you guys talk about where you're seeing stress build there? There's a little bit of seasonality to -- in the smaller loans, too. So we haven't -- in terms of data metrics, we haven't seen anything that's potential problems. Having said that, though, in this environment, I think the typical small businesses, whether it's SBA or equipment finance, they could get impacted. So what we did in the fourth quarter -- during the fourth quarter, we actually scrubbed the top 20% of our SBA loans and contacted every customer to see how they are doing and try to gauge and be in front of them as to any potential problems that they may have coming down in the next couple of quarters. So -- but we haven't seen anything alarming as of yet. Awesome. That's good to know. And then from people we've talked to in the commercial real estate space, demand there is slowing pretty quickly. How has demand been for you guys and your product? And then when do you think we'll see an uptick in originations in that space? That's a difficult question. So definitely, we have seen slowdown in the inbound inquiries and the commercial real estate loans. And we are being cautious in certain -- whether markets or certain type of properties definitely within the CRE, we are mindful of -- the situation is the office properties in selected markets and then also try to stay away from the retail type of CRE loans that is near big-box retailers. So we follow that in terms of CRE market very closely and as well as some of the health care industries to see commercial real estate as well. Got you. And then what -- could you give an example of a couple of markets where you would be hesitant to originate? As I just said, I think in terms of offices, I think it's different factors. I think it varies. And for the health care properties as well, I think that particular industry is experiencing higher rise in the labor cost and the average increase in the labor market. I just wanted to follow up on credit. You continue to release reserves at this point. I think you're at 120 basis points at this time. I understand the reserve levels are driven by the CECL model. But just given where we are heading into what could be a credit cycle, do you think this is the bottom? Or do you think there's still room to release reserves as we get into 2023? So again, a little bit difficult to respond definitively. But if the color of expectations relative to the economy actually start to play out in the first quarter, then you can anticipate that we're at the low level, if you will. But just like it's hard on the margin where are rates going to be, et cetera, it's difficult, but I would -- there, I would bet more concern and say, okay, you're probably at the low end. But if it should drift down, it's not going to drift down that much. You're not looking at huge ideas where we were like $140 million at the top of the year, $120 million at the bottom of the year. So there's not that much more bottom left. Got it. Sorry, I know I'm trying to ask you to look in your crystal ball with that. Last question for me. I apologize if you already addressed this. But Ron, with the occupancy and equipment line, it looks like there was some reversal that you called out in the release. Do you -- is that supposed to come back to more like 2Q, 3Q levels of like 4.6, 4.7? Or is that kind of 3.7 run rate on that line a good projection on a go-forward basis? Yes. I would look to the previous quarter for your run rates. And then they should kind of match again the aggregates because we have -- as was pointed out, we have some other things that went against that notion. So bottom line, the total of noninterest expense, I think, is a fairly good idea. So if in your modeling, you're coming too far away from that, then I'd ask you to go back and look at your model. There are no further questions in the queue. I'd like to hand the call back to Bonnie Lee for closing remarks. Thank you for participating in our call today. We appreciate your interest in Hanmi and look forward to sharing our continued progress with you throughout the year. Thank you. Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.
|
EarningCall_1189
|
Good morning, ladies and gentlemen. Welcome to the Silgan Holdings Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions] And please be advised that this call is being recorded. [Operator Instructions] And now at this time, I'll turn things over to Ms. Kim Ulmer, Senior Vice President, Finance and Treasurer. Please go ahead, ma'am. Thank you. Joining me from the company today are Adam Greenlee, President and CEO; Bob Lewis, EVP and CFO; and Alex Hutter, Vice President of Investor Relations. Before we begin the call today, we would like to make it clear that certain statements made today on this conference call may be forward-looking statements. These forward-looking statements are made based upon management's expectations and beliefs concerning future events impacting the company and therefore, involve a number of uncertainties and risks, including but not limited to, those described in the company's annual report and Form 10-K for 2021 and other filings with the SEC. Therefore, the actual results of operations or financial condition of the company could differ materially from those expressed or implied in the forward-looking statements. Thank you, Kim and welcome, everyone, to Silgan's fourth quarter and full year 2022 earnings call. On the call today, we will review the highlights of our full year performance and provide details around our fourth quarter results and our outlook for continued growth in 2023. 2022 was another exceptional year for Silgan, posting our sixth consecutive year of record sales and delivering yet another year of record double-digit growth in adjusted EPS as the momentum we've built in the business continues to show in our results. I'm incredibly proud of the entire Silgan team and the accomplishments that we've achieved together, proving that through a variety of economic environments, Silgan remains a steadfast partner to our customers, employees and shareholders. Day in and day out, our teams prove that our founding principles of competing and winning in the marketplace by being the best at what we do continues to translate into meaningful value creation for all of our stakeholders. Our ongoing and unwavering focused yielded significant adjusted earnings growth in 2022 despite difficult volume comparisons as our business overcame, known challenges from the prior year pre-buy activity ahead of significant raw material inflation. Ongoing supply chain disruptions and customer and retail inventory destocking throughout the year. In combination with our outstanding operational performance, our long-term contractual arrangements and focused discipline on passing through inflationary costs helped our business to grow adjusted earnings in a period of unprecedented inflation in raw materials, labor, energy and other costs. A few highlights we delivered in 2022 are as follows; record sales of $6.4 billion, up 13% versus the prior year. Record adjusted earnings per diluted share of $3.98 which increased 17% versus the record prior year. Free cash flow of $368 million while continuing to make investments in future growth opportunities; and finally, record revenue, volume and segment income in our high margin Dispensing and Specialty Closures business. As we exit 2022 with unit volumes well ahead of pre-pandemic levels and our businesses executing at an exceptionally high level, we remain confident in our ability to build on our momentum in 2023 and beyond. More specifically, as we look to 2023, we believe the business will continue to drive at least mid-single-digit improvement in total adjusted segment income organically which will be partially offset by higher interest expense due to higher interest rates expected in 2023. In addition and as outlined in the press release, beginning in 2023, we have adjusted the prior year results -- the prior year periods for pension income and the amortization of acquired intangibles. From a segment perspective, we expect our Dispensing and Specialty Closure segment to produce high single-digit adjusted segment income growth driven by mid-single-digit volume growth and improved mix, including double-digit volume growth in our higher-value dispensing products. In our Metal Container segment, we see low single-digit volume and low to mid-single-digit adjusted segment income growth in 2023, primarily as a result of mid-single-digit volume growth in our pet food markets which represent roughly half of our total volume in the segment and continued operational improvements in the business. In our Custom Containers segment, we expect adjusted segment income to grow in the low single digits, with low single digit volume growth as volume trends are expected to improve throughout the year as we continue to cycle over a previously discussed decision to not renew a long-term piece of business and to replace that volume with new higher-margin contractual business later in the year. We're excited about what the future has in store for Silgan and the opportunity to continue to showcase the unique nature and continued success of our business in 2023 and beyond. With that, Bob will take you through the specifics of our financial results for the quarter and provide additional color around our earnings estimates for 2023. Thank you, Adam. Good morning, everyone. As Adam highlighted, the business continues to execute at a high level, delivering record fourth quarter and full year sales and adjusted earnings per share. Our businesses did an outstanding job managing through a complex volume backdrop, ongoing supply chain disruptions and significant cost inflation. This is a testament to our contractual pass-throughs, cost recovery discipline and analyst pursuit of operational excellence to mitigate inflation. Net sales for the fourth quarter of 2022 were $1.46 billion, up $16 million or just over 1% versus the prior year. as net organic revenue growth was partially offset by unfavorable foreign currency of approximately $39 million. Our organic growth was driven by favorable price/mix resulting from inflationary cost pass-throughs which more than offset expected volume declines in each of our segments. Total segment income for the quarter of $81 million declined on a year-over-year basis, primarily as a result of rationalization charges of $67 million in the fourth quarter of 2022. During the quarter, we recorded a restructuring charge of $74 million to write down assets which were used to service the Russian market as we will no longer produce the limited humanitarian products sold in 2022 for this market. Highlights of our segment income for the quarter are as follows: Our Dispensing and Specialty Closure segment income increased from the prior year, driven by strong pricing and cost recovery disciplines and better operating performance. These benefits more than offset a foreign currency headwind of approximately $3 million and an 8% volume decline. The volume decline in the quarter was primarily the result of lower demand for steel closures in the food and beverage end markets as compared to the prior year period which benefited from pre-buy activity ahead of significant steel inflation in 2022. Our Metal Container segment decreased from the prior year as a result of $66 million of rationalization charges in the quarter. Excluding the impact of rationalization charges, segment income increased 28% versus the prior year, with strong operating efficiency as a result of lower volumes which allowed us to better utilize our footprint and more efficiently manage our inventory levels. These benefits, combined with inflationary costs recovered more than overcame a 13% volume decline. The decline in volumes in the quarter was primarily due to difficult volume comparisons from the pre-buy activity in the prior year quarter ahead of approximately 80% steel inflation in 2022. Segment income in our Custom Container segment decreased as a result of an expected 11% decline in volumes, overshadowing improvements in price pass-through and cost recovery. As we previously discussed, the decline in volumes in the quarter was primarily the result of not renewing a customer contract that did not meet our reinvestment return hurdles as well as the delayed recovery in lawn and garden, home and personal care products. The decision not to renew the expiring contract will continue to have an unfavorable impact on volumes through the first half of 2023 as we expect to commercialize new business awards later in the year. Turning to the outlook for 2023. As we leverage the momentum of delivering 6 consecutive years of record adjusting earnings, we are expecting further growth in 2023 as we estimate adjusted earnings per diluted share for 2023 in the range of $3.95 to $4.15. To align our external reporting more closely with the internal metrics by which we manage our businesses, we are excluding the impact of U.S. pension income and amortization of acquired intangible assets from our definition of adjusted segment income and adjusted earnings per diluted share. Our domestic pension plans ended 2022 at approximately 130% funded and are close to new participants. Therefore, we have elected to deploy a liability-driven investment portfolio which we believe will satisfy the cash requirements of the plan. As to the amortization of acquired intangibles, our view is this is a non-cash expense that is not reflective of the ongoing performance of the acquired business. Furthermore, this will align us on a comparison basis with our peers. For comparative purposes, a reconciliation of prior periods to remove these adjustments has been posted to our website on the Investor Relations section. We expect total adjusted segment income to increase by mid- to high single digits in 2023 as compared to the prior year. The midpoint of our range of adjusted earnings per share represents a year-over-year increase of $0.04 per share which includes full year interest expense of approximately $155 million, a year-over-year headwind of $0.20 per share and a tax rate of between 24% and 25%. These estimates exclude the impact from certain adjustments as outlined in Table B of our press release. Based on our current earnings outlook for 2023, we are providing an estimate of free cash flow of approximately $425 million in '23, a 16% increase from 2022 as earnings growth and lower use of cash for working capital as compared to '22 is partially offset by higher CapEx which we expect to be approximately $250 million in 2023 as we invest alongside our core and new customers. Turning to our outlook for the first quarter of 2023, we are providing an estimate of adjusted earnings in the range of $0.75 to $0.85 per diluted share as compared to adjusted net income per diluted share of $0.79 in the prior year period. Included in the first quarter of 2023 estimate is incremental interest expense of approximately $0.05 per share as a result of higher interest rates while the first quarter of '22 included approximately $0.01 per share from earnings from our Russian operations. Adjusted segment income in Dispensing and Specialty Closures is expected to be flat as the benefit in the first quarter of 2022 from the lag pass-through of resin price declines in the prior year is not expected to repeat. We anticipate higher adjusted segment income in our Metal Containers business as a result of the negative impact in the first quarter of 2022 from the customer pre-buy activities during the fourth quarter of 2021. We also expect slightly lower volumes and adjusted segment income in the Custom Containers business as a result of the previously discussed exit of a customer that did not meet return hurdles. Volumes in this segment are expected to improve throughout the year. That concludes our prepared comments and we're happy to open the question -- the call for questions. I'd like to ask everyone to limit your questions to 1 question and 1 follow-up. And if time allows, we'll take further questions from the queue. Adam, can you help me with the closures volume performance in the fourth quarter? I know a year ago, you called out the impact of the pre-buy in the metal cans business from rising tinplate costs. But I don't think you said anything about closures along similar lines but then you mentioned it this quarter as having been a very difficult comparison versus last period. Were you expecting your closures lines to be down as much as they were? Can you just talk about that segment's performance, both in terms of volume and profitability compared to what your expectations were and how that might affect your outlook for '23? Okay. Sure. So a couple of things. We did expect the pre-buy to have a negative impact just like it had in our Metal Containers business on our Dispensing and Specialty Closures. As a reminder, included within that segment is our kind of long-time legacy Silgan closures business that really supports the food and beverage industry. Combination of metal closures and plastic closures in that business. So we did anticipate that. What I'd tell you, Adam, is that as we sit here and look at the pre-buy impact it accounted for about 95% of the shortfall from a volume perspective in the quarter for Dispensing and Specialty Closures segment. So it just -- it was food and beverage, primarily, it's metal closures that go on glass jars that we typically supply for many, many years. So no real surprise for us. Then I think from a profit standpoint, we had a good quarter. We were really overcoming the volume shortfalls within the quarter, again, with good operating performance as we had. Resin was slightly favorable. We expected that. So in my words, Adam I'd say the quarter for DSC was really roughly just in line with expectations that we had. Okay. Got it. And Bob, when we -- I know we're the ones who come up with the consensus earnings estimate for '23, not you. But when I'm trying to compare your guidance to the estimate that was out there, obviously, versus 3 months ago, interest expense is $0.05 higher than what you and we were expecting. And then you chose to exclude amortization of intangibles and pension income or expense which added, I think, $0.03 to last year's earnings. So all else equal, consensus, I guess, should have been $0.03 higher in '23 as a consequence. But can you help me reconcile your guidance to what you think consensus was or was expecting, etcetera, if you catch my drift. Yes. I think you basically have it right. The 2 adjustments that we made for very different reasons, obviously but they basically offset. So if you think about where consensus would have been, it's roughly in line with what we're suggesting now. So there's really no more broader details to that than those 2 main points. I guess first off, on the destocking question, Adam. I mean, so many end market verticals have called out destocking all the way from the retail channel all the way down. You yourself have experienced that to some extent. What's your best guess in terms of where we are relative to -- with inventories relative to sort of the end market demand of the consumer uptake, if you will. Yes, sure. It's the great question. And I think maybe I'll go back to Q4 and give you some insight there. Just what we saw through Q4 was really a pretty good early part of Q4, October, November and that was, I'll just say, both in our North American markets and in Europe as well. What we saw also at the end of Q4 was that our large CPG customers essentially sort of shut down in the last couple of weeks. So a little bit unexpected for us but that was a bit of the volume shortfall for the quarter as well as sort of the abrupt end of the year. I think the better news is that we were also seeing some good signs of recovery in some of the markets and product lines that have been challenged due to the destocking effort a little bit earlier in the year. And most importantly, Ghansham, I'd tell you that January has started on a pretty strong note for us and all of those same customers. So we are seeing recovery. We've talked about trigger sprayers on this call or the last, I think, 2 calls. We've seen almost a full recovery in Europe at this point which typically is a precursor to what happens in North America for many of our product lines. So we're feeling better about the recovery of the destocking than we were, I think, as we entered the last call. And we've certainly seen more positive signs from our customers. And then we're having a really good start to the year so far here in January. Okay, terrific. That's very helpful. And then in terms of the inflation dynamics that you've been experiencing, maybe just lay out for us what your embedded assumptions are for the big -- substrates that you're exposed to? And then also on the variable cost side with transportation, etcetera, what are you seeing at this point in real time? Sure. So I guess we'll start with steel first that affects a couple of our segments. So look, we have -- as Bob mentioned in the prepared remarks, we passed through approximately 80% tinplate increase onto the market. It does appear that our customers were able to successfully pass that through at retail and to their customers. As we turn the page to '23, we do see stability in the prices of tinplate right now. So probably not a whole lot of change as we sit here in '23. I think there's some capacity availability challenges for the supply side of tinplate. I'll remind you, we are the largest tinplate buyer in the world and feel like we've got good relationships and partnerships with our supply base that we're going to get the tinplate that we need in the geographies in which we need it. Moving over to resin as we go forward, there's a very small benefit in resin built into our Q1 guidance. For the most part, I would tell you, as volatile as resin has been over the course of the last couple of years, it looks like there's stability in the price forecast going forward. We'll see what happens here. But as we typically do, Ghansham, we take the changes that we've got that are known right now for Q1 and we basically hold that rate for the balance of the year. So I think there are times where we've been conservative with that outlook. I think this year based upon the forecast it seems to be about right. Then your other question is kind of moving to some of the other categories like freight. We are seeing, again, some increased rate costs. I think the fuel surcharges have been down, rates and availability of freight have been challenging, certainly the last couple of years. I don't know that that's seem kind of the relief valve with some of that pressure that we've seen in other categories. I think we'll still experience inflation to some degree, not nearly to the extent that we had over, really, the course of the last 18 months. And again, as I think you all know and understand, most of our contractual agreements allow for the pass-through of that inflation onto the market. I wanted to talk about the importance on 2 factors to your guidance relative to DSC and Custom Containers. Can you size for us and that will be my 2 questions -- can you size for us how important that new business you're onboarding of Custom Containers is for the fourth quarter and for your overall guidance for the year? And what are the -- so the key things we need to be evaluating and that you'll need to tell us about that will mean that the business comes on, the earnings come on as expected or not? And relatedly, what are the risk factors there? Same thing with DSC with a very, very strong growth outlook this year that you're looking for recognizing we're done with destocking. What are the key risks in your view that we should be mindful of and checking back with you on in terms of that volume, that earnings that incremental margin showing up this year as you expect for DSC? Good luck in the quarter. Okay, George. So maybe we'll start with Custom Containers and the new business wins. Really, the impact for '23 is relatively small from a profit standpoint. Obviously, the volume kicks in and we'll call it [indiscernible]. So the good news is we're moving forward with getting capital spend in place and we'll work to commercialize those products, call it, late in Q3, early Q4. So it is more about the run rate as we exit 2023 and then enter 2024 with those new business wins. So I think we'll be talking about them as we go through the year on the earnings call, just to give an update on where we stand regarding those commercialization. So I think that's the right way to think about Custom Containers. And then on Dispensing and Specialty Closures, really, there's a couple of things. One, we don't have any pre-buy activity in our metal closures segment. So we'll have a normal year in that portion of our business. We see continued strength in fragrance and beauty and I think in the last 1 or 2 calls here for the earnings call, we had talked about our order book, we talked about our visibility. The reality is our customers had a really good holiday season and therefore, a really good product launch -- new product launch season here as we begin 2023. So our clarity into that order book has gone further into 2023 than we had on the last call. So we're thinking 2023 really is a strong year again for fragrance and beauty. We're engaged with our customers talking about the incremental capacity adds as we typically do at this point. So we're bullish on fragrance and beauty and really what it can deliver through the course of 2023. I think general risk, we're not expecting a massive recovery in lawn and garden that's going to impact either Dispensing and Specialty Closures or Custom Closures. So I don't think that risk is built into our budget as we think about the year. I think just broadly, economic conditions that are out there, we'll see how that impacts consumers. I continue to say the power of the Silgan portfolio of products tends to do really well regardless of the economic circumstances. So maybe different products do better in a poor economy versus a booming economy. But bottom line is we still continue to perform regardless of what that circumstance seems to be. I wanted to dig in a little bit -- I mean, your voice inflected, Adam, when you talked about DSC and the potential into 2023, specifically calling out, I think, the fragrance dispensers or the dispensing specifically being up low double digits. So I guess piggybacking off of George's question, is there something specifically that maybe you're doing with your customers that you've seen success with? And then any thought, I mean, George asked about risks. Is there upside potential that you might get from China reopening and more so about China consumer mobility and travel as it relates to duty free. Just any thoughts there would be helpful. Sure. So maybe it's -- I won't take the risk of repeating myself from what I said, so I apologize for the bad connection there. But what we're doing in the market, specifically, Gabe, on Dispensing and Specialty Closures, again, we've got a really strong team focused on that market, focused on areas of growth and delivering new products, new innovations to our customers that are allowing them to then take those products to market and grow their business and we're the beneficiaries of that, right. So long as our premium and luxury fragrance and beauty product lines. As long as we keep providing new products to those customers that allow them to win in the marketplace, we benefit from that. And we've seen that now for several years in our Dispensing and Specialty Closure segment. So we feel really good about it. I think if I broke up, Gabe, I tell you, we are in conversations to add capacity with our customers to support their growth in those markets. And we continue to feel very good about the prospects for future growth. And 2023 looks to be a really good year with, I'll say, limited downside risk based upon our conversations with our customers for volume specific to fragrance and beauty. And then as we think about China, there's a couple of things. One, China, Asia broadly is relatively small for Silgan, always has been and probably will be to some extent. But as we sit here and think about a more mobile consumer in those parts of the world, again, fragrance and beauty, there is an element of fragrance and beauty that goes through our kind of duty-free international airport locations and the more people are moving around, frankly the better that will be for the product lines that we're talking about. So I think it will be good. Likely you'll get an outsized -- you won't get an outsized benefit from Silgan related to the broader Chinese reopening. So it will be a bit impactful for travelers but for the market itself, we don't see a big impact for our business. Okay. Now the inflection comment was actually -- it sounded like you -- a little bit more increased conviction and optimism on the business in your opening remarks. yes, all good. The second one... Yes. No. Bob, maybe or Adam, talk about just sort of what you're seeing across the M&A landscape. That's been obviously in Silgan's DNA for a long time. Just in terms of assets coming to the market or expectations for sellers, etcetera, with rising interest rates and how that is evolving? Yes. Look, I think there's a lot to that point, right? I mean we're coming through the year-end being kind of right where we expected we would be from a leverage standpoint. So we'll be kind of right around the 3x leverage mark with improving free cash flow going into next year up to the -- to a level above what we delivered in 2022. That's probably just under another half a turn of deleveraging. So that will put us back kind of to the lower end of our range. I think the capital markets continue to evolve, still higher rates than maybe we've seen over the last decade or so but continuing to evolve. I think as we talked about on the last call, there was a bit of a pause in M&A opportunities coming to market as they sort of just wanted to get through year-end and see where the markets were heading. I think what we're seeing in the early part of the year that there's a lot of activity that started to generate businesses wanting to come to market. We'll see how that ultimately plays out but that's encouraging because there are certainly a few that we would have interest in. I think we're well positioned to take advantage of that on 2 fronts. One, not only is our leverage in the right spot but we've got a fair bit of available capacity on our revolver that puts us in a pretty good competitive position against other potential buyers of assets that we could move quickly and with some surety. So that's obviously favorable as well. So we'll see where that all goes. But the fact that we've got the most recent round of acquisitions fully integrated, we feel like we've got management bandwidth across our businesses to be able to integrate something new if and when we find it. So it's the same playbook really. It's been a core competency and one where we think we have and will continue to generate good value and good returns for shareholders. So hopefully, we get some opportunities here during the year. This is actually Bryan Burgmeier sitting in for Anthony. Just following up on Ghansham's question on inflation. Do you expect your PPI pass-throughs in Metal Containers will meet or exceed the level of cost inflation you're forecasting for 2023? And can you remind us when those pass-throughs typically reset? Sure. Bryan, so first of all, we do have inflation that we are continuing to experience in 2023. It will probably be no surprise that the level of that inflation is going to be less than what we experienced in 2022. So given the lag nature of that portion of our pass-through mechanism, you'll be passing through last year's inflation this year against a lower experienced inflation in 2023. So that should be a slight benefit for us. I don't think we get into the specific details of when those pass-throughs hit. They vary by contract and they are throughout the course of the year than they run for 12 months from the implementation date. Yes. I would add to that, that across the contracts, it's not one particular metric. I mean we speak to it as a PPI-like but the metrics do vary contract to contract. But Adam's point is the right one is that the pass-through given the fact that we've got relatively lesser inflation on a year-over-year basis should be some benefit for the year or it is some benefit to the year. Got it. And just one last one. It looks like 2022 CapEx came in a bit lighter than expected. Do you decide to push out or walk away from any projects? And then 2023 CapEx, are there any growth of productivity-related projects that you'd like to highlight? Yes. So the CapEx came in a little bit lighter, really more to do with the timing of payments to vendors than actual projects. So we feel like we're adequately investing in the right opportunities at the right time. So I think as you think about that from the free cash flow there's some noise in the overall number but up in total because you had less CapEx and more interest expense that we were carrying through the year. So overall, a really good free cash flow generation. And then as we look forward to the CapEx in next year, it's up a bit, largely because of some of these new opportunities really across the business but primarily in the Custom Containers business which we just talked about as well as some good opportunities in the Dispensing and Specialty Closures business. So we feel like we're adequately investing with -- for the right opportunities with the right customers. I want to go back to dispensing and the beauty and fragrance markets in terms of the growth rates that you called out. Are you seeing any differences between mass or prestige markets in beauty in terms of the growth rate for 2023? Or are you seeing any trade downs from consumers going away from prestige to mass or anything that you would call out? So really, no, we haven't seen that. I mean our presence is much more in the prestige and luxury and we're just seeing continued high demand in that segment of the market. And again, great relationships with our customers, very intimate relationship. And I think that they are clearly seeing additional growth opportunities. What I tell you, Kyle, is through the pandemic, new product launches were relatively limited and we're now just now getting to the point where the new product launches are hitting the market and they've been very well received for the holiday season. and we're feeling, again, really good about our volume as we go forward in the prestige area of the business without a whole lot of trade down that we can see into the mass market. Got it. And then on Metal Containers, you guys have called out some supply chain issues impacting commercialization of new product within, I believe, pet food at the customer level. Is that mostly resolved as we go into 2023? And then relatedly, how are you thinking about your footprint within metal food can in the U.S.? Any room for optimization? Or are you content with what you have? Sure. I'll take the second part first. And we're always thinking about that footprint. And what we typically say is for every 2 plants that we have in our Metal Containers business, we've closed one through the course of time. So that relentless focus on driving cost out of that business is critical to our success and that's just part of our DNA. So we're always looking at that. We don't have anything to talk about on this call at this point. But it's something that is very much a focus of what we do each and every day. And then the supply chain challenges that our customers experienced in 2022, again, are investments to support their growth we made, we were able to commercialize on time. Early in the year, there were ingredient problems for our customers. All of those have now been resolved. There's protein available, there's other packaging products available as well to ship additional products into the market. Really what we got to towards the latter half of the year in Q4 were labor availability challenges. And I tell you, for the most part, those are getting resolved as we start the year. We still have a couple of minor instances here or there across the broad set of customers. There was a lot of investment that went into the pet food category and filling additional products. And for the most part, we're seeing the progress that we wanted to see and it is part of our growth assumption for 2023 that roughly in the early part of the year here, the rest of that gets figured out at our customers. I guess maybe I wanted to start with some of the comments you made about returns, not meeting your return threshold from certain contracts. Does that just happen from time to time? Or what's the thrust of that? Is it maybe some of your customers also dealing with a lot of inflation and not being able to pass that on? Or maybe you can just provide a little bit more detail on that. Arun, it does happen from time to time, particularly as contracts age out and maybe volume trajectory changes a bit. The competitive landscape has something to do with that relative to what assets may be available in the marketplace versus a customer that wants to have new assets put in place. So there's a lot of different reasons for why that happens. I think what you're seeing here is just sort of the overall Silgan discipline in that we're cognizant of that. We're making sure that we're maintaining, particularly, in that business, right, we went back a long way to recover that business and say, look, we need to get the return profile to a point where that business can make money. We've actually done better than what we anticipated or what goal we set. So this is just staying the course with that and making sure that we're not doing anything that's detrimental to the overall profitability of that business and the long-term returns. Okay. And then on a similar note, it sounded like there was still some macro challenges, maybe some volume destocking that's pretty much run its course but still some potential risk. Would you say that the customer activity has migrated to now a little bit more promotional activity to move volumes? Is that something that we could potentially look forward to? And how does that affect your kind of decision making on some of these projects. And I'm just curious if promotional activity has picked up, if your customers are now feeling a little bit better, given that inflation has kind of moderated just a touch and maybe we can see some extra volume come through promotions. Well, I think maybe we should just talk about that by business segment because I think the answer will vary by segment. So certainly in Dispensing and Specialty Closures, promotion is part of the answer for those prestige and luxury fragrance and beauty products and we are seeing greater promotion. We understand greater promotion will continue in those particular markets. And maybe I would jump over to the Metal Containers business and say, we have seen more promotion in soup and we believe it's working for whatever that's worth. And I think pet foods, you're going to see more promotion in pet food in a variety of different formats. So I think in fits and starts, yes, there's more promotional activity. It's where I think volume growth is coming from as well. They're trying to leverage that volume growth and turn it into an even greater set of volume for the business. So I think our customers are feeling better broadly speaking, about where we are, where our products collectively sit in the marketplace for consumers as we turn the page to 2023. And then just lastly, if I could, just on the M&A front, maybe you can just discuss maybe some of your priorities, if you do have any, maybe does the Russia exit provide you with any extra capital to potentially deploy into that area? Or how should we think about M&A here going forward? Yes. Look, I think as I mentioned before, M&A is a core part of the strategy. It's where a lot of our growth over a longer period of time comes from. So we'll continue to remain active. I don't think it's any secret that Dispensing and Specialty Closure side of the business is kind of the tip of the spear of where we would like to continue to invest. But we're also not afraid to look for opportunities to strengthen other parts of our business as well. But I think if we could draw off the playbook, it would be oriented towards the dispensing side. The withdraw from Russia really doesn't have any bearing on our ability or our desire to allocate capital across the rest of the business. It remains part of the core competency. So that's just a -- that part of the business is just a victim of circumstance and we'll deal with it and we'll get on with running the broader business. I know you're a different company now but can you just for historical purposes, just show us what happened with volumes during the 2008 and 2009 recession. Were you largely unaffected? Or was it kind of a different time, different thing? Yes. I think that the -- the main impact, at least the 1 that I talked about the most was on food can volumes in that time frame. And essentially, what you saw was volumes hold pretty steady across both in the downturn and in the recovery for very different reasons, right? And so you saw, as an example, during the downturn, sort of fruit and vegetable, it really improved as you might expect, as people sort of hunker down and ate at home more often. Likewise, at that particular point in time, the pet food market, which was a different pet population, if you will, more broadly larger pets and that converted away from wet pet food to dry. And then as the recovery happened, there was a reversion. So through both periods, volumes were pretty steady. The mix changed, if you will. I think what's different this go around is the fact that there has been such a change in pet ownership and pet population that it is far more dependent on the wet pet food market and less likely to see a meaningful change away from what the pets are eating and how people are treating the pet. So I would expect that the food can business will continue to do well. I'm sorry for the dumb question but does it mean people have smaller dogs now? Is that what we're kind of saying? More of them as well. So yes, the pets in the households have trended to the smaller size and there's more of them as a consequence of smaller pets being more manageable in the house. And the wet pet food category, Dan, is both small dogs and cats. And the cat population has continued to grow over recent years as well. Okay. And then you mentioned, I think, 80% pass-through for metal costs or metal containers. Have you ever said what resin -- how much of resin is pass through? Did I miss it or something? Generally, we pass through resin on a lagged basis. So it varies by resin type and by business. But at its longest, it's probably 60 days in terms of the lag pass-through and in many cases, much shorter than that. But to be clear, we do pass through the cost changes of resin to the market as well. And I think if you go back to our Dispensing and Specialty Closures segment, it was a large negative roughly in 2021, if memory serves me correct and we basically recovered that negative through the course of 2022 and now we're anticipating relatively stable prices for resin as we move forward into 2023. Different pet associations are talking about how people can't afford their pets now, 1/3 of pet owners are worried that pet is putting too much of a strain on their income. And the number of pets and shelters has really risen both in the United States and Europe. Is the pet food -- is the cat food market that you're in higher end so that it's sheltered from some of these trends? Or do you not see these trends? That is, do you see more stress on the pet owner that may affect can demand or you don't? So a couple of things there, Jeff. I think, first of all, we don't see that stress through the markets that we serve. And again, I think Bob really highlighted a very good point about the mix of business that we had, call it, back in '08 or '09, I think large pets do have the pressure that you're talking about, a, the consumption of product just by the sheer nature of the size of the pet is much greater. And I do think you see a trade down to dry. I'll also say a 40-pound bag of dried pet food is quite expensive. When you look at the products that we manufacture and the markets that we serve and that kind of small dog and cat wet food population, we don't see a trade down. We don't see that same level of stress that you're describing again, we talk a lot about the Silgan customer service model and our customer intimacy, where we spend a lot of time talking to and with our customers about the specifics of the markets that we collectively serve. And we are not feeling that pressure in dealing with our customers having that dialogue. Yes, Jeff, I would take that a step further and just remind you that we are not speculating on the market, right? We're making investments where our customers are making investments and we're doing that with commitments from those customers. So we feel like we're pretty well aligned with what is happening in their markets and where their markets are going. Okay. And then for my follow-up, is it fair to say that your EBIT growth in 2023 to really be a function of your volume growth and that the price raw material spread really won't make so much of a difference to the EBIT change? I think that's right. There are no acquisition timing issues. So what you're seeing is, really what we've been talking about, right? I mean I think we stood and delivered in 2022 and we talked a lot about the dynamics of each of our segments and the growth profiles of each of our segments then delivered it in '22, it rolls right forward to '23. So you're seeing the kind of power of the portfolio and each of our individual operating segments delivering growth in their own way for 2023. I think you've got it right, Jeff. I'm guessing the answer will be no, there's no change but it's a box-checking exercise here. So given that there's been changes in the landscape of other players in the North American metal container sector, are you seeing any change in the level of competitive activity, bids, things like that, that we should be mindful of? And then knowing that it's not 2024 yet, can you size for us a couple of things. One, how big was that win that you're going to get at the end of this year on an annualized basis in terms of what it might mean for '24. And as we now or in the next sort of phase, are you done with your big contract renewals in metal container for the next several years. So maybe, Bob and I will ham and eggs through that for you, George. But for competitive activity, a good question. I think you're right with the answer to. So really no change. As a reminder, so much of our business is under long-term contract that we're just -- we're not necessarily out in the market bidding on new opportunities each and every day. We win and we grow when we have competitive advantage to our customers in that market and they go win in the markets that they serve [indiscernible]. And then as far as our contractual renewals in the Metal Container business, we always have a couple here and there. Nothing that I can think of off the top of my head as we sit here for 2024 that's significant. But again, you understand our business model as well, that we're always in conversations with our customers about investing in new capacity for their growth, etcetera. and we reserve the right to maintain those conversations. Yes. I would say, George, just to remind you that with 90-plus percent of our business under some form of long-term contracts, there's always something that's coming for renewal but there's nothing that's out of the ordinary nor is it a large block of business. We've had these periods where we have the conversation that we've renewed a significant piece of our business and it's had a meaningful price step down. We don't have any impacts coming at us in the near-term. So there's a couple of large contractual pieces of business. So I think, George, you should think about them in kind of the range of $8 million to $10 million of revenue kind of -- for each of those opportunities. So call it two opportunities that will be commercializing in that range. We'll take a follow-up question now from Gabe Hajde at Wells Fargo. We'll go next now to Adam Josephson at KeyBanc. To Jeff's question earlier, by the way, I certainly hope you're doing your part to support national pet ownership. Bob, in terms of... Fancy feast. Bob, on working capital, you're expecting improvement there. Can you flesh out roughly how big a source of cash you'd expect that to be? Is it coming from lower inventories, lower receivables, any impact on payables. Well, so what we're really looking at is a smaller use on a year-over-year basis. So it's a bit of a benefit. But given where inflation is and as we anticipate it to go, it's not like we're liquidating a lot of working capital. We just got a lesser use as we move year-over-year. So basically, if you think about where the free cash flow generation is coming from, it's essentially the improvement in earnings, a little bit less of a use of working capital and the elimination of the payment for the European Commission that was made offset by the slightly higher CapEx is how you get to the broad bridge for working capital change. Right. So there are no components of working capital that you're expecting to be major sources or uses it sounds like, just a modest use on an absolute basis. Okay. And Adam, just to put a bow around all the comments you've provided. Your guidance range for this year, the range is 5% which is entirely consistent with what it's been in previous years, obviously, many people have concerns about the global economy but those don't seem to be manifest in any wider range for you than normal? Because I ask because some other companies have provided much wider ranges than usual given the tremendous uncertainty that seems to exist. So do you have any less confidence just in the outlook than you've had in previous years given the state of the economy. I assume the answer is no but just hoping you could address that anyway. Sure. Maybe I'll start with the last piece. So no, you're right. The answer is no. We actually have more confidence, I think, as we sit here heading into 2023 than we had heading into 2022 because of all the uncertainty that we were facing. And Adam, we did have a lot of debate around this table and with our team about what that range should be. And ultimately, it's kind of the last point. We said that we think there's less volatility and less risk than what we came into 2022 with. And we think that we've got pretty good insight into the depths of our business and we should be providing that level of insight to the market. And there was discussion of a change but ultimately, we all agreed and decided that it would be appropriate to leave the range exactly where it was. No, I appreciate it. And what is the if there is a particular source of uncertainty for you, is it around inflation? Is it demand? Is there anything? Is that the pack? It's January, so you probably don't know much of anything about the pack. But is there any particular source of uncertainty that you would call out or not really? Well, I think, look, the destocking situation that affected both Dispensing and Specialty Closures and Custom Containers that will resolve itself at some point, right? We think we've got a really good signals that, that is resolving literally as we speak. If that gets delayed for any reason or for whatever reason, that would be a little bit of risk, Adam. That's probably the biggest one in dispensing and then over in custom. I think the food can business, you've got right. I think that is more about the pack. Remember, '21 was the year that the supply chain got replenished for [indiscernible]. So we were up significantly and expected a normal pack in '22 which we got. The pack ended in Q3 which was a little earlier than what we expected but that was fine for us. So we are anticipating a good pack this year. And there's always the normal risk around the pack but it's not like the year is dependent upon pack volumes. It's just the one item that does have some play into the absolute volume numbers at the end of the pack. Thank you. And since we have no further questions today. Mr. Greenlee, I'll hand things back to you for any closing comments. Great. Thank you, Bill and I appreciate everyone's interest and so good and we look forward to discussing the first quarter results in late April. Thank you. Thank you. Again, ladies and gentlemen, thank you for joining Silgan Holdings' fourth quarter earnings conference call. I'd like to thank you all so much again for joining us, and wish you all a great remainder of your day. Goodbye.
|
EarningCall_1190
|
Good day, everyone. My name is Todd, and I will be your conference facilitator this morning. At this time, I would like to welcome everyone to Danaher Corporation's Fourth Quarter 2022 Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakerâs remarks, thereâll be a question-and-answer session. [Operator Instructions]. I will now turn the call over to Mr. John Bedford, Vice President of Investor Relations. Mr. Bedford, you may begin your conference. Good morning, everyone, and thanks for joining us on the call. With us today are Rainer Blair, our President and Chief Executive Officer; and Matt McGrew, our Executive Vice President and Chief Financial Officer. I'd like to point out that our earnings release, the slide presentation supplementing today's call and the reconciliations and other information required by SEC Regulation G relating to any non-GAAP financial measures provided during the call are all available on the Investors section of our website, www.danaher.com, under the heading Quarterly Earnings. The audio portion of this call will be archived on the Investors section of our website later today under the heading Events and Presentations and will remain archived until our next quarterly call. A replay of this call will also be available until February 7, 2023. During the presentation, we will describe certain of the more significant factors that impacted year-over-year performance. Supplemental materials describe additional factors that impacted year-over-year performance. Unless otherwise noted, all references in these remarks and supplemental materials to company specific financial metrics refer to results from continuing operations and relate to the fourth quarter of 2022 and all references to period-to-period increases or decreases in financial metrics are year-over-year. We may also describe certain products and devices, which have applications submitted and pending for certain regulatory approvals or are available only in certain markets. During the call, we will make forward-looking statements within the meaning of the federal securities laws, including statements regarding events or developments that we believe or anticipate will or may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties, including those set forth in our SEC filings, and actual results might differ materially from any forward-looking statements that we make today. These forward-looking statements speak only as of the date that they are made, and we do not assume any obligation to update any forward-looking statements, except as required by law. Thank you, John, and good morning to all of you. We appreciate you joining us on the call today. Our terrific fourth quarter results rounded out another great year for Danaher. Broad-based strength across the portfolio drove nearly 10% core growth, strong earnings growth and free cash flow generation. We're particularly pleased with the performance of our base business, which grew high single digits for the year and has now grown high single digits or better each of the last 10 quarters. Our well-rounded results this year would not have been possible without the hard work and dedication of our more than 80,000 associates. The team overcame global supply chain challenges, logistics delays, COVID-driven lockdowns and inflationary pressures to reliably support our customers. We believe the DBS-driven execution, coupled with our proactive growth investments over the last several years contributed to meaningful market share gains in many of our businesses. Now looking to 2023 and beyond, we see a bright future ahead for Danaher. Our portfolio is made up of leading franchises of durable business models and attractive end markets that benefit from outstanding long-term secular growth drivers. We're well positioned financially with our strong free cash flow generation and balance sheet capacity, allowing us to actively pursue strategic M&A opportunities. So this unique combination of leading businesses and financial strength all powered by the Danaher Business System differentiates us and reinforces our sustainable long-term competitive advantage. So with that, let's take a closer look at our full year 2022 financial results. For the full year, we delivered nearly 10% core revenue and adjusted earnings per share growth, including 8% core revenue growth in our base business. We also expanded our core operating margins by 60 basis points and generated $7.4 billion of free cash flow. Our free cash flow to net income conversion ratio exceeded 100% for the 31st consecutive year. Our strong financial results allowed us to continue our cadence of high impact growth investments throughout the year. In fact, our investments in research and development of more than $1.7 billion in 2022 enabled us to accelerate innovation across Danaher. New products such as the Leica Microsystems, Beacon, Leica Biosystems automated advanced staining platform, Bond Prime; and Hach's Headquarter series portable meters are helping improve both human health and the environment, while enhancing our growth trajectory. Our capital expenditures of over $1 billion included substantial investments to expand production capacity in our bioprocessing and genomics businesses. These investments have been critical to support current customer demand but they're equally important to support the long-term growth opportunities and security of supply in these markets. With several of our customers' biologic therapies progressing through the regulatory approval process, we anticipate the size of our bioprocessing and genomics businesses to increase meaningfully here in the coming years. Now let's turn to our fourth quarter results in more detail. Sales were $8.4 billion, and we delivered 7.5% core revenue growth. Our base business core revenue growth was also 7.5% as our core revenue growth contribution from COVID-19 testing was neutral year-over-year. Geographically, core revenue growth in both North America and Western Europe was approximately 10%. We saw healthy demand across our major end markets with customer activity and funding levels largely consistent with the third quarter. High-growth markets core revenue was up slightly. China grew low single digits, driven by robust demand in our life sciences instruments and acute care diagnostic businesses. However, the reopening efforts associated with the ending of zero COVID policies and subsequent increase in COVID-19 infections resulted in reduced patients and testing volumes in our clinical diagnostics business. We anticipate lower testing volumes to continue through the first quarter of 2023 before gradually recovering through the balance of the year. Our gross profit margin for the fourth quarter was 59%, and our operating margin of 27.4% was up 100 basis points, including 105 basis points of core operating margin expansion. This strong margin performance was enabled by the disciplined cost management, productivity measures and price actions our teams implemented to help offset the impact of inflationary pressures across our business. While there continue to be supply chain disruptions and cost pressures, we saw a modest improvement in component availability again this year and this quarter. Adjusted diluted net earnings per common share of $2.87 was up 6.5% versus last year, and we also generated $2.2 billion of free cash flow in the quarter. Now before we get into the details of the quarter, I'd like to point out some updates we've made in our financial reporting. Due to changes in our organization resulting from the significant growth of our Life Sciences segment over the past several years, we have separated our former Life Science segment into two new reporting segments. Cytiva and Pall Life Sciences, which include bioprocessing and our discovery and medical businesses are now reported as the biotechnology segment. Our new life sciences segment is comprised of the remainder of the businesses in our former life sciences segment. The Diagnostics and Environmental & Applied Solutions segments are unchanged. Importantly, today's discussion reflects these changes. So now let's take a look at our fourth quarter results across the portfolio and give you some color on what we're seeing in our end markets today. Reported revenue in our Biotechnology segment declined 1% and core revenue was up 4%. In bioprocessing, robust customer activity across monoclonal antibodies, cell and gene therapies and antibody drug conjugates, or ADCs, drove another quarter of more than 20% growth in non-COVID revenue. Total core growth in bioprocessing was mid-single digits for the fourth quarter as customers continue to scale back their COVID-19 vaccine and therapeutic programs. For the full year 2022, core revenue growth in bioprocessing was high single digits, which included non-COVID revenue growth of more than 20%. Looking to 2023, we expect customers to further reduce their COVID-19-related programs. Vaccination and booster rates have been significantly lower than initially anticipated and the availability of alternative therapeutics has reduced the need for monoclonal antibody-based treatment. In light of these dynamics, we now anticipate COVID-19-related vaccine and therapeutic revenue will be approximately $150 million for the full year of 2023, down from approximately $800 million in 2022 and lower than our previous expectation of $500 million. Our non-COVID business has averaged more than 20% growth over the past two years. Given these elevated growth rates, we spent the past several weeks speaking with our customers to better understand their planning assumptions for 2023. And based on these discussions, we anticipate non-COVID bioprocessing core growth will be high single digits for the full year 2023. This includes low single-digit core growth in the first quarter as customers repurpose inventory purchased for COVID-19 vaccine and therapeutic programs to non-COVID projects. Now there is a bright future ahead for the biologics market and our leading bioprocessing business. The number of biologic and genomic-based therapies in development and production continues to rise, and we expect to see significant industry-wide investments in research, development and production capacity well into the future. With our differentiated portfolio, which is the broadest and deepest in the industry across upstream and downstream applications, our best-in-class scientific services and extensive global reach, we're exceptionally well positioned to support our customers as they undertake this complex life-changing work. Now moving to our Life Sciences segment. Reported revenue grew 8%, and core revenue was up 13%. Strength was broad-based across instruments and consumables with all major businesses delivering high single-digit or better core revenue growth. Our Life Sciences instrument businesses collectively delivered double-digit base business core revenue growth, led by Leica Microsystems and Beckman Coulter Life Sciences. Demand remains solid across our major geographies and end markets, and we're seeing good momentum in our opportunity funnels as we begin the new year. Our genomics consumables businesses had another quarter of double-digit core revenue growth, driven by strong demand for our plasmas, RNA and gene lighting and editing solutions. During the quarter, IDT strengthened its next-generation sequencing portfolio with the acquisition of Archer DX NGS assays. These assays are foundational in researching novel cancer fusions and bring new capabilities, including an enhanced bioinformatics platform to expand IDT's suite of sequencing solutions. Now moving to our Diagnostics segment. Reported revenue was up 3% and core revenue grew 7.5%, led by mid-teens growth at Cepheid. Radiometer grew double digits, led primarily by demand for blood gas testing in China. Leica Biosystems was also up double digits with growth across all major product lines. In our digital pathology business, we saw record placements of the GT 450, Leica's best-in-class digital pathology slide scanner, as customers are increasingly realizing the operational and clinical benefits of digitization. In Molecular Diagnostics, core revenue across Cepheid's non-respiratory chest menu grew more than 20% led by infectious disease testing, sexual health and hospital-acquired infections. The acceleration in growth this quarter was due in part to increased adoption of Cepheid's non-respiratory test menu across our nearly 50,000 instruments installed base, which has doubled since 2020. During the quarter, Cepheid expanded their competitively advantaged test menu with the launch of the Xpert Express MVP. The Express MVP rapidly diagnoses three distinct health conditions that cause overlapping vaginitis symptoms in women using a single sample. This addition to our sexual health portfolio enables physicians to quickly diagnose the patient's infection and prescribe a targeted treatment regimen, reducing the need for multiple office visits. Now this is a great example of how bringing accurate, easy-to-use molecular testing closer to patients is improving health care outcomes and driving long-term growth at Cepheid. In respiratory testing, global PCR testing volumes continued to moderate. The demand for Cepheid's point-of-care PCR testing remained robust. Cepheid's respiratory testing revenue of approximately $1.1 billion in the fourth quarter significantly exceeded our expectation of approximately $375 million. The respiratory season got off to an earlier-than-anticipated start with a high prevalence of circulating respiratory viruses, notably COVID-19, flu and RSV leading to both higher volume and a preference for our 4-in-1 test for COVID-19, Flu A&B and RSV. Now based on discussions with our customers, we believe COVID-19 will enter an endemic disease state in 2023, and as a result, expect to ship 30 million respiratory tests and generate $1.2 billion of revenue for the full year. As hospitals and health systems begin planning for their endemic testing needs, we're increasingly seeing customers consolidate their point-of-care PCR testing platforms on to Cepheid's GeneXpert. Our customers' preference for the GeneXpert for both respiratory and non-respiratory testing is a result of the significant value of the unique combination of fast, accurate lab quality results and a best-in-class workflow provide clinicians. The combination of these advantages, the broadest molecular diagnostic test menu on the market and our leading global installed base creates significant opportunities ahead for Cepheid's point-of-care solutions. Moving to our Environmental & Applied Solutions segment. Reported revenue grew 1% and core revenue was up 5.5%. Water quality core revenue growth was high single digits and product identification was flat. At product identification, marking and coding was up slightly while packaging and color management was down low single digits. Core revenue at Videojet was up slightly due in part to a difficult year-over-year comparison as the business grew low double digits in Q4 last year. In December, Pantone announced Viva Magenta as the 2023 Color of the Year. The color of the year and the billions of media impressions it generates solidifies Pantone's iconic brand and was one of the drivers of high single-digit full year core revenue growth in X-Rite [ph] color standards business in 2022. In water quality, Hach delivered their third consecutive quarter of double-digit growth. ChemTreat was also up double digits in the fourth quarter, capping its 54th consecutive year of growth, a remarkable accomplishment and a testament to the team's best-in-class execution and their commitment to continuous improvement. During the quarter, demand for analytical chemistries and consumables remained strong across municipal and industrial end markets, but we did see a slight moderation of larger project activity at Trojan. Throughout the year, our teams and EAS did a great job leveraging the Danaher Business System to overcome supply chain challenges and manage inflationary pressures. They were at the forefront of identifying potential constraints and quickly deployed DBS tools like daily management to work with suppliers and ensure production part availability. They also use visual project management to rapidly reengineer products and to reduce our reliance on hard-to-source electronic components. Also, strong price performance helped the team expand operating profit margins by more than 80 basis points in 2022, while continuing their cadence of growth investments. We believe this outstanding execution paired with our proactive growth investments drove market share gains and enhanced our long-term competitive advantage in both product identification and water quality. So with that color on what we're seeing in our businesses and end markets, let's now look ahead to our expectations for the first quarter and the full year. Beginning with the first quarter of 2023, we are updating our base business core revenue growth definition to exclude the impact of COVID-19-related testing and the impact of COVID-19 vaccine and therapeutic revenue. In the first quarter, we expect core revenue growth in our base business to be up mid-single digits. We also expect total core revenue growth to decline mid-single digits as a result of lower demand for COVID-19 testing, vaccines and therapeutics. Additionally, we expect the first quarter adjusted operating profit margin of approximately 30%. Now for the full year 2023. We expect high single-digit core growth in our base business. And we also expect total core revenue growth to decline mid-single digits for the year as a result of lower demand for COVID-19 testing, vaccines and therapeutics. Additionally, we expect the full year adjusted operating profit margin of approximately 31%. So to wrap up, 2022 was another terrific year for Danaher. Our team successfully executed through a challenging environment to reliably support our customers and deliver outstanding financial results, all while investing for the future. As we look ahead, we believe the combination of our talented team, differentiated portfolio of businesses and strong balance sheet, all powered by the Danaher Business System, position Danaher to outperform well into the future. Hey, good morning. And thank you for taking my question. So, a couple of questions to start. I guess the first one would be just on the inventory situation and sort of like how we should think about that working through and just sort of your expectations on the bioprocessing front on the non-COVID bioprocessing. Just some sense of timing. Is this a 1Q, 2Q phenomenon? Just general thoughts there. Derik, as it relates to the inventory situation, let's think about sort of our Q1 guide here as a starting point and the context for that. We expect for our overall guide to have a base business growth of mid-single digits, and we expect COVID testing, including now vaccine and therapeutics to have high single-digit and low double-digit headwind, giving us that decline of mid-single digits in the first quarter. Now let me come back to the base business because, of course, that's where your question resides. And once more, we have to be clear that we have now excluded vaccine and therapeutic revenues from the base business, right? So our mid-single-digit base business is down from the comparable low double-digit core growth we saw in Q4 and most of 2022. And that's due mainly to bioprocessing, ex-COVID, and I want to dig into that a little bit, but also because we're expecting lower patient volumes here in China as zero COVID policies are ended. So that's what's happening there in that base business in Q1. Now if we look, and we dig in a little bit deeper into bioprocessing, we anticipate that our non-COVID bioprocessing business will be low single digits, and that's really for two reasons. One, we're coming off of 30% growth in Q1 of 2022. But we're also working through the inventory pockets that we spoke about that was related primarily to COVID programs. And we do expect Q1 to be an inflection point there that we work through the majority of that in Q1 and then after that, continue to see improvement. Got it. Okay. And I have to ask the obligatory analytical instrumentation demand, SCIEX demand coming off of some really strong growth this year. What are your sort of expectations on instruments? And I would expect you would see some slowdown in the back half of the year is embedded in your numbers. I think that reflects our perspective. We saw low double-digit plus core growth in our instrument businesses here in 2022 and believe that we definitely took share there. And frankly our funnels are still very strong here going into the new year. But as we look to the total year, we would expect that low double-digit plus to moderate to the more normal growth of mid-single digit plus certainly towards the back end of the year. So as you know, in the fourth quarter on pricing, Derik, we came in over 400 basis points, with the teams really executing very well. And that represents roughly where we were for all of 2022. As we look forward then into 2023, we continue to expect some cost pressures there, and we'll look to have pricing of 200 to 300 basis points, probably closer to 300 basis points. Yes. Okay. Got it. Got it. Like that. Okay. I think I'll get back in the queue. I've got some other ones where I need to digest some stuff, but thank you. I'll get back in the queue. Thanks. Good morning. So first up, just on China. So you mentioned that you're expecting some softness there. Can you just dig a little bit deeper, how much of the softness on that 1Q is going to be pressured there? And then what do you expect for China in total for the year as well? Thanks. So as I mentioned, China is -- and of course, everybody knows coming out of the zero COVID lockdowns and that's affecting patient volumes here. And we saw that in December, in particular, and have taken that as an indicator for how we should think about the first quarter in China, which we expect to be down around high single digits here in the first quarter, but then moderating as the Chinese population gets through sort of the various infection waves that are expected. And we expect that patient volumes then improve throughout the year and are expecting low single digits for the full year in China. Great. That's helpful. And then just a follow-up. You mentioned that Western Europe was 10% core during 4Q. Can you just talk about your expectations for Europe with this year? Have you seen any softness related to any budget constraints on your conversations with customers there? Thanks. I would tell you, if we think about non-COVID, we continue to see good demand in Western Europe. We have seen the cycle time of deals. So that period of time between lead, capture and capturing the order extending here in the fourth quarter, and we would expect that to continue. As you think about Western Europe, including COVID headwinds, we would expect that to be flat here in the first quarter and then up low single digits. But once again, that includes some COVID headwinds. Helpful. And then final question for me, just around bioprocessing. Can you just walk us through kind of the order book and how book-to-bill has trended within bioprocessing given some of the puts and takes there getting us to that low single digits in the first quarter and rounding out the year at high single digits on the non-COVID side? Sure. So as it relates to orders, and I talked about this in the past as well as book-to-bill. In fact, we don't really look at book-to-bill for the bioprocessing business because it may not be the best way, and we don't think it is the best way to really understand the underlying health of the business, particularly given the extended lead times that we had here in the prior period. So we've been looking at orders really on a two to three-year horizon to take out the lumpiness as well as the extended lead times. And over the last three years, really, both orders and revenues have grown at a mid-single teens average rate. Now from a current trend perspective, in the fourth quarter, our order rate improved by over 500 basis points sequentially but was still down mid-teens, which was as expected as customers continue to adjust for our shorter lead times. Now to be clear, our full year 2023 guide anticipates Q1 being the low point at low single digits for the bioprocessing non-COVID core growth. And that also takes account to any inventories that might be with some of our COVID program customers, which are now being repurposed. We're working with those customers to repurpose that inventory. So whatever these order dynamics are revenue forecast for bioprocessing non-COVID in first quarter low single digits, we expect that to be the low point of the inventory work off or burn off and then move forward to what is high single-digit bioprocessing, non-COVID core growth for the full year. Good morning, Rainer. Thanks for taking my question. So I had my first question on bioprocessing here just about clarify some of these numbers here. I think a couple of months ago, Rainer, I think the expectation was for base bioprocessing, anywhere from high singles to teens. When you look at the high single, if it's at the low end of the range, did anything change? And when I think about that cadence throughout the year, I think first half is somewhere in the mid-single digits imply second half and double-digit range. Is there any risk out there in the back half? What gives you the visibility in the back half activation [ph] bioprocessing? Thanks, Vijay. So as early as the JPMorgan conference, we did talk about the bioprocessing growth range being from high single digits to mid-teens range. And as I mentioned then, and I'll confirm now, we have spent the last several weeks talking to our customers to understand their planning assumptions for the year. And the clear message is the underlying demand remains robust and unchanged. So we continue to see monoclonal antibodies, cell therapy and gene therapy activity continue to be strong, and we're even seeing more work on mRNA on the back of its success with COVID vaccine. So while the demand is remaining solid, customers are actually not anticipating a step-up in activity. So activity remains strong and as we've seen in prior quarters, but they're not anticipating a step-up versus what we've seen here in the last couple of years. And so as you look at the two, three, even four year stacks here, we've seen mid-teens growth CAGRs for bioprocessing non-COVID. So coming back then, if you take our high single-digit bioprocessing non-COVID full year guide on the back of an approximately 30% comp from 2022, it's right in the mid-teens range, both on a two and a three-year basis. So we think that's especially strong in light of the fact that in Q1, we do expect to burn off some inventory and will start low single digits. And in fact, if we had assumed the mid-teens to the higher part of the range for '23, that actually would have implied an acceleration of demand to over 20% on a two-year stack. And frankly, that's just not supported by our customer discussions. So as we think about burning off these inventories, you asked about the confidence in the later part of the year, and that confidence is based on our discussions with customers, the backlog that we have, the continued order activity that we see and that has improved over prior periods. And so we feel very good about the high single digits non-COVID bioprocessing growth for 2023. And maybe, Vijay, just to give you a bit -- sorry, yes. Just to give you kind of numbers to it because I know we've talked about this a lot recently, just so that we kind of repeated here. If you look at bioprocessing, ex-COVID growth, right, over the last four years, inclusive of our '23 guide, you have 7%, 8% type growth in 2020 as we are sort of moving into and away from the core bioprocessing doing more COVID work. And then in 2021 and 2022, we grew, ex-COVID, 20% plus in each of those two years. And so now this year in '23, the high single-digit guide, it's sort of kind of an inverse barbell, if you will. But if you look at kind of high single digits to start in '20, high single digits as we get through the last of COVID in '23 with 20% and 25% growth in the middle in '21 and '22, that's sort of the period that we're looking back and over because I don't think you can look at just any one period or quarter, given everything Rainer said that happened in '21 and '22 with the extended lead times and what was happening with COVID. So just so that we're all on the same page on sort of the numbers historically on how we have sort of arrived at that mid-teens growth rate in discussion with our customers who say, Hey, look, if you look back over the last three, four years, my demand is about the same. My order pattern is going to be slightly different, but my end demand is about the same. That's helpful color and perspective. And then one last question here for me, perhaps, Matt, this is you. The high single-digit guide for bioprocessing implies like the non-bioprocessing that's nearly 75% of Danaher revenues. That's also up high singles. That's a strong number. Again, any confidence here? I think there's been some concerns around capital order trends. So what's the order book shaping up for instruments? And margins here, 31% that's stepped down from Q4. Given that high single digits will resume and the pricing commentary, your volume leverage and pricing contribution should be pretty strong. So maybe if you could just comment on the non-bioprocessing high single-digit assumptions and margin assumptions? Let me take margins. And I think we sort of covered the high-single digits bit, but maybe Rainer can kind of wrap it up on bioprocessing. I'm sorry. I'm sorry. Okay. Everything outside of bioprocessing. Got you. So let me start with the margin question first because I think that's one that's topical here, too. So if you think about margins for the full year, and then I can kind of touch on '21 or Q1 as well. When you look at margins, we're talking about kind of 31% adjusted margin. And that's going to be a bit lower than we were in '23 on the margin, if you will, with the biggest factor going to be the value of leverage, like you alluded to there. We're going to lose, call it, $3.2 billion of COVID headwinds in the year, $700 million from the vaccines and therapeutics as we go from, call it, $800 million to a little over $150 million or a little under $150 million. And then we're going to have $2.5 billion of testing follow-up as we think we get to a more endemic state on Cepheid testing. So the margin profile on that stuff on the headwinds is basically the fleet average. I'd say that probably falls through at 40%. So kind of in line with our normal fall through, but that volume is pretty meaningful at $3.2 billion as you talked about. So we will offset some of that. High single-digit core and base business is going to be $1.7 billion in change, let's call it, falling through 35% to 40%, but just not enough to fully compensate what's happening with our COVID headwinds here. So I think you combine that the volume with sort of an overall macro backdrop, Vijay, that I still want to kind of be prudent here from a planning perspective as we head into the year. I want to see how the inflation of the supply chain kind of progresses through the year. China is still a bit of an unknown on how that bounces back. And I kind of I like to start the year with cost structure that's in the right place, and let's see how some of these things sort of play out. And as the year goes on, we'll obviously try to do better, but that's sort of how I'm kind of thinking about the margin for the year. And really, the only difference between Q1 and Q2 from 31% for the full year -- I'm sorry, in Q1, is FX in the first quarter. That's it. We'll have a $225 million FX headwind in Q1. And so, I would say that the same drivers, if you will, for the full year are for Q1. And then Vijay, just coming back to your question regarding the base business without Biotechnology growth here for 2023. We talked about Life Sciences instruments going from the low double digits or to the mid-single-digit plus here as we expect that to moderate during the course of the year. But in our Life Science businesses, we also have our genomics businesses, which are growing at double digits. So when you look at our under the new definition, Life Sciences business, so that would be the instrument businesses and genomics businesses, we expect high single-digit growth for the year. As it relates to our Diagnostics business, without COVID testing, we also expect high single-digit growth there, if you think about the growth in Leica Biosystems, Radiometer and as patient volumes normalize, supported also by solid growth at Beckman diagnostics, once again without COVID testing high single digits. And then as it relates to EAS, we would expect that now to normalize after having had just banner growth here in the last couple of years to be more the low to mid-single-digit growth, probably skewed more to mid-single digits for the year. Hey, good morning, guys. Lots of detail already discussed here, so I'll try to go back to a little bigger picture. What assumptions are you guys using for kind of labor and material inflation for 2023? I assume this is mitigated a little bit from the high labor inflation you've had the last couple of years, but curious on your view there? Yes, Scott. I think when I think about price cost, kind of back to that 200 to 300 basis points of price, we have been positive on price/cost the last, I guess, year here and probably a little bit more. So I think we -- that guide of 200 to 300 basis points would keep us at positive price cost. We are seeing -- I would say that we're seeing some things from a supply chain pressure come down. Freight lanes is probably the one the biggest one that I can think of from a cost perspective. I would tell you that other parts of the supply chain, we probably are seeing availability be better but not necessarily seeing costs come down yet. So I think we're sort of still in that 200 to 300 basis points of price to help offset what is still out there, but there are early signs of things may be turning. No. No, it's out. Yes, it's already out there. If we need to if we need to -- we can go for more as we've done here, Scott, and you saw that as we built through the year this year. And can you guys remind us what are the remaining steps you need for the EAS separation? Is there any kind of upside to getting that done on the earlier than planned? I'd love to say that it's easy to do, but there's quite a bit of work to get through it, Scott. I mean we've got -- we're still in the early days of the audits, getting the audits done. And after that, we've got a lot of org work, obviously, to do and a whole work stream of people who are working on it. I think we are still very much on track for Q4, the ability to do something here in Q4. Anything earlier, I think just between the audits, the work that remains and the tax ruling, it just takes time for these. So I don't think that's probably a base case scenario for us right now, Scott. I still think Q4 is the way to think about it. Great. Good morning, Rainer, good morning, Matt. Thanks for taking my questions here. Maybe first one would just be on China. I know there was a question asked earlier, but just wondering, some peers have commented that obviously, there's a headwind right now as the COVID rates have spiked but that as the year plays out, you could see China actually turned out to be stronger than maybe you were -- than peers were anticipating, excuse me, given the benefits on the economy. So kind of what are you assuming in that low single? Is that -- do you think you need some cushion in there? Or just how do you contemplate China playing out for the year given the change of policy? Dan, so -- I mean, the near term, just to recap is, in fact, that we saw, particularly in our Diagnostics business, lower patient volumes related to the hospitals in China being overwhelmed with COVID-infected patients. And we expect that to continue here in the Q1. It's currently the Lunar New Year holiday, where we expect infections to spread here in the next 30 days or so. And then over time, that, that would start waning, reducing. With -- it's kind of unknown as to how many other waves follow that. But we do believe that during the course of the year, especially as it relates to our business, patient volumes start recovering. We've seen this again and again after severe lockdowns of large cities in the previous years. And so we expect that to be pretty resilient. And that's why we end up then with a full year China guide of low single digits. Now could there be upside? Potentially. There's clearly some pent-up demand in the Chinese economy. And it just depends now on how quickly people can get back to work and some normalcy returns to the markets in general. So we think from where we sit today, low single digits for the full year is a good way to think about it. And of course, we'll continue to update as we go through the year here. But it's a good starting point, and there may be some upside should in fact that pent-up demand be released here in 2023. Great. And then just on the M&A environment. We've heard some commentary in kind of recent weeks that there seems to be a more willing seller environment, maybe just a reflection of macro and interest rates. So there seems to be maybe more folks coming to the table. How would you characterize obviously, it's impossible to time M&A, but how would you characterize the current environment? And just any color in terms of the outlook, whether it be from private targets or public targets and obviously, I'm sure all the remaining businesses post the EAS spin, EAS and excuse me, are candidates for M&A, but just how would you characterize kind of the interest levels by your business? Thank you. So our perspective on M&A remains unchanged here. First of all, our funnels continue to be very active. As you know, our balance sheet, which is now at 1.5 turns is in great shape. We're starting to see in the marketplace some recognition and I'll even say some acceptance of the lower valuation levels that we have now seen for a good period of time. And I would say it is early days, but the environment for M&A continues to improve. And as you know, in the past, when there have been these kind of situations, Danaher has been able to deploy capital in a really value-creating way. And of course, it's our intention to do that here in the future as well. Good morning, Rainer. Thanks for taking my question. Maybe one on -- back to the Diagnostics business. On Cepheid, can you just talk about the non-COVID piece, what you're hearing customers in terms of utilization, usage, particularly those who bought instruments during COVID? Obviously, you saw the installed base double over a couple of years there. Would love just some perspective in terms of what you're seeing as COVID comes down a bit, respiratory comes down here shortly, what the expectations there are? I mean, Patrick, we're very encouraged by what we're seeing. As you mentioned, over 50,000 instruments placed, more than double than we've had; well into the mid-20s in the number of tests. Now as you can imagine here in the fourth quarter and sort of the beginning of the first quarter, our customers have been busy with respiratory testing. No question about that. But we're very encouraged by the fact that even in the fourth quarter, we saw that non-COVID testing growing at over 20%. And I think that's indicative of a couple of things. First of all, we were very strategic in how we thought about placing our instrument in the sense that we really stayed at the point of care with customers that would be able to standardize their larger IDNs around the GeneXpert architecture as well as leverage subsequent to the pandemic, the broad testing menu that we offer, and we continue to see that. Not only do we continue to see that, but we see continued consolidation of point-of-care molecular testing onto the GeneXpert platform, which is likely also another driver for us seeing the continued adoption of the non-respiratory menu. So very positive outlook here. We're encouraged and its still kind of early days. Okay. That's helpful. And then maybe just a follow-up on Dan's capital deployment one there. Can you just refresh us on kind of how you think about leverage ratios and if the current rate environment changes your perspective at all in terms of what size deal you guys would look at? Yes, Patrick. Yes, I mean from a leverage perspective, we've been, I think, a couple of times in our history, we got to a little bit over four. So -- I mean, I think we've always said we don't have much of an appetite to be rated any lower than we are, for sure. So I think that's sort of the outer boundaries of what kind of think about. But we kind of -- we've been all over the place historically. We don't really have a target of two or three. It just sort of moves around with the deal activity, and we sort of take our time to it. And as far as the current rate environment, I don't think it changes it for us. I think we still think about sort of returns in the same way that we did. We've been doing this a long time. We've been in rate environments like this before. We've been in the rate environments that are worse. Last 10 or 12 years, obviously, had at close to zero was a very different time, but I don't think we have fundamentally any changes here given where we're at. Thank you. At this time, I would like to turn the call back over to John Bedford for any additional or closing remarks. Well, first of all, thanks again, everybody. We are thrilled with the way we closed out 2022, and we see a strong 2023 ahead with all the numbers, maybe just a quick recap. For 2023, we see our base business growing at high single digits. And in the first quarter, we see that base business despite the fact that we're working off some biotech and bioprocessing inventories at mid-single digits. Now we've talked at length about COVID testing and vaccine, therapeutic headwinds and I think those are real. But despite those headwinds, we feel great about the important role that we played in the pandemic. Keep in mind, we have reinvested COVID-related cash flows to create lasting annuities with acquisitions and breakthrough innovation while further strengthening our balance sheet. And so, we exit the pandemic much stronger than we entered with higher growth and higher margins in our base business.
|
EarningCall_1191
|
Ladies and gentlemen, thank you for standing by. Welcome to the American Express Q4 2022 Earnings Call. [Operator Instructions] As a reminder, todayâs call is being recorded. I would now like to turn the conference over to our host, Head of Investor Relations, Ms. Kerri Bernstein. Thank you. Please go ahead. Thank you, Donna and thank you all for joining todayâs call. As a reminder, before we begin, todayâs discussion contains forward-looking statements about the companyâs future business and financial performance. These are based on managementâs current expectations and are subject to risks and uncertainties. Factors that could cause actual results to differ materially from these statements are included in todayâs presentation slides and in our reports on file with the SEC. The discussion today also contains non-GAAP financial measures. The comparable GAAP financial measures are included in this quarterâs earnings materials as well as the earnings materials for the prior periods we discussed. All of these are posted on our website at ir.americanexpress.com. We will begin today with Steve Squeri, Chairman and CEO, who will start with some remarks about the companyâs progress and results and then Jeff Campbell, Chief Financial Officer, will provide a more detailed review of our financial performance. After that, we will move to a Q&A session on the results with both Steve and Jeff. With that, let me turn it over to Steve. Thanks, Kerri. Good morning, everyone. Thanks for joining us today. Itâs great to be with you to talk about our 2022 results and our outlook for 2023. As I go through our results, I will tell you why they strengthened my confidence in our plan to generate strong growth over the long-term. A year ago, we introduced our growth plan, which provided a roadmap for delivering annual growth rates for revenue and earnings per share at levels that are higher than the strong growth rates we were delivering before the pandemic. Our results over the last four quarters demonstrate that our strategy is clearly working. We exceeded the full year guidance we laid out in our growth plan for both revenues and EPS and we did so against the mixed economic environment. Revenues, which reached all-time highs for both the quarter and the year, were up 25% for the full year, exceeding the 18% to 20% guidance we started the year with. An earnings per share of $9.85 was well above our guidance of $9.25 to $9.65. The momentum we saw through the year in Card Member spending, engagement and retention continued in the fourth quarter. Fourth quarter billed business reached a record quarterly high of $357 billion and was up 25% for the full year demonstrating our continued ability to acquire, engage and retain high spending premium card members. Customer retention and satisfaction remained very strong. In addition to strong internal metrics, we were recognized once again by our customers for providing industry best products and services, ranking number one in customer satisfaction in both the 2022 J.D. Power U.S. consumer credit card study and the U.S. small business card study. The investments we have made in our value propositions continue to attract large numbers of new premium customers. We acquired 3 million new card members in the fourth quarter even as we increased our already high credit thresholds through the year. For the full year, new card acquisitions reached a record level, growing at $12.5 million and nearly 70% of our new accounts acquired are on our fee-based products. Millennial and Gen Z customers continue to be the largest drivers of our growth, representing over 60% of proprietary consumer card acquisitions in the quarter and for the full year. Credit metrics remained strong, supported by the premium nature of our customer base, our exceptional risk management capabilities and the thoughtful risk actions we have taken for the year. Looking ahead to 2023 and beyond, let me tell you why these results increase my confidence that we are positioned to deliver on our growth plan aspirations. First, we are in a great business. We operate in the most attractive segments and geographies of the fast growing payment space. As highlighted by our leadership positions with premium consumers, including millennials and Gen Zers small and medium-sized businesses as well as serving the largest corporations in the world. We bring to this space a number of advantages that are very difficult for our competitors to replicate. These include our brand, our unique membership model, a premium global customer base and an integrated payments model. Forming the foundation of these advantages is our talented dedicated colleagues who deliver unparalleled service to our customers. Put together, the marketplace opportunities we see and the competitive advantages we can leverage create a long runway for growth. We intend to capture these opportunities and building our momentum by continuing to invest at high levels in several key areas, continuously innovating our consumer and SME products, refining our powerful marketing and risk management engines and capturing our fair share of lending. Growing merchant acceptance with a particular focus outside the U.S. and expanding partnerships to drive customer value across the enterprise, continuing to introduce new digital capabilities that deliver seamless, intuitive customer experiences in their channels of choice and expanding into adjacencies that reinforce our core, such as new lifestyle and financial services for consumers and SMEs, which adds more value to our membership model. All this investment happens while continually focused on gaining efficiencies in our marketing and operating expenses. As we have demonstrated consistently over the past 2 years, executing this investment strategy builds scale, which fuels a virtuous cycle of growth, it starts with a high spending, highly engaged premium customer base. These premium customers attract a growing network of merchants and partners who add more value to our membership model, which in turn enables us to attract more premium customers who attract more merchants and partners, which creates more scale. This scale enables us to generate more investment and operating efficiencies in our membership model making it more difficult for our competitors to catch up. So what does this mean for 2023? Our plan for this year is built on continuing our investment strategy in the areas I mentioned while factoring in the blue-chip economic consensus for slowing macroeconomic growth. And as always, we have plans in place to pivot should the economic environment change dramatically. This translates into 2023 guidance consistent with what we originally laid out in our growth plan last year. Specifically, we expect revenue growth of 15% to 17%, which is higher than our long-term growth plan aspirations and EPS of $11 to $11.40. In addition, we plan to increase our quarterly dividend on common shares outstanding to $0.60 a share, up from $0.52 beginning with the first quarter 2023 dividend declaration. To sum up, our 2022 performance shows that our strategy is working. And based on our performance to-date and what we see for 2023, I am even more confident in our ability to achieve our aspirations for double-digit annual revenue growth and mid-teens EPS growth in 2024 and beyond. I will now turn it over to Jeff to provide more detail about our performance. Well, thank you, Steve and good morning, everyone. Itâs good to be here to talk about our â22 results, which reflects steady progress against our multiyear growth plan that we announced last January and also to talk about what our 2022 results mean for 2023. I will also spend some of our time this morning focusing on our full year trends since it is year-end and since looking at our business on an annual basis is more in sync with how we actually run the company. Starting with our summary financials on Slide 2, full year revenues reached an all-time high of $52.9 billion, up 27% on an FX-adjusted basis. Notably, our fourth quarter revenues of $14.1 billion also reached a record high for the third straight quarter and grew 19% on an FX adjusted basis. This revenue momentum drove reported full year net income of $7.5 billion and earnings per share of $9.85. For the quarter, we reported net income of $1.6 billion and earnings per share of $2.07, which did include a $234 million impact from our net losses in our Amex Ventures strategic investment portfolio. As I have said throughout the year, year-over-year comparisons of net income have been challenging due to the sizable credit reserve releases we had in 2021. Because of these prior year reserve releases, we have also included pre-tax pre-provision income as a supplemental disclosure again this quarter. On this basis, pre-tax, pre-provision income was $11.8 billion for the full year and $2.9 billion in the fourth quarter, up 27% and 23% respectively versus the prior year, reflecting the growth momentum in our underlying earnings. So now letâs get into a more detailed look at our results, beginning with volumes, starting on Slide 3, we saw good quarter-over-quarter growth in volumes. I would note that we reached record levels of spending on our network in both the fourth quarter and full year 2022. Total network volumes in billed business were up 16% and 15% year-over-year in the fourth quarter and 24% and 25% for the full year, all on an FX-adjusted basis. Now of course, growth rates for quarters earlier in the year included more of a recovery on the lower levels of volumes in 2021. And we are now to the point where we have lapped the majority of this recovery. We are pleased with this growth and the fact that it is being driven across customer types and geographies. On Slides 4 through 7, we have given you a variety of views across our U.S. consumer services, commercial services and International Card Services segments and the various customer types within each. There is a few key points I suggest you take away from these various perspectives. Starting with our largest segment, U.S. consumer billings grew 15% in the fourth quarter, reflecting the continued strength in spending trends from our premium U.S. consumers. Our focus on attracting, engaging and retaining younger cohorts of card members through our value propositions, drove the 30% growth in spending from our millennial and Gen Z customers on Slide 5, who you can now see make up 30% of spend within the segment. Turning to Commercial Services, you see that spending from our U.S. small and medium-sized enterprise customers represents the majority of our billings in the segment, supported by our strategic focus on expanding our range of products to help our SME clients run their businesses. We saw another quarter of solid growth in U.S. SME, though you can see that it was the slowest growing customer type this quarter, up 80% year-over-year. As you heard Steve talk about a bit last month at an investor conference, our SMEs have recently started to slow down spending in service categories such as digital advertising, so we continue to monitor spending trends. Moving to our U.S. large and global corporate customers, the one small customer type that has not come back to pre-pandemic spend levels, they did continue though their steady recovery this quarter with overall billings now 11% below pre-pandemic levels. And lastly, you see our highest growth in international card services as this segment is now in a steep recovery mode given it started its pandemic recovery later than other segments. Spending from international consumer and international SME and large corporate customers grew 23% and 32% year-over-year respectively in Q4. Across all customer types, T&E spending momentum remained particularly strong in the fourth quarter. While we also saw a nice sequential growth in the amount of goods and services spending versus last quarter, so there were a few pockets that slowed, such as the digital advertising spend in SME that I mentioned earlier. So what do all of these takeaways mean for 2023? At this point, on a dollar basis, most of our spending categories have fully recovered. So I would expect more stable growth rates this year across spending categories with the exception that year-over-year growth rates for T&E spending will likely be elevated in Q1 as we lap the impact of Omicron from the prior year. Importantly, all of the things that Steve just talked about that make up the strategy underlying our growth plan have created a foundation for sustainable growth rates greater than what we were seeing pre-pandemic. Now moving on to loans and Card Member receivables on Slide 8, we saw year-over-year growth of 24% in our loan balances as well as good sequential growth. This loan growth is now exceeding our spend growth as customers steadily rebuild their balances. Given the volumes, of course, have now lapped, there is deep phase of recovery, we do expect the growth rate of our loan balances to moderate as we progress through 2023, but to remain elevated versus pre-pandemic levels. The interest-bearing portion of our loan balances, which surpassed 2019 levels last quarter also continues to consistently rebuild with over 70% of year-over-year growth in the U.S. coming from our existing customers, which is about 10 percentage points more than what we saw in the years leading up to the pandemic. As you then turn to credit and provision on Slides 9 through 11, the high credit quality of our customer base continues to show through in our strong credit performance. Card Member loans and receivables write-off and delinquency rates remain below pre-pandemic levels. So they did continue to pick up this quarter as we expected, which you can see on Slide 9. Going forward, we expect delinquency and write-off rates to continue to move up over time, but to remain below pre-pandemic levels in 2023 for Card Member loans. Turning now to the accounting for this credit performance on Slide 10 and to this year-end and because the pandemic has clearly impacted the timing of quarterly reserve build and release adjustments across the industry, I think itâs helpful to look at our full year provision results. Full year 2022 provision expense was $2.2 billion, which included a $617 million reserve build, primarily driven by loan growth, the continued steady and expected increase in delinquency rates and changes in the macroeconomic outlook as the year progressed. The $2.2 billion number is of course still unusually low by historical standards relative to the size of our loan balances and card member receivables. Of the full year $617 million reserve build, we saw $492 million of it in the fourth quarter. Since earlier this year, we were still releasing a significant amount of the credit reserves we have built to capture the uncertainty of the pandemic. At this point, we no longer have any of these pandemic-driven reserves remaining on our balance sheet. Moving to reserves on Slide 11, you can see that we ended 2022 with $4 billion of reserves, representing 2.4% of our total loans in Card Member receivables. This reserve rate is about 50 basis points below the levels we had pre-pandemic or day 1 CECL reflecting the continued premiumization of our portfolio and the strong credit performance we have seen. We view this consolidated reserve rate as more comparable to day 1 CECL than the individual loans and receivables rates. Because as we talked a bit last quarter, our charge products in many instances now have some embedded lending functionality. We expect this reserve rate to increase a bit as we move through 2023, but to remain below pre-pandemic levels. Taking all of this into account, in 2023, you should expect to see provision expense move back towards more of a steady state relative to the size of our loan balances and Card Member receivables for the first time since we adopted CECL in early 2020. Given the combination of our strong loan growth and the unusually low level by historical standards of provision expense in 2022, I would expect a significant year-over-year increase in provision expense. Moving next to revenue on Slide 12, total revenues were up 17% year-over-year in the fourth quarter and up 25% for the full year. This is well above our original expectations, driven by the successful execution of our strategy and is part of which strengthens our confidence in our long-term aspirations. Before I get into more details about our largest revenue drivers in the next few slides, I would note that you see a 200 basis point spread between our FX-adjusted revenue growth and reported revenue growth for this quarter. While this is less of an impact from the strong dollar than what we saw in the prior quarter, it does remain a modest headwind. Our largest revenue line, discount revenue grew 16% year-over-year in Q4 and 27% for the full year on an FX-adjusted basis. As you can see on Slide 13, this growth is primarily driven by the momentum seen in our spending volumes throughout 2022. Net card fee revenues continued to accelerate throughout this year, up 25% year-over-year in the fourth quarter and 21% for the full year on an FX-adjusted basis, as you can see on Slide 14. In 2023, I expect net card fees to be our fastest growing revenue line. I would expect growth to moderate from the extremely high level we saw this quarter. This steady growth is powered by the continued attractiveness to both prospects and existing customers of our fee-paying products due to the investments we have made in our premium value propositions, as Steve discussed earlier, with acquisitions of U.S. Consumer Platinum and Gold Card members and U.S. business Platinum Card members, all reaching record highs in 2022. Moving on to Slide 15, you can see that net interest income was up 32% year-over-year in Q4 and 28% for the year on an FX-adjusted basis due to the recovery of our revolving loan balances. The rising interest rate environment has had a fairly neutral impact on our results in â22 as deposit betas lagged the rapid and steep benchmark rate increases during the year. However, when you think about 2023, deposit betas are now in line with more historical levels. So I would expect the year-over-year impact from rising rates to represent more of a headwind in 2023. To sum up on revenues, we are seeing strong results across the board and really good momentum. Looking forward into 2023, we expect to see revenue growth of 15% to 17%. Now all this revenue momentum we just discussed has been driven by the investments we have made in those investments show up across the expense lines you see on Slide 17. Starting with variable customer engagement expenses, these costs, as you see on Slide 17, came in at 42% total revenues for the fourth quarter and 41% for the full year. Based off the Q4 exit rates, combined with our continued focus on investing to innovate our products, I would expect variable customer engagement costs to approach 43% of total revenues in 2023. On the marketing line, we invested around $1.3 billion in the fourth quarter and $5.5 billion in the full year. As a reminder, our marketing dollars mostly represent the things we do to directly drive the great customer acquisition results we are seeing. As we look forward, we remain focused on driving efficiency so that our marketing dollars grow far slower than revenues as we did for many years prior to the pandemic. As a result in 2023, we expect to have marketing spend that is fairly flat to 2022. Moving to the bottom of Slide 17 brings us to operating expenses, which were $4.1 billion in the fourth quarter and $13.7 billion for full year â22. In understanding our OpEx results, itâs important to note the net mark-to-market impact to our Amex Ventures strategic investment portfolio that I mentioned earlier with reference to Q4. These gains and losses are reported in the OpEx line and totaled $302 million in losses for full year 2022, while in the prior year, we had a $767 million benefit in net gains. Even putting this aside, as Steve and I have discussed all year, our 2022 operating expenses do represent a step function increase compared to prior years as we have invested in key underpinnings to support our revenue growth and this inflation has had some impact on our expenses. Moving forward, similar to marketing, we are focused on gaining efficiencies and getting back to the low levels of growth in OpEx that we have historically seen. For 2023, we expect operating expenses to be around $14 billion and see these costs as a key source of leverage relative to the high level of revenue growth in our growth plan. Last, our effective tax rate for full year 2022 was around 22%. Our best estimate of the effective tax rate in 2023 is between 23% to 24%, absent any legislative changes. Turning next to capital, on Slide 18, we returned $4.9 billion in capital to our shareholders in 2022, including $1 billion in the fourth quarter with $639 million of common stock repurchases and $389 billion in common stock dividends, all on the back of strong earnings generation. We ended the year with our CET1 ratio at 10.3% within our target range of 10% to 11%. In Q1 â23, as Steve discussed, we do expect to increase our dividend by 15% to $0.60 per quarter, consistent with our approach of growing our dividend decline with earnings and our 20% to 25% target payout ratio. We will continue to return to shareholders the excess capital we generate while supporting our balance sheet growth going forward. That then brings me to our growth plan and 2023 guidance on Slide 19. 2022 was a strong year where we exceeded our full year guidance that we laid out in our growth plan last January for both the revenues and EPS. These results have strengthened our confidence in our 2023 guidance. First and most importantly, we expect the strategies that Steve laid out earlier to deliver continued high levels of revenue growth, leading to our revenue growth guidance for 2023 of 15% to 17% and setting us up well for 2024 and beyond. As you think about the drivers of EPS growth in 2023, first, we expect to return to the low levels of growth we have historically driven in our marketing and operating expenses producing some nice leverage. Going the other driver, the two notable headwinds that should be just 2023 challenges are around the year-over-year impacts of provision and of interest rates, as I discussed earlier. Combining all of these factors together, it leads to our EPS guidance of $11 to $11.40 for 2023. There is clearly uncertainty as it relates to the macroeconomic environment. But as Steve discussed, our 2023 guidance factors in the blue-chip macroeconomic consensus, which is for slowing growth though not a significant recession. Iâd also say that our guidance is based on what we are actually seeing in terms of behavior from our customers around the globe. And of course, it reflects what we know today about the regulatory and competitive environment. We feel good about the momentum we see in our business and in any environment, remain committed to running the company with a focus on achieving our aspirations of sustainably delivering revenue growth in excess of 10% and mid-teens EPS growth in 2024 and beyond as we get to a more steady-state macro environment. So Steve, maybe just to focus on the revenue growth, so obviously, 15% to 17% is much better than the market was expecting, given macro concerns. And there is obviously been a little bit of an uptick in white collar unemployment. So could you maybe just talk high level about how youâre able to put up this type of revenue growth in a somewhat weakening environment? Maybe just talk through some of the things that are idiosyncratic to Amex that Jeff just referenced, at the end of the call that maybe the market isnât appreciating that should be big drivers of revenue growth in the year ahead. Thanks. Well, I think Jeff really hit it. I mean, what he basically said was, and this is where we what weâre focused on is we can only run the business and forecast the business on what weâre seeing. And what weâre seeing is weâre still seeing high consumer growth. Weâre seeing high consumer growth in international. We talked about some moderation in small business. Corporate spending still has not come back. Jeff talked about T&E. But I think when you think about the model, I think what â you have to get an appreciation for is weâre a small segment of the overall U.S. population, and itâs a premium customer base. And that premium customer base, while not immune to economic downturn, certainly, right now is spending on through. And so the other thing that weâve been doing is weâre constantly tightening up the card members that weâre acquiring. I mean, look, the card member base we have today is from a credit perspective, better than the card member base that we had pre-pandemic. And card members weâre acquiring today are reaching a higher hurdle rate than ones we acquired just a year ago. And because of the value, there is still a good pool of customers that are out there. As far as overall white-collar unemployment, what I would say is, yes, youâve seen some headlines of individual companies that are going through layoffs. But the one thing that I would say is I think itâs really important to look at where these companies were pre-pandemic. And they are probably still at employment levels that are much higher than what they were pre-pandemic. And so there is a rightsizing a little bit. But even with that rightsizing, we still have unemployment rates under 4%. And so look, we look at unemployment. But it has not, at this particular point in time, had any impact on our on our card member base. I mean, again, keeping our write-offs at 0.8 and 0.6 is sort of not sustainable and were 1.1, as Jeff said, it shows on the slides. And that will tick up a little bit over time. But thatâs just normal for the business. So I think what you have to really â you have to look at is this is a premium card member base that appreciates premium products and is spending. And it is a â it is a small piece of the overall U.S. economy. And weâve talked about the economy being bifurcated and itâs probably no better example of what we have here. The other thing that I would say, when you think about revenue growth, unlike our competitors, we have a 3-legged revenue stool here, right? Youâve got â youâve got fees that we get for merchants, you have card fees. No card fees were 25% growth in the fourth quarter. And while thatâs a high number, we certainly expect double-digit card fee growth to continue. And then you have, obviously, which is a smaller portion of our business. We have obviously interest revenue as well. So when we look at the card members weâre acquiring, weâre really looking at acquiring revenue across those three components. And the other thing Iâd point you to is 70% of the cards that we acquire are paying fees. So thatâs how we come up with 15% to 17% Thanks. Good morning. I had a revenue question as well. Jeff, could you maybe just disaggregate the building blocks of the revenue growth. I know you mentioned a couple of things in terms of the trends on fees and NII. Iâm just looking at discount revenue and the year-over-year change in growth, and that sort of decelerated a little bit more than I had anticipated, I guess, does that slow down? Maybe some help there would be helpful? I think, Sanjay, the building blocks are pretty straightforward. And of course, as Steve just pointed out in our model, you always have to start expecting, right? Thatâs what drives our model, that lending. And I think probably the important words that I would pick out of some of the things Steve and I have just said, for most of our spending categories, if you think about whatâs important in terms of dollars, we really have hit recovery point. And so as we look at the Q4 rate, I actually see those exit rates is approaching pretty stable levels for what we think given the tremendous success weâre having in bringing new customers into the franchise because as you know, Sanjay, that is a key aspect of what drives our growth. I actually see those rates being fairly stable going forward. So thatâs what drives first really strong discount revenue growth. Our card fee growth, as Steve just mentioned, is super sustainable. Iâd just remind everyone that is the front-line item that grew double digits right through all the ups and downs of the pandemic. And gosh, our latest figures that Steve just gave you, 70% of our card members on fee-paying products this quarter, we have a long ways to go to keep growing net card fees. And then, look, itâs the third leg of the stool. Itâs only 19%, 20% of our revenues, but net interest income matters. And we are still in a rebuilding mode of balance. Certainly, that process has now begun in earnest, and thatâs why you saw our loans grow a little faster than volumes this quarter. So I donât expect to see quite as high a rate next year as you saw in Q4. But itâs still above in 2023, I would say the stable level and still above where we were pre pandemic because of that rebuilding process. So you put all that together with the comments that youâve now heard both Steve and I make, which is, look, we got to run the business based on what we see with our customers who are premium consumers, select segments of small businesses and the largest companies in the world, and thatâs where you get to the 15% to 17% revenue growth. So another kind of subtext on this theme. I wanted to understand a little bit about how I should be triangulating the revenue growth outlook, which is very clear with the comments around normalization of credit, should I be expecting that youâre underwriting to that pre-pandemic level of was it 2.3 on the slide, with marketing spend being flat and the proprietary net acquired accounts here coming down a little bit in the quarter. So when I see all that, Iâm thinking that your bubble of account acquisitions is through, I suppose, and you donât need that marketing dollars to drive that incremental rev growth at the same time as youâre underwriting to a group, a credit pool thatâs similar to pre-pandemic so we should have that NCO trajectory move back up towards pre pandemic? Or is there something that Iâm missing in pulling that all together? Thanks. Well, there is a lot there, but let me try and talk about marketing, and Jeff can pick up on other components. But â so look, the $5.5 billion of marketing spend was all-time record high. And the 12.5 million cards that we acquired. The fact that you saw a 300,000 card decrease sort of sequentially quarter-over-quarter is not something that weâre concerned about at all. And some of the comped timing of when you do your acquisition and so forth. And so â but the key point here is that weâre all looking at marketing efficiencies. And we continuously raise the bar on who we are bringing into the franchise. So weâre not â I wouldnât say weâre at a bubble in terms of card acquisition. We donât project card acquisition. We provide the card acquisition numbers, but for us, and probably we need to do a better job going forward from a metrics perspective, but we really look at revenue. I mean we look at the cards that we acquire in terms of how much revenue we can acquire. Itâs the same thing with billings. I mean, not all billings are created equal. I mean there is billings that you have that donât have a lot of value to it within the industry, we look at profitable billings, we look at card fees and we look at that, as Jeff said, interest income. So I wouldnât take away from this that we were at an inflection point or a bubble or anything like that. I think the $5.5 billion is a tremendous amount of money to go out there and acquire with, and weâre pushing the organization to even be more efficient and more effective with that money. So we are looking at the same kind of acquisition levels that weâve had in the past with higher underwriting standards as well. As far as operating expenses go, and as you start to think about that, we had a big step-up in operating expenses as we had tremendous growth. And having had a lot of experience running the components of this organization from both a technology perspective and an operating perspective, travel and what have you, as you see those volume increases, you need to manage and to get to that next level of scale. And we believe that we have gotten to that next level of scale, and we will get back to normal operating expense growth. And the other part of it just like everybody else look rates increased there was some inflationary pressure within there, but make no mistake about it, there was â we had to get to another scale. When you have 25% revenue growth, we have 25% billings growth. When you have travel bookings that at all-time highs and continuing to increase quarter-over-quarter, you have to put in place not only the digital capabilities, but the people to make sure that you can handle all that. So from an expense perspective, the reason weâre able to say that we think marketing will be where it is and operating expenses will not grow at the same level that they will because we believe weâve gotten to that scale component that we now believe that we can grow revenues 15% to 17% get into a 10% growth mode 2020 â plus 10% plus growth mode 2024 and beyond with that scale until the point in time. And I donât know when that is where we have to have another scale jump. But what you saw from a growth perspective, last year was all about the scale. So Jeff, do you want to talk about credit or anything else or... So thatâs how I would think about that in terms of going below sort of the components of revenue and how expenses relate to that revenue. Yes. Thank you. Sorry if I missed this, but can you talk about how sensitive your revenue guidance is to the macro, kind of what gets you to the high and low end of the range you provided? And are you using at all the same assumptions around GDP and unemployment that you used to kind of set the reserve levels? Mark, one of the interesting things that I think surprises people is we have looked historically every way you could imagine, trying to find really direct correlations between GDP growth and for that matter between movements in the markets that affect peopleâs financial wealth. And the, I think, surprising things to many people is we canât find any direct correlation between those two things. So when you look at our 15% to 17% guidance, itâs really â I go back to what Steve and I have both now said a couple of times, driven by â our best indicator is what we see with our customers around the globe and how they are behaving. And we certainly are aware of and thinking about various macroeconomic forecasts but you start with what behaviors are we actually seeing. And Iâd also remind everyone that the U.S. remains by far our largest market. The U.S. economy shrank in the first two quarters of 2022, and we just posted revenue growth for the full year, 25%. So when I think about the 15% to 17% range, itâs really not a 15% is a weaker economy, 17%. Frankly, itâs â I wish we were more precise about forecasting, but itâs just a little bit of forecast error, I would say, based on the trends weâve seen and the macroeconomic consensus, which is absolutely. The economy is supposed to slow when you look at that consensus, and thatâs factored in here as well. Good morning. I think you said 70% of existing loan lending growth came from existing members. Is there a similar metric you can share on the spending side? Just trying to understand as things normalize and we get into more of a normal cadence how maybe help us project a little bit on spending growth, how that can translate as we look at your last few quarters of strong acquisitions? Thanks. Well, so what Iâd say is that when you look at lending, Iâm going to go back to that 70% number. And I do think itâs an important one to think about the implications. I think occasionally people look at our loan growth and say, is that all the new customers youâre acquiring and what do you know about them? And so we actually draw a lot of comfort from the fact that you have 70% of that loan growth coming from just our existing customers that we know well, we have history with really just rebuilding more towards historical levels. If you think about spending, in our model, we talk a lot about the fact that we have, I think, by the standards of most industries, remarkably high retention rates in the high 90% range. And thatâs a real key strength of our model. Once we get someone into the franchise, they intend to stay. That group, depending on the economy is growing organically a little bit. When you think about adding our new customers that is a key engine at any point in time of adding another normal environment. And it varies over time, but I might anchor around an 8% to 10% kind of number. So itâs a mixture of super low retention what we are doing to spur more spending by our existing customers and that steady flow of new customers. And so one of the things again, that Steve and I have both just talked about, because I think people seem a little surprised to you by the 15% to 17% is a key driver, why we are comfortable with that is our tremendous success over the last year, and in the first weeks of 2023 and bringing great new customers into the franchise. Yes. And the other thing that I would say is and I said this in my remarks, this virtuous cycle that we talk about, the more card members we bring in, the more merchant and partner offers that we can get. And so the engagement â the increased engagement from existing cardholders is a really important driver of growth. So that â the membership model is we just donât bring our card members in and sort of watch them hope they grow. We bring our card members in and we want to work with them to grow. We do that from a small business perspective with our account development teams, making sure that they are taking advantage of all the benefits of the card, making sure that they are spending in categories that they can spend in, maximizing rewards and so forth. And we do that with our card base from an offer perspective through Amex offers through other direct offers from partners embedded offers within the model. And so a lot of our engagement not only from a customer service perspective is to making sure that our card members are taking advantage of all the aspects of the card that are out there. And so we really look to grow same-store sales, right. I mean so from existing card members, we are constantly looking to grow that share of their wallet. And again, that gets easier as the cycle gets bigger because more and more merchants want to reach more and more of our card members. Hi, obviously, a very positive outlook. I donât want to sound negative, but I think what we are all kind of dealing with is investors being like this is great? I will take it, but help me think about what are the risks? Where could it go wrong? So, maybe one question and one follow-up along the same theme, Jeff, when you were talking about the macro sensitivity, one question I hear sometimes is the note that the aspirational 2024 and beyond is a steady-state macro. And I get the investor question like, where is the dividing line? Like what would non-steady state macro look like where that guidance would then or aspiration within not apply? So, maybe you could touch on that, like what are the bounds in your mind for a steady-state macro? Well, I think Brian, I would start with two comments. First, when you think about our long-term aspirations, we donât actually worry about recessions at all because the reality is, at some point, and I donât know if itâs six months from now or 6 years, there will be a recession. And after that recession, there will be a recovery. And it doesnât change our view of we should be able to steadily grow this company in excess of 10%. Now, when there is a recession where you see a very significant shrinkage in GDP. So, not like the first half of last year where maybe the U.S. GDP went down 0.5 point or something. But where you suddenly see a quarter or two quarters where you have a pandemic like or great financial crisis like large percentage declines in GDP and you see huge spikes in unemployment. If you go back to one of the appendix slides, you will see that our CECL credit reserve accounting assumes a baseline and also builds in a downside scenario. In that downside scenario, you have 8% unemployment by the third quarter of 2023. Well, if there is 8% unemployment by the third quarter of 2023, we are going to have a few quarters where we are probably below our longer term aspirations. But is that kind of large shock thatâs going to knock us off for a few quarters, but I really want to keep coming back to and I suspect, Steve, you might reinforce this, but it doesnât change our long-term aspirations or how we are going to run the company. No. And I think just go back to the pandemic. So, look, we pulled back on acquiring card members because I donât think anybody had any line of sight. I mean that the pandemic was worse than the financial crisis from a credit underwriting perspective. You never say never, but thatâs sort of like the 100-year flood, right. And so my perspective is we will still acquire in that kind of scenario. And remember, everything we acquired today, we acquired through the cycle, but what we would do is move the credit criteria even further up. But what we would do again is we would engage with our card members. I think one of the most successful things that we did during the pandemic was retaining card hold, retaining those cardholders, whether it was through financial relief programs that got them through the hump for a couple of months or six months, whatever it was, or engaging them to spend in other areas and to stick with us. So, the reality is, is that if we were running this business quarter-to-quarter, which we donât, you would pull back. But the reality is, as Jeff said, after every recession there is a recovery. And the last thing you want to do is retrench in such a way that you are not going to be able to take advantage of the recovery. And that retrenchment, looks â it looks like layoffs that donât make sense and pulling back on marketing and trying to hit an EPS number for a quarter or for a year that is irrelevant. Whatâs relevant is for a 172-year-old company to continue to grow over the medium and long-term. And the way you do that is you invest judiciously and you invest smartly. And in times when things are bad, you invest in your infrastructure, you invest in your people because you are going to need great people through when a recession is over, and your infrastructure is going to need to do that. And where companies make mistakes is let go of great people, and also do not invest in those things, they are going to need six months to nine months from now when the recession is over. So, yes, we may have a moment in time, as Jeff said, it could be six months, it could be 6 years, but there will be a time when we donât make that. And â but there will be a time where we exceed that. And thatâs why we say our long-term aspiration is for 10%-plus growth in revenue, and we feel we are on a way to that. Thanks for taking my question. Look, when we look at Slide 5, itâs really interesting in terms of the contribution and the significant growth from millennials and Gen Z. You guys have been really successful there. And we have seen that progress over time. I am curious, given that the millennial Gen Z growth in the last year was basically 5x, 4x to 5x other cohorts and the significant loan growth. If we looked at this distribution by age cohort, not for build business, but by portfolio in terms of borrowings, what the distribution would look like with millennials over-index versus the peers? Well, the short answer, Rick, is no. When you think about the behavior of the millennials and Gen Zs, there are a few distinguishing features, and we have talked about these. They tend to be more digitally and engaged. They tend to be more engaged with the overall value proposition, which we actually see as a good thing. Because of that, they often will engage more quickly when they get the new product. But I would also remind you of the other stat we have talked about this morning, which is 70% of our growth in loans right now is coming from existing customer facilities. We add a lot of these millennials there. That segment is still not adding as much to the loan growth because of the rebuild imbalances by your existing customers. So, while the behaviors of the younger card members are on average, similar to the older card members when you think about borrowing, just sort of the math here because you have got this rebuilding effect would say that they are not driving that bigger portion of our loan growth. Yes. And we tend to get a higher share of their wallet, but they have lower â they do have lower spending. And the great part about millennials and Gen Zs is that they are â and depending on where you are in millennial. I mean some millennials are 40 now. So, I mean, they are in a different thing. But the reality is the lifetime value of these cardholders is going to be significantly more than the lifetime value of acquiring a boomer or acquiring a Gen Xer right now. And that is â thatâs very attractive as well. And if you look, again, Rick, on Page 5, you will see that, look, itâs 30% of the business growth. On the other hand, the boomer growth is only 6%. And some of those have been leery to go back travel still. So, we would also expect that to go up. Great results. Good morning. I just want to change the topic a little bit. I just wanted your updated thoughts if you could just remind everybody about your ability to make account-by-account purchase limit authorization decisions given many of the accounts donât actually have stated line sizes on the charge cards. So, I am just really wondering about severity of loss in the downturn versus the frequency is more based on unemployment, but your ability to really hone in on limiting the severity of loss given your underwriting techniques. Thanks so much guys. I mean I think you just reminded us. The reality is, itâs a couple of things, right. Number one, we constantly go through and look at contingent liability thatâs not being utilized. And so if we have somebody that has X for Align and they are only using 25% of X, we may not keep X there that long. We donât want to be a lender of last resort, right. Thatâs number one. Number two, we also are â for new card members, we are raising those cycles, but raising the limit, the hurdle rate that we acquire card members. But we underwrite every transaction. We make a credit decision not based on the line because most of our card members do not have a line. I mean obviously, traditional lending cards have line. But other than that, we are underwriting every single transaction. So, we are not letting somebody just run it up because they have run it up in the past. And we are not letting somebody run up to a limit and have that write-off. One of the advantages of our model, and I am not going to get into all the variables underneath for a couple of reasons. Number one, we donât have time. And number two, itâs very complicated. And number three, I probably donât fully all understand the whole thing either. But itâs â an advantage of this model is that every single transaction is adjudicated on its own merits. Itâs not adjudicated based on an open to buy. And that is very important. It also â but thatâs from a credit perspective, thatâs a really reassuring thing. But from a spending perspective, it also enables why you read some of these stories of, hey, I just bought a painting for $75 million. There is nobody that has a $75 million line, right. Now, those are very difficult underwriting decisions and not for the faint of heart, but it does show that we make those same kind of decisions on a $200 purchase, on a $400 purchase. Every single transaction that comes through this system is adjudicated on its own merits, not on sort of some open to buy, and that gives us great comfort in terms of not having somebody just run something up and then have something written off. Yes. The only thing I would add, I think that is a unique capability we have honed over many decades since we first started the charge card product. The other advantage of the charge card product, I would say, Dominick, is it does give us this population who is supposed to pay us in full every 30 days, which actually is almost like an early warning system from an overall risk management perspective of when there are problems that pop up in various parts of the world or various segments or various customer types. And we think thatâs actually helpful to our overall results, and itâs the part of the many things that drives us historically and today to have by far, best-of-class credit metrics. Great. Sorry to go back to the revenue guide. But Jeff, and I appreciate the 25% revenue growth for the full year, but the quarter was 17%. And between you and Steve, you both said that there was going to be a slowdown, itâs still strong, obviously, but a slowdown in card fee revenue growth and with the comments about margin, probably net interest income. So, I guess is there a part of the revenue base that you think is accelerating in â23? Well, so, two comments. I think itâs a good call out, Moshe. The first comment is as you think about 2021, of course, the base year here, you saw things progressively pick up as you went through the year. So, thatâs why each quarter our volumes on a year-over-year basis has slowed a little bit. But we also have pointed out that I think you are sort of through that recovery period now. So, I think what you see in Q4 in our view, is very typical of what you are going to get. Now, the one exception that we do think will accelerate is the net interest income piece, because you do have customers continuing to rebuild balances. So, net card fees probably moderates a little bit. Net interest income probably accelerates a little bit. But your discount revenue should be pretty consistent with what you would have seen in this quarter. And thatâs really the model that leads you from Q4 to what we expect for 2023. Thank you. And maybe some topics that havenât been touched on yet. And Steve, you called out investment in services and adjacencies, I would say and also, the international piece, expanding your merchant acceptance there. So, just any call-outs on adjacencies, the B2B payments and your â how that contributes to your long-term strategy. And then international, I seem to recall Japan being an important market for, you saw some good growth internationally, Japan reopened, China is reopening. Is there acceleration potential in international in 2023? Yes. So, let me hit a couple of these topics and hopefully, I remember the mall that you went through. But look, I think international, we have seen which is really good and just look at the slides, you have seen really good growth from not only a consumer perspective, which is over 20%, but international SME and large corporations are growing at 32%. So â and remember, pre-pandemic, those are the fastest-growing parts of our business. So, we expect that to continue to grow, which obviously Japan is part of it and one of our top markets. From an acceptance perspective, we continue to grow acceptance internationally. We are really happy with the coverage gains that we have had, and we will continue to focus on that. We have talked about focusing on priority cities. We focused on all the categories, e-commerce, restaurants and lodging and tourist attractions, airlines, hotel and so forth to get those up. But again, with that we are getting 23% and 32% billings growth and our coverage is not where we want it to be yet, and we will continue to invest in that coverage. Look, as far as B2B goes, B2B continues to be a good story for us, but itâs just a small part â itâs a smaller part of the business. And we continue to invest in capabilities and we will continue to focus on B2B, but that will add not only to commercial spending, but that will also add to small business spending as well. And remember, 80% of the small business spending that we have is in the category of B2B spending. And so we will continue to hunt for that and try and automate more and more of those billings, and it makes it easy to get on the card. Hi Steve. Just curious if you have seen anything that sort of raised your concern level around competition in U.S. consumer or small business. I mean it seems to us like you might be pulling away a little bit from competitors. I am not sure if your metrics suggest that or not? Well, I mean I donât â we continually look to raise the bar. And I think that there is a lot of great competitors out there. We have got JPMorgan and Bank of America and Wells Fargo and U.S. Bank and Capital One. And everybody is â they are all strong. And they â I mean they all had pretty strong results from a growth perspective. But as I said in my remarks, the more value we continue to add, the more we get our flywheel working, the harder it is to catch up. And we are not resting on our laurels. And thatâs why we continue to invest. We continue to invest in value propositions. We continue to invest in capabilities. We continue to invest in service. And so are we increasing the distance between us and our competitors, I donât know how you measure that, but I think we â our goal is to constantly make it hard for them to catch up. And our goal is to make sure that we are trying to be one step, two steps or three steps ahead of them. And itâs flattering, actually that they are coming after the segments that we are in. And â but competition is there, and it is fierce. And for us, competition is just not U.S. consumer. Itâs a small business. Itâs corporate. Itâs in international. And so we are fighting a lot of battles here in terms of defending our territory, but I think the team is doing a really, really good job. But we are never going to rest. And if in fact they stopped, we still keep going. So, it is really important. I think itâs one of the things that we decided a number of years ago that we would constantly refresh our products on a very regular basis and add value on an interim basis, which you have seen with our Platinum Card and our other products. And I think thatâs really helped us out quite a bit. Terrific. Thank you. Thanks for squeezing me in. I had a question about international. The 26% of business growth in international really caught my eye because that figure is more than 2x of what Visa and Mastercardâs international credit growth was in the fourth quarter. And so I was hoping to just dig in a little bit, so into what â looking at your international business is driving that and how sustainable it is? It looks like itâs mostly driven by spending per card. The card growth isnât unusually high. So, is there a â I am trying to understand, is this a significant share gain going on? Is this acceptance that you are driving? Is this something unique about the geographic composition of the customer base. Can you just dig into that a little bit? Thank you. Yes. So, Lisa, I think itâs â look, pre-pandemic, we are pretty close to 20% anyway from an international perspective. And look, itâs a smaller base than Visa, Mastercard. And itâs a really high premium customer segment. And itâs a segment that travels â itâs a card base that travels quite a bit. So, pre-pandemic, we were growing in that 20% range. And that growth was due to a real focus on value proposition and a focus on merchant acceptance. I think what you are seeing right now, which is 26% growth, which is slightly outsized growth is still a recovery from the pandemic, right. I mean if you think about it, this 26% growth quarter-over-quarter, you still had a lot of lockdowns. People were not traveling last year at this time in international and so. Look, we are â our goal is to â our hope is to continue to grow this business as it was pre-pandemic at around that 20% level. But from my perspective, there is really nothing unusual here. We are sticking to our strategy, enhancing the value, continuing to add merchant acceptance and continuing to invest in this segment â these two segments of small business and international consumer card, which were fast-growing pre-pandemic, so nothing really unusual. And it probably normalizes a little bit as the year goes because people were getting out there and traveling and we got into the second and third quarters. With that, we will bring the call to an end. Thank you for joining todayâs call and for your continued interest in American Express. The IR team will be available for any follow-up questions. Operator, back to you. Ladies and gentlemen, the webcast replay will be available on our Investor Relations website at ir.americanexpress.com shortly after the call. You can also access a digital replay of the call at 877-660-6853 or 201-612-7415, access code 13734498 after 1:00 p.m. Eastern Time on January 27th through February 3rd. That will conclude our conference call for today. Thank you for your participation. You may now disconnect.
|
EarningCall_1192
|
[Foreign Language] Good afternoon, everyone and welcome to TSMCâs Fourth Quarter 2022 Earnings Conference Call. This is Jeff Su, TSMCâs Director of Investor Relations and your host for today. TSMC is hosting our earnings conference call via live audio webcast through the companyâs website at www.tsmc.com, where you can also download the earnings release materials. If you are joining us through the conference call, your dial-in lines are in listen-only mode. The format for todayâs event will be as follows. First, TSMCâs Vice President and CFO, Mr. Wendell Huang, will summarize our operations in the fourth quarter 2022, followed by our guidance for the first quarter 2023. Afterwards, Mr. Huang and TSMCâs CEO, Dr. C. C. Wei, will jointly provide the companyâs key messages. Then TSMCâs Chairman, Dr. Mark Liu, will host the Q&A session, where all three executives will entertain your questions. As usual, I would like to remind everybody that todayâs discussions may contain forward-looking statements that are subject to significant risks and uncertainties and which could actual results could differ materially from those contained in the forward-looking statements. Please refer to the Safe Harbor notice that appears in our press release. And now, I would like to turn the call over to TSMCâs CFO, Mr. Wendell Huang, for the summary of operations and the current quarter guidance. Thank you, Jeff. Happy New Year everyone. Thank you for joining us today. My presentation will start with financial highlights for the fourth quarter and a recap of full year 2022. After that, I will provide the guidance for the first quarter 2023. First quarter revenue decreased 1.5% sequentially in U.S. dollar terms as our business was dampened by the end market demand softness and customersâ inventory adjustment despite the continued ramp up of our industry leading 5-nanometer technologies. It is at the low end of our previous guidance. In NT dollar terms, revenue increased 2% in the fourth quarter due to a more favorable foreign exchange rate. Gross margin increased 1.8 percentage points sequentially to 62.2% mainly due to a more favorable foreign exchange rate and cost improvement efforts, partially offset by lower capacity utilization. Total operating expenses accounted for 10.3% of net revenue. Operating margin was 52%, up 1.4 percentage points from the previous quarter. Overall, our fourth quarter EPS was TWD11.41 and ROE was 41.7%. Now, letâs move on to the revenue by technology. 5-nanometer process technology contributed 32% of wafer revenue in the fourth quarter while 7-nanometer accounted for 22%. Advanced Technologies defined as 7-nanometer and below, accounted for 54% of wafer revenue. On a full year basis, 5-nanometer technology contributed 26% of 2022 wafer revenue. 7-nanometer was 27%. Advanced Technologies accounted for 53% of total wafer revenue, up from 50% in 2021. Moving on to revenue contribution by platform. HPC increased 10% quarter-over-quarter to account for 42% of our fourth quarter revenue. Smartphone decreased 4% to account for 38%, IoT decreased 11% to account for 8%, automotive increased 10% to account for 6% and DCE decreased 23% to account for 2%. On a full year basis, all 6 platforms had year-on-year growth. HPC increased 59% year-on-year to account for 41% of our 2022 revenue. Smartphone increased 28% to account for 39%, IoT increased 47% to account for 9%, automotive increased 74% to account for 5%, and DCE increased 1% to account for 3%. Moving on to the balance sheet, we ended the fourth quarter with cash and marketable securities of TWD1.56 trillion or $51 billion. On the liability side, current liabilities increased by TWD137 billion, mainly due to the increase of TWD48 billion in accounts payable, an increase of TWD93 billion in accrued liabilities and others. On financial ratios, accounts receivable turnover days remain at 36 days while days of inventory increased 3 days to 93 days. Regarding cash flow and CapEx, during the fourth quarter, we generated about TWD487 billion in cash from operations, spent TWD337 billion in CapEx and distributed TWD71 billion for first quarter 2022 cash dividend. Overall, our cash balance increased TWD47 billion to TWD1.34 trillion at the end of the quarter. In U.S. dollar terms, our fourth quarter capital expenditures totaled $10.82 billion. To recap our performance in 2022, we had a strong growth in 2022 as our technology leadership position enabled us to capture the industryâs megatrends of 5G and HPC. Our revenue increased 33.5% in U.S. dollar terms to reach $76 billion and 42.6% in NT terms to reach TWD2.26 trillion. Gross margin increased 8 percentage points to 59.6%, mainly reflecting a more favorable foreign exchange rate, value-selling efforts and cost improvement, partially offset by lower capacity utilization. Thanks to better operating leverage, operating margin increased 8.6 percentage points to 49.5%. Overall, full year EPS increased 70.4% to TWD39.2 and ROE was 39.8%. On cash flow, we spent $36.3 billion or TWD1.1 trillion in CapEx. We generated TWD1.6 trillion in operating cash flow and TWD528 billion in free cash flow. We also paid TWD285 billion in cash dividends in 2022, up from TWD266 billion in 2021. I have finished my financial summary. Now, letâs turn to our current quarter guidance. As overall macroeconomic conditions remain weak, we expect our business to be further impacted by continued end market demand softness and customersâ further inventory adjustment. Based on the current business outlook, we expect our first quarter revenue to be between $16.7 billion and $17.5 billion, representing a 14.2% sequential decline at the midpoint. Based on the exchange rate assumption of $1 to TWD30.7, gross margin is expected to be between 53.5% and 55.5%, operating margin between 41.5% and 43.5%. Starting in 2023, certain tax exemptions from the Taiwan government have expired. However, the government has recently passed the amendments to the statute for industrial innovations. All things considered, we expect our effective tax rate in 2023 and beyond to be approximately 15%. This concludes my financial presentation. Now let me turn to our key messages. I will start by making some comments on our fourth quarter â22 and first quarter â23 profitability. Compared to third quarter, our fourth quarter gross margin increased by 180 basis points sequentially to 62.2%, of which 140 basis points was contributed by a more favorable foreign exchange rate. Meanwhile, cost improvement efforts also helped offset the impact from lower capacity utilization. Compared to our fourth quarter guidance, our actual gross margin exceeded the high-end of the range provided 3 months ago, mainly due to cost improvement efforts. We have just guided our first quarter gross margin to be 54.5% at the midpoint mainly due to a lower capacity utilization rate as customers further adjust their inventory levels and a less favorable foreign exchange rate. In 2023, our gross margin faces challenges from lower capacity utilization due to semiconductor cyclicality, the ramp-up of entry, overseas fab expansion and inflationary cost. In addition, R&D expenses accounted for 7.2% of our net revenue in 2022. In 2023, we as we increase our focus on technology development and add more resources, we expect R&D expenses to increase by about 20% year-on-year and account for 8% to 8.5% of our net revenue. To manage our profitability in 2023, we will work diligently on internal cost improvement efforts while continuing to strategically and consistently sell our value. Excluding the impact of foreign exchange rate, we continue to forecast a long-term gross margin of 53% and higher is achievable. Next, let me talk about our 2023 capital budget and depreciation. Every year, our CapEx is spent in anticipation of the growth that will follow in future years. As I have stated before, given the near-term uncertainties, we continue to manage our business prudently and tighten up our capital spending where appropriate. That said, our commitment to support customersâ structural growth remains unchanged and our disciplined CapEx and capacity planning remains based on the long-term market demand profile. In 2022, we spent $36.3 billion to capture the structural demand and support our customersâ growth. In 2023, our capital budget is expected to be between $32 billion and $36 billion. Out of the $32 billion to $36 billion CapEx for 2023, about 70% will be allocated for advanced process technologies, about 20% will be spent for specialty technologies, and about 10% will be spent for advanced packaging, mass making and others. Our depreciation expense is expected to increase by approximately 30% year-over-year in 2023 mainly as we ramp our 3-nanometer technologies. With this level of CapEx spending in 2023, we reiterate that TSMC remains committed to sustainable cash dividends on both an annual and quarterly basis. We will continue to work closely with our customers to plan our long-term capacity and invest in leading-edge and specialty technologies to support their growth while delivering profitable growth to our shareholders. Concluding 2022, the semiconductor industry growth excluding memory, was about 10%, while foundry industry increased about 27% year-over-year. TSMCâs revenue grew $33.5 million year-over-year in U.S. dollar terms. Our business was supported by our strong technology leadership and differentiation, even as our semiconductor inventory correction began to dampen the momentum in second half 2022. Entering 2023, we continue to observe softness in consumer end market segment, while other end market segments such as data center related have softened as well. As customers and the supply chain continue to take action, we forecast a semiconductor supply chain inventory, while reduced sharply through first half 2023, to rebalance to a healthier level. In the first half of 2023, we expect our revenue to decline mid to high single-digit percent over the same period last year in U.S. dollar terms. Having said that, we also start to observe some initial signs of demand stabilization and we will watch closely for more signals. We forecast the semiconductor cycle to bottom sometimes in first half 2023 and to see a healthy recovery in second half this year. In the second half of 2023, we expect our revenue to increase over the same period last year in U.S. dollar terms. For the full year of 2023, we forecast the semiconductor market, excluding memory, to decline approximately 4%, while foundry industry is forecast to decline 3%. For TSMC, supported by our strong technology leadership and differentiation, we will continue to expand our customer product portfolio and increase our addressable market and we expect 2023 to be a slight growth year for TSMC in U.S. data terms. Next, let me talk about the N7, N6 demand outlook. 3 months ago, we set our N7, N6 capacity utilization in first half â23 will not be as high as it has been in the past 3 years due to end market weakness in smartphone and PCs and customerâs product schedule delay. Since then, the end market demand for smartphone and PCs has further weakened and the capacity utilization of N7, N6 is lower than our expectation 3 months ago. We expect this to persist through first half â23 as our semiconductor supply chain inventory takes a few quarters to rebalance to a healthier level and we expect a mild pickup in our N7, N6 demand in second half 2013 than our prior expectation. However, we continue to believe N7, N6 demand is more a cyclical issue rather than structural. We are working closely with our customers to develop specialty and differentiated technologies to drive additional wave of structural demand from consumer, RF, connectivity and other applications to backfill our N7, N6 capacity over the next several years. Thus, we are confident our 7-nanometer family will continue to be a large and long-lasting node for TSMC. Now, I will talk about our N3 and N3E status. Our N3 has successfully entered volume production in late fourth quarter last year as planned with good yield. We expect a smooth ramp in 2023 driven by both HPC and smartphone applications. As our customersâ demand for N3 exceeds our ability to supply, we expect the N3 to be fully utilized in 2023. Sizable N3 revenue contribution, we expect to start in third quarter â23 and N3 will contribute mid single-digit percentage of our total wafer revenue in 2023. We expect the N3 revenue in 2023 to be higher than N5 revenue in its fourth year in 2020. N3E will further extend our N3 family with enhanced performance, power and yield and offer complete platform support for both smartphone and HPC applications. Volume production is scheduled for second half â23. Despite the ongoing inventory correction, we continue to observe a high level of customer engagement at both the N3 and N3E with a number of tape-outs more than 2x that of N5 in its first and second year. Our 3-nanometer technology is the most advanced semiconductor technology in both PPA and transistor technology, thus, we expect customers a strong demand in 2023, 2024, 2025 and beyond for our 3-nanometer technologies and are confident that our N3 family will be another large and non-large node for TSMC. Finally, let me talk about our plans to expand TSMCâs global manufacturing footprint to increase customersâ trust and expand our future growth potential. TSMC submission is to be trusted technology and capacity provider for the global IC, logic IC industry for years to come. Our job is to provide the optimal solutions for our customers to enable their success, this including technology leadership, manufacturing, cost, trust and recently also including more geographic manufacturing flexibility. Based on customersâ request, we are increasing our capacity outside of Taiwan to continue to provide our customers the optimal solution they need to be successful. TSMCâs decisions are based on our customersâ need and the necessary level of government support. This is to maximize the value for our shareholders. Our decisions are also based on the talent pool, land, electricity and water needs for TSMCâs long-term growth. In the U.S., we are in the process of building two advanced semiconductor fabs in Arizona. Our U.S. customers welcome us to build capacity in the U.S. to support their needs and have placed their strong commitment and support. We had an opening ceremony on December 6 last year to celebrate the arrival of the fourth batch of state-of-the-art semiconductor manufacturing equipment and Fab 1 is on track to begin production of N4 process technology in 2024. We also announced the construction of a second fab, which is scheduled to begin production of 3-nanometer process technology in 2026. TSMC Arizona will continue to provide the most advanced semiconductor technology commercially available in the U.S., enabling next-generation, high-performance and low-power computing products in the future years. Each of our fab will have a clean-room area that is approximately double the size of a typical logic fab. We will also consider building additional mature node capacity outside of Taiwan. In Japan, we are building a specialty technology fab, which will utilize 12 and 16-nanometer and 22, 28-process technologies. Volume production is scheduled for late 2024. We are also considering building a second fab in Japan as long as the demand from customers and the level of government support makes sense. In Europe, we are engaging with customers and partners to evaluate the possibility of building a specialty fab, focusing on automotive-specific technologies based on the demand from customers and level of government support. In China, we expand 28-nanometer in Nanjing as planned to support local customers and we continue to follow all the rules and regulation fully. At the same time, we continue to invest in Taiwan and expand our capacity to support our customerâs growth. Our N3 has just entered volume production in Tainan Science Park. We are also preparing for N2 volume production starting in 2025, which will be located in Chengdu and Taichung Science Park. While capacity is not born overnight and takes time to build, we are committed to expanding our global manufacturing footprint to increase customer trust and expand our future growth potential. Depending on the demand from customers and level of government support, our 28-nanometer and below overseas capacity could be 20% or more of our total 28 and below capacity in 5 years or more time. While initial cost of overseas fab are higher than TSMC software in Taiwan, our goal is â and minimize the cost gap. Our pricing will remain strategic to reflect our value, which also including the value of geographic flexibility. At the same time, we are leveraging our competitive advantage of lost volume, economies of scale and manufacturing technology leadership to continuously drive cost down. We will also continue to work closely with our government to secure their support. By taking such actions, TSMC will have the ability to absorb the higher cost of overseas fabs while remaining the most efficient and cost effective manufacturer, no matter where we operate. Even we increased our capacity outside of Taiwan, we believe long-term gross margin of 53% and higher continue to be achievable and we can earn a sustainable and healthy ROE of greater than 25%, while delivering profitable growth for our shareholders. This concluding our key message. Thank you for your attention. Thank you, C. C. This concludes our prepared remarks. [Operator Instructions] Now we will begin the Q&A session. Our Chairman, Dr. Mark Liu, will be the host. Hello, everyone. Itâs good to meet every one of you online again. At the beginning of the year, I wish you all stay healthy and have a happy new year. Now, letâs have answer your question. Okay. Yes, thank you. I wanted to ask the first question just about the rising investment costs and also the cost differential with the U.S. Just based on the two press releases, the Taiwan fab, you cited Fab 18, about $60 billion investment for eight phases, which would be, I estimate about 200,000 capacity, thatâs about $300 million per thousand wafer. The Arizona fab was $40 billion for about 50,000, $800 million per thousand wafers. So, just two questions on it. If you could maybe discuss a bit more if there is differences in those releases on the investment in calculation and a bit more color on the relative costs since you did the U.S. expansion? And then the second part of the question is, is the cost seeing a significant acceleration? Itâs been rising with each new node. But are you seeing an accelerating pace as you move through 3 and 2-nanometer? Okay. Randy, thank you. Please allow me to summarize your question. So Randyâs first question is he wants to understand, I think, heâs referring, I think, to our press release when we â about N3 in Tainan and the total investment there, and how does that compare to our announcement of the investment in Arizona for two phases. Randy, if I got you correctly, basically what Randy is asking is, what is the cost in the U.S. seem much higher in terms of the investment? So what is driving this big difference or a gap, so to speak. Thatâs the first part of your question, right, Randy. Okay. So thatâs the first part. Okay. Hi, Randy, this is Wendell. Let me share with you this. The Arizona fab, we make the decision based on customersâ request. And so weâre planning on building the two fabs, one N5, actually N4 and the other one N3. Weâre not able to share with you a specific cost gap number between Taiwan and U.S., but we can share with you that the major reason for the cost gap is the construction cost of building and facilities, which can be 4 to 5x greater for U.S. fab versus a fab in Taiwan. The high cost of construction includes labor cost, cost of permits, cost of occupational safety and health regulations, inflationary costs in recent years and people and learning curve costs. Therefore, the initial cost of overseas fabs are higher than our fabs in Taiwan. And I think the second part of Randyâs question was about the â how do we see the CapEx per K as we go from, I guess, Randy, youâre asking N5, N3 and 2. Right. Randy, weâre not able to disclose the specific CapEx per K for each node, but certainly, the CapEx is, K is more expensive for a new node as the process capacity increases. Okay? Okay. And the second question, just on actually two areas that came up in the remarks. The R&D, the over 20% increase. If you could give a feel like whatâs mainly driving that additional step up, is it the development cost for the new nodes, the packaging? Or is it some now expanding R&D into new geographic areas? And if I can fit in the second part, just the tax rate, Taiwan was hyping a pretty big program of CapEx and R&D, but tax breaks, but your tax rate is going up from 11% to 15%. Is that alternative minimum tax or global tax? Just want to understand why not any benefit from that? Okay. So Randyâs second question, I guess, is sort of two parts financial related. First, we â our CFO said, our R&D spending will increase about 20% year-on-year. So Randy wants to know what is driving behind that? Is it customer going overseas? Is it more technology development as a technology leader, etcetera? And then the second part, he wants to understand the guidance of effective tax rate of 15% given the recent legislation passed in Taiwan. Why is it not lower? Okay. Randy, for the first question, weâre the technology leader, and we intend to continue to maintain the leadership. Therefore, we are devoting more and more resources in R&D, including people and other kind of resource. Thatâs the reason why our R&D expense will increase in 2023 and probably beyond. The other thing about tax in 2023, part of the tax exemptions â or incentives in Taiwan have expired. Without the new amendments to this industrial innovation, the statute of industrial innovation, our tax rate would have become between 18% to 19%. With this new amendment, our tax rates will drop to about 15%. Yes, that does, I mean this mid-term R&D do you think the rate stays at this level or could go up one more? Thatâs my final one. Thank you. From what we are seeing at this moment, we expect the R&D to revenue ratio to be between 8% to 8.5% in the next several years. Okay, thank you for taking my question. The first question is focused on the overseas capacity expansion. So I think you just mentioned that even though we cannot disclose it, but the cost is definitely higher for the overseas capacity, but the management believes that the margin will stay the same. So I mean â I think I asked this question back to 2019, the manager was talking about the pricing will be the same across the board regardless of geographical locations. So what has changed now? So with the different pricing, can we say the overseas capacity will generate a similar return on profitability throughout the cycle? So â or what is the benchmark youâre looking for when you set of the different pricing scheme? Okay. So Bruce from Goldman Sachs actually, his question is regarding â first question regarding overseas expansion. His question is we said overseas costs are higher, yet that â so his question is in regards to our pricing. Are we a higher price overseas? Or if itâs overall? And what is the benchmark that we use when we go overseas in terms of financial returns and price? Is that roughly correct, Bruce? Okay, Bruce, this is Wendell, weâre not able to comment on pricing details, but our pricing is always strategic and consistent to reflect our value. Now value to our customers as C. C. said in this statement includes technology leadership, manufacturing efficiency and quality, cost, trust and recently also includes more geographic manufacturing facilities. Therefore, our overall pricing will remain strategic to reflect our value, which includes the value of geographic flexibilities. Does that answer your question? Well, to some extent. Let me ask the question in different ways is that we do understand it will reflect TSMCâs value, i.e., geographical location is a bad, but at the end of the day, itâs a cost plus for everybody across the board. I mean, how confident that TSMC feels that the customers can swallow all the cost and the end customer with one of the costs, i.e., without triggering the potential wafer price inflation or semiconductor inflation at the end of the day with more and more global capacity for TSMC. Yes. Okay. Bruce, let me add that in C. C.âs statement, he also mentioned that we will â aside from selling our value, we will continue to drive down our cost, but also to leverage our competitive advantages of large volume, economy of scale and manufacturing technology leadership. And with all these actions plus the government support, we are able to absorb the higher cost of overseas fabs and maintain our long-term financial goals, gross margin of 53% and higher. Let me add some color. this is C. C. Wei. Actually, in our view, the semiconductor becomes more essential and more pervasive in peopleâs life. And the semiconductor industry value in the supply chain is increasing. And if we look at our customersâ performance, they are rising structural gross margin over the past 5 to 6 years, it continued to improve. That reflects what I just said, the semiconductor value has been recognized and also very important in our daily life. And so we set up our pricing strategy to reflect all the values we share to customer and customer also in the value from the end market. Yes, please. The second question is for the N7. I think we spent some time for 7-nanometer, which is more cyclical. I think after 3 months, I think the correction is even bigger. So how â can you share us the full year outlook for 7-nanometer? When we can expect the customer or the 7-nanometer capacity return to normal back to like fully utilized? Or can we avoid the same cyclical symptom in 5-nanometer and 3-nanometer in 2, 3 years from now? Okay. So Bruceâs second question was on 7-nanometer. So his question is 7-nanometer seems to have deteriorated versus 3 months ago. So what is our view? Can it fully recover in this year? And then I think, Bruce, the second part of your question is also how can we avoid the same cyclical systems at other nodes in the future. Is that correct? So I answer this one? First, N7 most of business for TSMC in the last 2 years is from the PC and smartphone. And that happened to correct â or let me say that inventory correct happened to be the most severe one. And so the end market dropped most severely generally thought. In fact, the unit will not increase, but the content will be increased, so is demand be more softened than we thought 3 months ago? Why be repeated at 5 or 3? Cyclicality of the semiconductor always exist, but itâs unlikely this time the scenario was to be repeated because our current downturn actually, itâs kind of being enhanced or being degraded by the pandemic. Due to the pandemic, the digital transformation progress have been enhanced. And so the demand being increased dramatically. But then due to the pandemic, the supply chain disruption happened. And people during this time, probably changed their strategy or their thoughts on the inventory buildup. So artificially, the inventory has been built up quickly and dramatically. And then the response to the each industry are different. And so they manage the inventory correction also differently. This kind of phenomenon all because of â largely because of pandemic, and we donât think that it will happen again. And in the next 5-nanometer, 3-nanometer, I believe TSMC and TSMCâs customer will be more prudent on planning that what is the demand and also the supply. Yes, let me follow-up a little bit. I mean C. C. just mentioned external factors, right? So what did TSMC do to avoid the same thing for 5 and 3 in the future for someone like if you are cutting your capacity plan into a more conservative way or something like that? Is that something we should expect in future nodes? So Bruce is asking sort of a follow-on. So then with 7-nanometer, how do we avoid the same thing happening at 5 or 3 in the future? Will we cut our capacity? How do we change our capacity planning and build to avoid a similar situation? Bruce, this is a very good question. Actually, let me share with you how we deal with it. In fact, between the N5, N3, the technology node our capacity buildup and with a lot of tools that can be company used by these two nodes. So in fact, for TSMC to build capacity, we put N5, N3 and maybe in the future N2 as a total picture to look at it. And we will keep our flexibility to create or to adjust for the future. So we will be better prepared. Thatâs what I can tell you. Hey, thanks. Happy new year. And let me take my first question on the near-term 2023. So you mentioned first half, we have seen a worse kind of environment compared to 3 months back. Is it mainly HPC data center that has seen further reduction? Or are we seeing it across the board, including smartphone for first half? And also on second half, just putting in rough numbers on your guidance, looks like we are looking for a pretty sharp rebound in second half of 2023, something like 25% to 30% second half versus first half of this year. Could we have some more color on what is that gives you the confidence for such a strong rebound in the second half of the year to get us back to like a flattish revenue growth for the year? Okay. So Gokulâs first question is on the near-term outlook. He wants to understand first half, we said the inventory correction in sharper. So he wants to understand what are we seeing in different end market segments? Is the sharper correction driven by data center? Is it smartphone PC? What are we seeing across the different segments first? Well, let me answer the question. The inventory correction actually began last year. And at the peak of the third quarter, and we think the inventory has been picked in third quarter last year and gradually reduced in the fourth quarter, and we did see some inventory reduced sharply recently, and it will continue to be so to first half of this year. So thatâs why we say we have confidence that in the second half, the business will rebound. But is that a very strong V shape? We didnât know yet, but certainly, itâs not a U shape for the business to recover in the second half. Okay. I think N3 is clearly one part of that ramp. But is there anything else that is â that you are already seeing that strong confidence for the second half rebound in addition to the N3 ramp-up? Sorry. So Gokul is asking sort of in terms of second half, why can TSMCâs business be better than the overall industry besides N3. Are there any other factors when you think about technology leadership? Gokul, you are right. enters a ramp-up here of the business to rebound, and also actually, let me share with you some of the HPC customer. Also, I have a new product launch in the second half, especially in the AI area or in computing area. Did that answer your question? Yes, thank you. My second question is on CapEx and capital intensity. CapEx, we are taking it down a notch for this year given the downturn, I guess, and some conservatism. Are we already seeing the peak in CapEx intensity in the cycle? Or we are likely to given the plans in Europe plans to expand more capacity in U.S.? Are we likely to see higher CapEx intensity in the out years as well? Okay. Sorry. Is that your okay, Gokul. I think I got the gist of your question. So Gokulâs second question is on CapEx and capital intensity. He notes this year, we have guided 32% to 36% given sort of some tightening up and such. So his question is â does this represent, have we already seen or past the peak in terms of our capital intensity this cycle, or as we may continue to evaluate and expand overseas and such? Will there be another step-up in our capital intensity? Okay. Gokul, this is Wendell. As we said before, we invest the CapEx this year for the growth in the future years. So we also said earlier that we are tightening up the spending where appropriate. But as long as we believe the growth opportunity is there, we will continue to invest. Now weâve given the guidance for this year, so you can calculate the capital intensity. It will be over 40%. From what we are able to see at this moment, several years down the road, weâre seeing the CapEx intensity to be between mid to high 30s. Thatâs the current view. Thanks for taking my questions, gentlemen. So first of all, a question to C. C. And so thanks for your sharing during the [indiscernible] association, presentation on semiconductor challenge was pretty insightful. So my question is that you mentioned during your speech saying that the biggest change for semiconductor cost is getting higher, better long so-called [indiscernible] supply chain. So I wanted to ask C. C., whatâs the true value add of worth low going forward becomes much more expensive and whether you really see that customers can continue to expand our gross margin and create value to this world. So this is my first question. Thank you. Okay. So Charlieâs first question is around technology. He notes that the cost, I guess, and cost per transistor is getting higher and overall global costs are increasing as well. So his question is, what is the value or is there still value in the so-called Mooreâs Law going forward? How does TSMC view this issue? Well, Charlie, let me share with you, nowadays, we look at our technologies value not only geometries shrinkage actually. More important actually is the power consumption efficiency. And also, we try to help our customers with our advanced 3D IC Fabric technology to improve the system performance, and thatâs where itâs important. In the future, we want the world to be more greener more safer, better. So power consumption needs become very, very important. And while we still improve the system performance and thatâs where our customer can get their value. And thatâs what we view in the future. Thank you. Thanks for the explanation. So the follow-up to that is that we noticed that for your major smartphone SoC customers, they seem to slow down the migration to the newer nodes, right, or so-called bifurcation for their new SoC adoption. So do you think for mobile computing, particularly do you think a value-add is diminishing based on what you just said. And also another structural trend we are seeing is about the cost of chip by ASIC in HPC segment. So can management talk about that part of business, meaning the ASIC design themselves of total revenue contribution in HPC and the growth rate of the 8-figure business? Thank you. Okay. So Charlie, Iâm going to interpret. So he has a follow-up to his first question and then his second question. So the follow-up to his first question is then in terms of going back to cost again, do we see any sign of slowdown in smartphone SoC migration at the leading node. Thatâs his follow-up. And then his second question is then do we see more companies designing ASICs? And can we disclose the revenue contribution from such customers? Correct, Charlie? Okay. Charlie, let me answer your question. In fact, we do not see any slowdown on our customer to adopt the TSMCâs leading-edge technology. Actually, they might have a different kind of product schedule. They might have a different kind of product plan and etcetera. But the technology adoption, actually, it did not slow down. Thatâs my answer to your first follow-up question. And the whether that some kind of customer, some of the hyperscale customers want to develop their own chip. Yes, but I cannot give you more information than that. However, I can tell you that they also look at compute for their own business, the positioning for the opportunity actually increase our opportunity. And that requires TSMC is a leading-edge technology. So we do have quite a few hyperscale customers working with TSMC to develop their own chips. And would that cannibalize your merchant business, for example, those on change CPU, GPU are they going to be replaced or impacted by those custom design growth? If I may? Okay. Last question, Charlie is asking then his concern is that any hyperscalers are developing will that cannibalize business for other types of companies? I cannot comment, but I donât think so. They also developed the specific purpose for own I mean itâs not a kind of to replace, generalize the purpose of CPU, GPU, all those kind of things. And I think also for TSMC, weâre happy to work with all types of customers, whatever type they may be. Okay, thank you, Charlie. Letâs move on to the next participant. Sure. Thank you. Good afternoon. Thank you for taking my questions. So my first question is on the SoC ramp up and so if we look at the share revenue could be higher than 5-nanometer for the first year. But if we look at the sales contribution as a percentage of total sales, itâs actually a bit lower. And so I wonder for this year, perhaps there is some market issue. But looking into 2024 and 2025 based on your current customer engagement, should we model a faster ramp up into 2024 or 2025 or its overall ramp-up could be slower because of maybe customer schedule issues or planning? And if we think about the peak revenue contribution for 3-nanometer over time, do you think you will be able to reach 30% range, as N5 and N7. Thatâs the first question. Thank you. Okay. Sunnyâs first question is on 3-nanometer. She notes 3-nanometer revenue is greater than 5-nanometer in its first year, but the revenue percentage contribution of mid-single digit is smaller or lower. So sheâs wondering why is that. Is it because the market slowed down? Is it less customer adoption and interest? What is the reason behind that? And does that mean what is our expectation for that ramp to continue? [Technical Difficulty] N3, N3E the number of tape-outs more than double that N5 in the first and the second year. So as a result, we expect the strong demand will continue in 2023, â24, â25 and beyond, for our N3 technologies driven by both the HPC and smartphone applications. Too early to talk about that N3, but we continue to believe that it will be a large and long-lasting node for us. Got it. Thank you. My second question is a quick one. And so, for you to growth by [indiscernible] share, just wonder what kind of industry growth are you assuming for the major end markets, including smartphone, PC, server, automotive? Okay. Sunny, second question is TSMC. We have said we will grow â have slight growth year-on-year in U.S. dollar terms this year. Her question is what are we assuming for the end market growth in areas like smartphones, PCs, automotive and others? Well, let me answer the question, Sunny. What do we look at in 2023, actually, we look at smartphone and PC unit, we think thereâs a little bit drop in terms of units. And the content will continue to increase. And for TSMC, actually, we increased our product portfolio. We also extend our market segment â available market segment to TSMC, so thatâs why we expect the whole industry to drop slightly and TSMC still grow slightly. Sunny, did that⦠Sorry. Yes. So, just a quick follow-up on server and automotive. So, any expectations on server units for this year? And for auto, I think October earnings call, you mentioned there could be some slowdown going to first half of the year. Have you started to see the deceleration? Thatâs all my questions. Thank you very much. Okay. So, Sunny also wants to know what is our forecast for server units, automotive units, and then we said in October, three months ago, we said automotive demand was holding steady. What is the case now? Well, the automotive demand continued to be very tight. I meant that â I mean demand continued to increase actually. And today, we are still probably not 100% supply enough wafers to them. But itâs improving, and we expect the automotive to â the shortage to be relaxed quickly. And the units, for the units to grow, we expect the automotive to grow this year, but thatâs OEM stuff. Hello. Hi. Thank you very much for taking my questions. My first question is also about the overseas expansion. Like C. C. mentioned that the overseas more advanced than 20-nanometer, we account for 20% in the longer term perspective. And also, we are expanding more in the advancement in the U.S. I am just wondering that will you also expand more like second or the advanced packaging, along with your advanced now say like 5-nanometer or 3-nanometer in Arizona as well. Okay. So, Lauraâs first question is actually, C. C. said the 20-nanometer below capacity could be 20% and more in several yearsâ time depending on customer demand and government support. But her question is, would we consider expanding advanced packaging overseas as well? Well, today, we actually donât have a plan, but we do not rule out the possibility because the back end is a part of the total wafer service for our customer, okay. Okay. Got it. And because we see that a lot of advanced now used for the high-computing PC, so along with that kind of application, we see now TSMC is very to that both 3D IC or the advanced packaging. So, I am just wondering that longer term perspective, whether that is also the direction in the U.S. So, I think what Laura is saying because, of course, that TSMC 3D IC solutions leading and HPC adoption is strong. So, with advanced technologies, will there be a need to build or have packaging in the U.S. as we move advanced technology portion to the U.S.? Sure. Thank you very much. And my second question is about the gain around roadmap. Can you give us more color on the current progress? We know that we have the schedule to ramping up in 2025 versus the EUV, the high-voltage equipment will probably only ready then. Do you think that could be any like potential pushback to like a 2026 onward? Okay. So, Lauraâs second question is on the nanosheet transistor structure. She wants to know what is the progress for TSMC as we are adopting nanosheet structure at our N2. Will this be impacted or pushed out by the availability of things such as, I think you are asking high NA, Laura and things like that, correct? Okay. Actually, our N2 technology development is on track, actually is better than what we thought. We have very good progress recently, and our risk production will be in 2024 and volume production in 2025. The schedule is not changed if we donât put it in, but so far so good, let me assure you that. Yes. Thank you for taking my question. I had a question on your 2023 CapEx budget and your fab build-out plan. You, earlier on in the conference call, you talked about the build-out cost of hats in the U.S. being 5x higher versus Taiwan. And in that context, I was wondering if you could talk about the share of CapEx spending that you expect to go towards that build-out versus equipment this year versus last year? Will the larger share of CapEx go to those fab build-outs and if so, how much more? Thank you. Okay. Sorry. Rolf, let me try to summarize your first question. His first question is on our CapEx in 2023, and our fab build-out plans. I believe Rolf, you are referring to fab build-out plans overseas, correct? Yes, exactly. What I am trying to understand is if I think about your CapEx such as for this year versus last year, what share will go towards infrastructure of that build-out, what percentage will go to equipment roughly? Okay. So, Rolf wants to know for our CapEx, how much is going to building and facilities, how much is your tools? Rolf, I want to make one correction when our CFO said that the, when you refer to 5x greater, I think our CFO was saying the construction costs are 4x to 5x higher, not the CapEx cost, but nonetheless, Rolf is asking for a breakout, of the CapEx? Well, Rolf, we provide the breakdown of CapEx per year, advanced versus specialty technology, but we do not provide the breakdown between tools and constructions. But as I have said, in the U.S., the construction of building and facilities is probably 5x that of Taiwan. And it lasts for a few years, right. Okay. Thank you very much. Yes, as the second question. Could you talk about the growth that you achieved in your Advanced Packaging segment in 2022? And what growth you are expecting in 2023? And in particular, could you talk about your SoIC products and whether interest in those products is accelerating? Thank you. Okay. Thank you, Rolf. So, Rolfâs second question is on the advanced packaging business. What was the growth in advanced packaging last year? And what do we expect the growth to be this year? And then also more specifically in terms of our SoIC technology, what is the outlook or the momentum there? Okay. Rolf, this is Wendell again. In 2022, our advanced packaging grew at a similar rate to our corporate rate. So, it accounted for about 7% of our total revenue in 2022. And we think that in this year, the growth will be also similar pretty â well, slightly lower than the corporate, it will be probably flattish for the back end. Thank you. In the interest of time, maybe we will take questions from the last three participants. Operator, can we move on to the next participant, please. Okay. Thank you for taking my question. I just want to ask a little bit about the 20% R&D expense step-up in this year. Can you provide a little bit more detail what the incremental R&D expenses are going to be directed at? Well, for one thing, if I understand correctly, your N3 R&D team are going to move on to the N+2 [ph] node if we are seeing nanometers current end node, or is there any other incremental R&D spending this year you are expecting to be around design enablement of as packaging, specialty technology. Can you kind of give us a sense where the big step-up is coming from? Thank you. Okay. So, Charles first question is on R&D. He wants to understand or actually more details in terms of the 20% approximately year-on-year increase. What is driving â or the R&D spending going to be focused on? Is it N3? Is it N2? Is it design enablement by specific breakdown? Charles, let me answer your question. All your comments are correct. I mean that is because of a newer technology like N2, N1.4 and also a lot of new teams are more expensive than before. And actually, the technology complexity continued to increase exponentially. So, thatâs why we spend much more R&D budget. We want to continue to be number one in the world. So, we continue to invest including the geometric shrinkage, including the new transistor architecture, including the design enablement and including buying the new equipment that all is. Yes, I do. Maybe a second question, I want to ask about specialty technology. Obviously, you expect specialty technology to backfill your 7-nanometer fabs. I think this may be a more common knowledge inside the industry, but I recently spoke to some of your customers who are more on the analog mixed signal side. A lot of them are, I mean driving volumes more from 28-nanometer and above, and they could tell me that the benefit of going to 14-nanometer, 16-nanometer for 7-nanometer is there, but itâs not large as in the past, moving node-to-node. And at the same time, the cost is much higher, and I look at your technology roadmap, specialty technology roadmap, it does seems to me that the specialty technology platforms are not as broad at the 7-nanometer if I compare with the 28-nanometer and above. I just want to get some insights from you. How do you think about the progression of specialty technology going forward, as it seems to me that itâs kind of slowing down a little bit more slowing a little bit down faster for the analog mixed signal customers? Thank you. Charlesâ second question is on specialty technology. His observation is that the technology, specialty technology portfolio at 7-nanometer seems not as broad as prior nodes and that the â his question is, do we see the slowing scaling of analog and mixed signal areas in terms of the specialty technology development and moving down to lower nodes or more advanced nodes? Charles, your observation is quite good. Actually, you are right. But then let me share with you a little bit more detail inside. Actually, you are right, for the analog portion or mixed signal portion, we do not need to really move into 7-nanometer or more ones now. But as time goes by, now is more and more computing functionality needed to be added into the product. Let me share with you that one thing like the WiFi, you need a really very high speed to move to the next generation and also the RF. For those kind of things, you need a very high-performance of the computing together with low-power consumption. It is important. And if you want to get the lower power consumption, the only the leading-edge node can give you that kind of opportunities, all the footprint stays the same. Then if you want to have a higher functionality with a lower power consumption, thatâs where you have to move into the 7-nanometer or more end node even with the analog product. Did that answer your question? Yes. So, I think this is about the reason that you feel so quite comfortable about 7-nanometer utilization will come back. You said it will mildly come back a little bit in â23, but you are still confident â24 and forward that the 7-nanometer will also be a very, very long-lasting node for you. Hi. Happy New Year. Thank you for taking my question. I have two questions. One is on the globalization challenge and the other on the mature nodes. So, first of all, we know TSMC is excellent in managing the supply chain and the cluster in Taiwan. However, when we now expand Japan and U.S. footprint with the last of the cluster there, would management please share with us why the strategy is to maintain the strong efficiency and the excellence that TSMC has been delivering? Thank you. Okay. Bradâs first question is on our global footprint. He notes that TSMC has done a good job in terms of supply chain and cluster management. But as we go overseas to U.S. and Japan, how will we continue to ensure that we do a good job? Alright. Okay, let me answer. I think Wendell has answered this question earlier, let me summarize a little bit. TSMC is a service business, not in just pure production. The service depends on the trust from the customers. So, in the past, our trust and service depends on our technology leadership, manufacturing excellence and the lowest cost and quality. But recently, the geopolitical development is evolving just in front of us. That 100% in one place cannot suffice our customersâ needs. Therefore, we started the overall global footprint planning. Now of course, the cost will be higher. And I think our team has been focused on how do we do this at the same time, keep our minimum gross margin to be 53% and above. And that is the standard that we decide how the pace of our global expansion going to be, and there are other segments in terms of the space, of course. The global expansion increased the value to our customers and the new geopolitical environment. And therefore, the pricing, how the customer can shoulder the increased cost in terms of pricing. And of course, the â geopolitically, the semiconductor in the U.S. and Japan are all new. So, I believe we are working hard on how to reduce the cost by building up the semiconductor supply ecosystem in U.S. and Japan. And I think indeed, both governments echo are â not just us, also rather other major companies to build a similar capacity in this place to reduce the costs. So, that is the general arrangement we are planning. There is no fixed rate. Of course, the government support will be another factor. And so that is, we are cautiously step-by-step to make sure our shareholdersâ value still be kept. Yes. Thank you very much for that juncture. So, my second question is on the three node. And there will be no mature node is investing and generates pretty good progress with TSMC technology leadership. So, while we are expanding overseas, what is the strategy for mature node in the long run, especially China expansion baked by â also by the government subsidies? And also R&D is quite valuable for TSMC. And should we continue to allocate the R&D to mature node when maintaining group pace in testing adds [ph] and advanced packaging? Thank you. Okay. So, Brad, second question, I think maybe to summarize this more on the mature nodes. So, he wants to better understand our strategy on the mature nodes. As we expand our manufacturing footprint and increase capacity outside of Taiwan, what is our strategy for mature nodes? Will we bring mature nodes overseas? What is the product status in China? How are we allocating R&D resources to mature nodes already specialty technology strategies, etcetera? Well, actually, our mature node capacity strategy is very simple. We develop differentiated specialty technology for our customer. In fact, we are working with customers and to define what they need and then what kind of technology that we need to develop. We donât add any commonly used the large technology per se, but we develop specialty and differentiated and for the long-term, structural market demand, and thatâs our current strategy. And because of that, of course, we put R&Dâs effort and resources to cooperate with our customer. And so we can generate profitability with reasonable utilization. Yes. Thanks for letting me ask the questions. I want to go back to gross margin. I am a little bit confused if you could clarify something. Your wafer shipment in Q4 declined and also FX actually strengthened by a little bit, which should be negative on gross margin. So your cost-cutting efforts must have been greatly exceeding these trends and I want to get a better feel for it, and I have a follow-up? Mehdiâs first question is on gross margin. He is â he notes wafer shipments declined sequentially in the fourth quarter. The â but with the foreign exchange movement, he notes itâs a negative for gross margin. So, he wants to â and then he wants to understand what is the magnitude or rate of cost improvement. Maybe our CFO can clarify some of these, particularly the FX. Right. Our fourth quarter gross margin is 180 basis points higher than that in the third quarter. Foreign exchange rate actually went towards our favor. The NT depreciated in the fourth quarter from TWD32 in the third quarter to TWD31, TWD39, so that gave us about 140 basis points of gross margin expansion. Now, the remaining one, there are cost improvement but offset by, as we said, lower wafer utilization. Okay. So, the volume helped. Now, if I just take your comment about the first half, declining 5% to 10% on a year-over-year basis, it does imply that there is a chance that revenues in Q2 would decline on a sequential basis. Would that also drive gross margin down on a sequential basis? Okay. So Mehdiâs second question is then we have noted, we did not say 5% to 10%, but our first half revenue will decline mid to high-single digit year-on-year. So, he wants to know does this mean that second quarter revenue will be down sequentially? And is there â does that mean that the gross margin will go below 53% or decline intoâ¦? Okay. Right. We give you the guidance, so you can really calculate yourself on the revenue growth on the second quarter. And itâs too early to talk about the gross margin in the second quarter and beyond. However, we can tell you that we work very diligently to make sure our gross â long-term gross margins of 53% and higher is achievable even in this year. Itâs too early to talk about that. But as I have said, we work very diligently to make sure this long-term gross margin target of 53% and above can be achievable, including this year. Alright. Thank you. Okay. This concludes our Q&A session. Before we conclude todayâs conference, please be advised that the replay of the conference will be accessible within 30 minutes from now. The transcript will be available 24 hours from now, both of which you can find and is available through TSMCâs website at www.tsmc.com. Thank you again for joining us today. We wish everyone a happy Lunar New Year and we hope you will join us again next quarter. Goodbye, and have a good day.
|
EarningCall_1193
|
Good morning, ladies and gentlemen, and welcome to the Celestica Q4 2022 Earnings Conference Call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded today, Thursday, January 26, 2023. Good morning, and thank you for joining us on Celesticaâs fourth quarter 2022 earnings conference call. On the call today are Rob Mionis, President and Chief Executive Officer; and Mandeep Chawla, Chief Financial Officer. As a reminder, during this call, we will make forward-looking statements within the meanings of the U.S. Private Securities Litigation Reform Act of 1995 and applicable Canadian Securities Laws. Such forward-looking statements are based on managementâs current expectations, forecasts and assumptions, which are subject to risks, uncertainties and other factors that could cause actual outcomes and results to differ materially from conclusions, forecasts or projections expressed in such statements. For identification and discussion of such factors and assumptions, as well as further information concerning forward-looking statements, please refer to yesterdayâs press release including the cautionary note regarding forward-looking statements therein, our most recent Annual Report on Form 20-F and our other public filings, which can be accessed at sec.gov and sedar.com. We assume no obligation to update any forward-looking statement except as required by law. In addition, during this call, we will refer to various non-IFRS financial measures including ratios based on non-IFRS financial measures, consisting of non-IFRS operating earnings, non-IFRS operating margin, adjusted gross margin, adjusted return on invested capital or adjusted ROIC, adjusted free cash flow, gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio, adjusted net earnings, adjusted earnings per share or adjusted EPS, adjusted SG&A expense, Lifecycle Solutions revenue, and adjusted effective tax rate. Listeners should be cautioned that references to any of the foregoing measures during this call denote non-IFRS financial measures, whether or not specifically designated as such. These non-IFRS financial measures do not have any standardized meanings prescribed by IFRS and may not be comparable to similar measures presented by other public companies that report under IFRS or who report under U.S. GAAP and use non-GAAP financial measures to describe similar operating metrics. We refer you to yesterdayâs press release and our Q4 2022 earnings presentation, which are available at celestica.com under the Investor Relations tab, for more information about these and certain other non-IFRS financial measures, including a reconciliation of historical non-IFRS financial measures to the most directly comparable IFRS financial measures from our financial statements. Unless otherwise specified, all references to dollars on this call are to U.S. dollars, and per share information is based on diluted shares outstanding. Thank you, Craig, and good morning, everyone, and thank you for joining us on today's call. Celestica had a strong fourth quarter as we continue to drive solid performance despite continuing challenges presented by the macro environment. Our fourth quarter revenue of $2.04 billion and non-IFRS adjusted EPS of $0.56 were both above the high-end of our guidance ranges. In addition, our fourth quarter non-IFRS operating margin and non-IFRS adjusted EPS were the highest in the company's history. 2022 was an extraordinary year for Celestica, where we achieved a number of important milestones. First, we returned to top line revenue growth on an annual basis for the first time since 2018, following the completion of a multiyear portfolio transformation initiative. Revenue grew 29% overall and 24% organically compared to 2021, as we surpassed $7 billion in annual revenue for the first time since 2011. Second, we recorded our highest ever annual non-IFRS operating margin of 4.9% reflecting our ability to win and deliver on higher value added programs in alignment with our strategy. And finally, we achieved our highest ever annual non-IFRS adjusted EPS of $1.90, a 46% improvement compared to 2021. Our Lifecycle Solutions portfolio continues to be the primary driver of our both in revenue and profitability, reflecting our strategic focus on high value markets, where we see the long term tailwinds supporting sustainable growth. Our Lifecycle Solutions portfolio now represents roughly two-thirds of our business achieving 39% year-over-year revenue growth as both our HPS business and our ATS segment recorded their highest revenues ever in 2022. Our ATS segment recorded 29% annual revenue growth coming in at approximately $3 billion in revenue in 2022. With our strategic diversification and exposure to markets with strong secular tailwinds, we expect strong growth fundamentals in ATS to continue in 2023. Our CCS segment also demonstrated substantial growth in 2022 recording 29% year-over-year revenue growth and segment margin of 5.1% the highest ever. Our strong CCS performance continues to be driven in large part by our HPS business, which achieved revenues of $1.83 billion in 2022, representing 59% year-over-year revenue growth. This growth has been supported by strong demand from our service provider customers for our differentiated offerings. We are confident that our strategic initiatives over the past several years focused on diversifying our business and growing our exposure to high value markets will help us sustain our trajectory of strong financial performance into 2023 and over the long term. Before I offer some additional color on the outlook for each of our markets, I would like to turn the call over to Mandeep, who will provide details on our financial performance in the fourth quarter, as well as our guidance for the first quarter of 2023. Thank you, Rob, and good morning, everyone. Fourth quarter revenue came in at $2.04 billion. This exceeded the high end of our guidance range and was 35% higher year-over-year, supported by revenue growth across each of our businesses. We achieved fourth quarter non-IFRS operating margin of 5.3%, 40 basis points higher year-over-year. The strong performance was driven in large part by record profitability in our CCS segment and represented the highest quarterly non-IFRS operating margin in the company's history. Non-IFRS adjusted earnings per share were $0.56 for the fourth quarter, above the high end of our guidance range and up $0.12 year-over-year, driven by higher volumes and improved mix. ATS segment revenue was up 30% year-over-year in the fourth quarter, higher than our expectations of a mid-20s percentage year-over-year increase. Year over year growth in ATS segment revenue was driven by the strong performance of our Industrial and A&D businesses, supported by solid demand, new program ramps and improved materials availability. ATS segment revenue accounted for 40% of total revenues in the fourth quarter. Our CCS segment delivered another quarter of robust growth with revenue up 39% year-over-year driven by outperformance in both our Communications and Enterprise end markets. Our HPS business continues to deliver strong results recording revenues of $491 million in the fourth quarter, up 40% year-over-year. The growth in HPS revenue was driven by market share gains and strong demand from our service provider customers, as they have continued to make significant investments in expanding data center capacity. HPS revenues were 24% of total company revenues in the fourth quarter up from 20% in 2021. Communications end market revenue was up 34% year-over-year just ahead of our expectations of a low-30s percentage increase, driven by program ramps in our HPS business and improved materials availability. Enterprise end market revenue in the quarter was up 49% year-over-year, well above our expectations of a mid-20s percentage increase, driven primarily by new RAC (ph) programs, increased demand in compute and improved materials availability. Turning to segment margins. ATS segment margin was 4.4% in the fourth quarter, 120 basis points lower year-over-year. The decline in segment margin was driven by late quarter demand shifts in capital equipment, compounded by a large number of ramping programs in Industrial, partially offset by sequential improvement in PCI. Our expectation is for ATS segment margins to expand in the coming quarters. CCS segment margin of 5.9% was up 150 basis points year-over-year. The increase was driven by strong HPS mix and operational productivity, driven by improved material flow, strong service billings and volume leverage. Moving on to some additional financial metrics. IFRS net earnings for the quarter were $42 million or $0.35 per share, compared to net earnings of $32 million or $0.26 per share in the same quarter last year. Adjusted gross margin for the fourth quarter was 9.4% down 20 basis points year-over-year, primarily due to higher variable compensation. Our non-IFRS adjusted effective tax rate for the fourth quarter was 22.7%. Non-IFRS adjusted ROIC was 20.7% for the fourth quarter, up 4.1% year-over-year and our highest results since 2017. Moving on to working capital. Our inventory at the end of the fourth quarter was $2.35 billion, up $24 million sequentially and up $653 million year-over-year. While the challenging supply chain environment has contributed and continues to contribute in driving up our inventory levels, a substantial portion of the increase is also attributable to our strong sales growth over the past two years. We continue to work collaboratively with our customers to help fund the growth in inventory as evidenced by over $800 million in customer cash deposits at the end of the fourth quarter, an increase of approximately $200 million sequentially and nearly $400 million year-over-year. When offsetting inventory by cash deposits, our inventory balance actually decreased by approximately $150 million compared to the previous quarter. Cash cycle days were 64 during the fourth quarter, one day higher than the third quarter and 11 days lower than the prior year period. We are also seeing continuing signs of supply chain constraints improving, with fewer material constraints compared to previous quarters and early signs of material lead times being reduced from record levels. While we remain diligent and proactive, we do expect to see improvements in working capital in 2023. Capital expenditures for the fourth quarter were $32 million, or approximately 1.6% of revenue compared with 1.1% in the fourth quarter of 2021. This increase was in line with our previously communicated expectations for slightly elevated investment in the back half of the year. The increased expenditures were primarily to fund investments in our Southeast Asia and Mexico facilities in support of new program wins. Non-IFRS adjusted free cash flow was $43 million in the fourth quarter compared to $36 million in the prior year period. Fiscal 2022 non-IFRS adjusted free cash flow totaled $94 million, ahead of our expectations due to strong working capital management. Our expectations are to achieve at least $100 million in non-IFRS adjusted free cash flow in 2023, consistent with our long term goal. Moving on to some additional key metrics. Our cash balance at the end of the year was $375 million, down $19 million year-over-year and up $12 million sequentially. Our cash balance in addition to our approximately $600 million of borrowing capacity under our revolver, provide us with liquidity of approximately $1 billion, which we believe is sufficient to meet our anticipated business needs. We ended the year with gross debt of $627 million down $20 million from the previous quarter, leaving us with a net debt position of $252 million. Our fourth quarter gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio was 1.3 turns, down 0.2 turns sequentially and down 0.7 turns compared to the same quarter of last year. At December 31, 2022 we were compliant with all financial covenants under our credit agreement. During the fourth quarter, we purchased approximately 1.2 million shares for cancellation at a cost of approximately $12 million. We repurchased a total of 3.4 million shares for $35 million for cancellation during 2022. In December of 2022, the TSX accepted our new NCIB program, which permits us to purchase up to 8.8 million shares over the next 12 months. Our return on capital strategy remains consistent as we aim to return 50% of our non-IFRS adjusted free cash flow to shareholders and reinvest 50% into the business over the long term. Now turning to our guidance for the first quarter of 2023. Our first quarter revenues are expected to be in the range of $1.725 billion to $1.875 billion. If the midpoint of this range is achieved, revenue will be up 15% year-over-year. First quarter, non-IFRS adjusted earnings per share are expected to be in the range of $0.41 to $0.47 per share. If the midpoint of our revenue and non-IFRS adjusted EPS guidance ranges are achieved. Non-IFRS operating margin will be approximately 5.0%, which will represent an increase of 60 basis points over the prior year period. Non-IFRS adjusted SG&A expense for the first quarter is expected to be in the range of $56 million to $58 million. We anticipate our non-IFRS adjusted effective tax rate to be approximately 21% for the first quarter, excluding any impact from taxable foreign exchange. Now turning to our end market outlook for the first quarter of 2023. In our ATS end markets, we anticipate revenue to be up in the low-single digit percentage range year-over-year, driven by double-digit growth in Industrial and A&D, partially offset by softer demand in capital equipment. In our CCS segment, we anticipate revenues in our communication end market to be up in the high-teens percentage range year-over-year, driven by continued strong demand from service provider customers, supported by our HPS offering. Finally, in our Enterprise end market, we anticipate revenue growth in the mid-30 percentage range year-over-year, supported by strong demand in compute. Thank you, Mandeep. After a banner year for Celestica in 2022, I'd like to start-off by reaffirming our outlook for 2023, which we shared during our October conference call. To reiterate, our 2023 outlook is for revenue of at least $7.5 billion, while we are targeting non-IFRS adjusted EPS in the range of $1.95 to $2.05. These results if achieved would represent improvements on a year in which the company achieved record financial results in the areas of revenue, non-IFRS operating margin and non-IFRS adjusted EPS. Our anticipated 2023 non-IFRS operating margin range is between 4.5% and 5.5% up 50 basis points from 2022. While the broad market continues to be dynamic, we are confident in our planning and execution as well as the resiliency of our diversified portfolio. We feel that our business is positioned to continue to outperform our broader markets and achieve strong financial results going forward. We are pleased that we are ahead of the non-IFRS adjusted EPS objectives we set in our March 2022 Investor Call, which was to grow non-IFRS adjusted EPS at 10% or more per year for 2022 through 2025. In 2022, we grew non-IFRS adjusted EPS substantially. And at the midpoint of the targeted range for 2023, our two year average annual growth rate would be 24% for 2022 and 2023. For 2024 through 2025, our average annual non-IFRS adjusted EPS growth rate objective continues to be 10% or more. To incentivize our continuing focus on driving profitable growth, we have restructured our long term incentive plan for senior executives by adding a non-IFRS adjusted EPS as a key performance measure. Now, I'd like to turn to our outlook for each of our businesses. 2022 was a great year for both ATS and CCS. And we expect to build on that momentum in 2023, with ATS segment revenue growing in the high-single digits and CCS segment revenue growing in the low-single digits. In our ATS segment, our industrial business continues to post strong results with 24% organic growth in 2022 compared to 2021 with sequential improvement in each quarter throughout the year. Also, PCI continued to impress in 2022, as it posted strong operating results and exceeded our year one synergy targets. The outlook for our Industrial business remains robust. As demand is expected to continue to benefit from secular tailwinds in the green energy market, including electrical vehicles, where we are ramping a number of new programs. We expect our industrial business to have strong growth in 2023 with approximately 75% of that anticipated growth coming from green energy programs. Turning to capital equipment. Our capital equipment business had solid performance in 2022, driven by secular demand, market share gains and strong operational execution. On our previous call, we highlighted the expectation for wafer fab equipment spending to reduce in 2023 after several years of rapid growth with the majority of the decline coming from the memory market. We are now seeing estimates for the overall wafer fab equipment market to decline by approximately 20% in 2023 with the majority of the decline still in memory. While the overall market is expected to be down materially, we anticipate our capital equipment revenues to be down slightly in 2023 compared to 2022. The benefits of our business mix, market share gains and new program wins are expected to enable us to outperform the broader market. Looking beyond 2023, we are encouraged that the current market outlook anticipates the wafer fab equipment market to return to growth in 2024. Turning to A&D. Our A&D business saw a strong recovery in 2022 showing sequential improvement in each quarter and double-digit annual revenue growth. In our Commercial Aerospace business, we continue to see a normalization of commercial air traffic towards pre-COVID levels, a trend which is anticipated to continue through 2023. Revenue in our Defense business saw a double-digit growth in 2022 and is expected to maintain its solid trajectory in 2023, supported by increased military spending and investments in equipment upgrades from European and North American governments, amid rising geopolitical tensions. Our HealthTech business is experiencing strong growth. Due to the nature of demand for healthcare goods and services, we believe the outlook for our HealthTech business is less sensitive to recessionary pressures. We anticipate year-over-year revenue growth in 2023, supported by new project ramps in surgical, imaging and patient monitoring devices. Now turning to our CCS segment. Our HPS business has exhibited remarkable growth over the past three years, posting an annualized growth rate of 56% more than tripling in size. The substantial capital investments in data set expansion made by our service provider customers and our ability to gain market share from ODMs with our differentiated offerings has supported this exceptional period of performance. Based on our current market outlook, we expect to see a moderation of growth in service provider customer programs in 2023. This is primarily the result of more difficult comps after a record 2022, as well as a potential softening of demand in light of the current economic environment. Our expectation is for our HPS business to continue to see growth in 2023, however, at more moderate levels. Our outlook for our communications end market is aligned with that of our HPS business, given that it has been the primary driver of growth in recent quarters. We expect communications business to grow in 2023, but at more moderate levels due to tougher comps. Finally, in our Enterprise end market, we expect the business to grow in 2023 as a result of new program ramps but again at more moderate levels due to tougher comps. I am very pleased with what we have accomplished in 2022 and have confidence in our ability to achieve our 2023 objectives. That confidence is underpinned by our portfolio diversification, investments we have made to support meaningful growth opportunities and our proven ability to consistently execute across our global network. I would like to close out the call, by acknowledging the efforts and accomplishments of our global team, who have tirelessly worked towards the implementation and execution of our vision. The successes over the past year would not be possible without their dedication. Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Jim Suva from Citigroup. Please go ahead. Thank you so much for the details. My question is you have had tremendous success with sales to the cloud and hyperscalers (ph). Are you getting from that type of demand product? You mentioned that you expect enterprise, I believe you said it will grow towards the end of your prepared comments. But I'm just curious about kind of hyperscalers and cloud and are you seeing any competitive changes in that area? Thank you. Hi, Jim. Thanks for the question. Broadly speaking with the hyperscalers and the cloud, what we're seeing in the current environment is order visibility is back to kind of normal levels we're seeing growth tempering for most products, some increasing due to expanded use cases, i.e. it could have been part of the back pain and now it's part of the fabric. We're seeing China hyperscalers doing a little bit of a reset and creating some demand softness. But on the flip side, we're still seeing growth, more moderate growth though coming from just about all the hyperscalers China side. And we're still seeing customers paying premiums for airfreight at lower levels than previous quarters, but still relatively strong given the current environment. Great. Thanks. And as a follow-up, are you seeing any competitive changes not just on the cloud hyperscalers, but like overall business, because it seems like during COVID, when nobody could get the golden screw or the missing key parts pricing was less competitive. I'm just wondering now that available is becoming supply more available. Is pricing changing at all in the industry? I know it's always a competitive industry, but I'm wondering, or is the industry going to turn the page to be a lot more disciplined compared to some past cycles? It's a good question. Given the fact that a large majority of our CCS business is now HPS, and we've established ourselves as an innovative with exceptional execution. We're not seeing, call it, extreme pricing pressure just because of the stickiness and the design nature of the products and services that we provide to our customers. Hi. Good morning. Rob, maybe just stepping back on the macro, obviously a dynamic environment. So if we think about just the change in what you're seeing over the last three months. It sounds like, I mean, my takeaway from your commentary is that demand is kind of pretty consistent. Maybe with the exception of some softening incrementally in capital equipmentâs and then supply chain showing some improvement versus last quarter. Would that be fair? I mean, just again thinking about changes versus last quarter, anything else you call out or are those the key takeaways? Yeah, that's right. So within ATS, we're seeing growth across all the verticals with the exception being capital equipment and we expect that to be mildly down in 2023, largely driven by the fact that we have new program ramps and some of them are even with new lithography customers which shows that we're actually diversifying our capital equipment customer base, which is a huge positive. And within CCS, frankly, the comps, so just really tough from 2022 going to 2023. But we are seeing growth across comps in Enterprise and HPS certainly into Q1 and for the full year. And then on the CCS margins, which were obviously exceptionally strong. Any one time things that may benefited Q4 or is this kind of margin stream for sustainable as we think about the first half of the year? Yeah. Hi, Thanos. I wouldn't say that there is one-time items to call out, but what I would say is that our broader teams have done an exceptional job in this tough environment on maximizing pricing. And so there are a level of service billings that we've been seeing through 2022 for great service that we're providing our customers. As the supply chain environment starts to normalize as lead times come in, there'll be less opportunity for those types of service billings. And so we do think that there'll be a slight moderation of CCS margins as we go into next year. But obviously the performance this year has been exceptional. So I think that could also be expected. Hey. Thanks very much and good morning. Just wanted to hone in on your comment about the late quarter demand shifting to some capital equipment. Could you just elaborate a bit more there? And then perhaps just indicate how to change -- what led to the change versus your prior expectations going into this quarter? Sure, Paul. Yeah. So within capital equipment early December, late November, some of our customers notified us that they had some inventory kind of built up in their supply chain as such they wanted to defer some orders from the fourth quarter into the first quarter. So given it happened late, we were unable to kind of flex our costs in the last couple of weeks of the month. So that kind of led to a little bit of pressure. That issue is now corrected, if you will. And we kind of have a beat on what we think Q1 will be and the full year will be and our supply and demand we think is relatively aligned. Yeah. Paul, if you'll recall, when the China export controls challenges came out, they came out right at the end of October while we were financing our results. And so we provided the color that our customers had at that point as the understanding of that became more through the quarter. Our customers were able to go and reassess their near term delivery schedules and that's why we had some of that late demand churn closer to the second half of the quarter. Okay. That's helpful, Rob [indiscernible]. As we think about â23 and the linearity of growth within capital equipment, I mean do you see a reacceleration or a return to growth steadily through the year or is it back end loaded, like, how should we think about that? Yeah. I would say within capital equipment, broadly speaking, we think that our base business will be down on a year-over-year business, but the new program ramps will be supplementing or offsetting some of those headwinds and there will be more back end loaded than front end loaded. Yeah. Paul, from a market perspective, as you would know, what we're seeing in the overall market is that memory is down significantly. You're aware that we have less exposure to memory, a lot more exposure to logic. And then as we go through the year, what we're hearing from our customer base is that there is an expectation that there will be some demand strength as we exit â23. And so right now, we are looking 2023 based on what Rob just said, but the longer or medium term fundamentals for the semi market continue to be attractive. And last question for me. Just non-lifecycle revenue, it was very strong Q4 and I think it was also strong Q3. What are the reasons for the growth in that piece of the business? It's primarily driven by data center growth rates as well. As you know, we do multiple things for our customers. So we can have a customer where we're doing both HPS programs and non-HPS programs with them. We actually find that being able to provide those both services create secure relationships. And so when we've been seeing growth in our non-HPS programs, they're with largely hyperscaler customers for data center deployments. Hi. Good morning. I'm just curious about the supply chain. It sounds like there's -- you're expecting to be better in 2023 and I'm just curious how it -- how that evolution impacts your visibility. You benefited a lot from maybe better understanding of your customers' build schedules. And then as footprints are changing, people shifting towards onshore, maybe away from China, how does your footprint match up with where your customers want to go? Two questions related to supply chain there. Thanks, Rob. Yeah. From a supply chain perspective, the constraints are certainly eased from last quarter. And as we enter 2023, I think we're getting close to pre-COVID levels. Nevertheless, supply lead times are still elevated, especially on some of the older chip technologies such as the narrow space and some automotive products as it relates to lift us, as it supports the EV market. With respect to giving us visibility on build schedules, build schedules and visibility is really function of lead times, so given that lead times are still relatively high, again, semiconductor lead times were about 15 weeks. There are now about 34 weeks coming off a higher 40. So based on the increased lead times for semiconductors, we still have increased lead times and visibility into our customers' forecast, which is a positive. And regarding our footprint, we think we're really well positioned. Right now, weâve announced some expansions in Malaysia to support some growth there and we also announced some expansions in Mexico to support some growth there and that's really to facilitate customers wanting supply chain resilience and having multiple nodes supporting them and also to support additional onshoring. Okay. And then second question, I wanted to dig into the EPS guide for 2023. You said that EPS, adjusted EPS is now a key performance measure. And so it seems odd that the guide for 2023 is 5% growth and 10% -- at the midpoint 5%, at the midpoint and then 10% in 2024 and 2025. So I'm just curious what the driver is that leads you to be a little more cautious on EPS growth in 2023? Yeah. Hey, Rob. So we've been consistent with our EPS outlook for 2023 from what we had provided in October $1.95 to $2.05. To your point, when you look -- off of the very strong results that we had in 2022, it's a single-digit growth rate. 2022, as you know, is an exceptional year. If you looked at our EPS growth on a two year stack basis, we're above 20% growth. What we are seeing right now is continuing growth going into next year on the top line. We are being prudent to be very frank at this moment given its January only of 2023. And we would hope that we would continue to see strong performance even as we exit Q1 and going into the rest of the year. So we will provide updates along the way. But right now, as you can see with our guide in Q1, the near term visibility is quite robust. Okay. And just last quickly on PCI. I think you said that you had a recovery there? Did you recover everything from the fire and is that back to normal? And then I'll pass the line. Yeah. Hi, Rob. As we exited Q4, we're now at call it pre-incident levels from a production point of view. So yeah, we feel really good that we remained on plan to our original plan with respect to getting back to pre-incident levels as we exited the year. Hi. Yes. Good morning, everyone. I wanted to ask a couple of questions. I'll first start out on capital allocation. You've had a good experience with the PCI acquisition. It's now integrated and you're surpassing synergy targets. Is there -- are there any other M&A opportunities you're considering and could you give us a general idea what might fit with your footprint at the moment? Sure. I'll start off and I'll leave Rob add on as he wishes. So we're pleased with the overall strength of the balance sheet. Gross leverage now is at 1.3 times, which is, gives us a lot of flexibility. We're pleased with the free cash flow that we were able to generate Todd this year, $94 million. We're targeting over $100 million next year as well. And we want to continue to be opportunistic along the way. So our long term strategy is to return half of our free cash flow to our shareholders. We were active in 2022 on buying back stock when the stock wasn't trading at levels that really made sense and I say that from a multiples perspective. So we continue that flexibility going into 2023. In terms of M&A, so first off, we're extremely pleased with the performance of PCI. The business has been doing very well. They surpassed our first year synergy targets as was mentioned in the script and that business continues to have a very robust outlook as well. We have a very active funnel. We're continuing to look for primarily capability based acquisitions largely tied to our Lifecycle Solutions portfolio. So looking at targets in most of the end markets in ATS, with the exception of capital equipment, it's not really an area that we're looking to lean into from an M&A perspective, but now also looking at targets in the HPS side. We haven't pulled the trigger in 12 months. And the reason for that is just because we continue to have a very robust filter. The very first thing is it doesn't line up with our strategic roadmaps and then we want to ensure that its meeting our other financial filters and so we continue to be open to it. We have the balance of flexibility to do it, but we're going to be disciplined. Okay. That's helpful. Thank you. And then if we could just step back from 2023 and if we think about the business in sort of a three-year timeframe, what type of production shifts do you expect to take place from Asia-Pac to North America? And how would you anticipate Celestica participating with that? Thanks a lot. Yeah. Thanks. I think over a period of time, we'll see China looking to serve China, so China for Chinese markets. And that might be multinationals in China that are selling products into China or Chinese customers in China serving China requirements. I think the production that has been in China multinationals are looking to either move those Southeast Asia or into North America or into -- whether that's Mexico or other requirements in North America. So the broad shift I think is China going down, Southeast Asia growing, Mexico and North America is certainly growing. And based on our footprint, we have very little exposure to China, which bodes well for us. I think about less than 10% of our sales are coming from China. And we have expansions going on in Malaysia and we certainly been expanding our Mexico facility. And last year, we opened up a new facility in Richardson, Texas and that is growing up very nicely with a very strong pipeline. So you'll just see this evolve -- I guess perspective is those are the trends that are happening and you're already positioned. So you just need to evolve with them as opposed to having to make any material step outs? Thank you. I'm pleased with our performance in the fourth quarter and for all of 2022. In 2022, we grew our adjusted EPS by 46% marking another strong year performance. In fact, over the past three years, Celestica has grown adjusted EPS by over 50%, a true testament to our ability to execute in difficult markets. I'm encouraged with the momentum we have as we enter 2023. We are well skilled at managing our business through economic cycles and feel confident in our ability to navigate through economic uncertainties. Thank you again for joining today's call and I look forward to updating you as we progress throughout the year. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.
|
EarningCall_1194
|
Good morning, ladies and gentlemen, and welcome to Comcast's Fourth Quarter and Full Year 2022 Earnings Conference Call. At this time all participants are in listen-only mode. Please note that this conference call is being recorded. I will now turn the call over to Executive Vice President, Investor Relations, Ms. Marci Ryvicker. Please go ahead, Ms. Ryvicker. Thank you, operator, and welcome, everyone. On this morning's call are Brian Roberts, Mike Cavanagh and Jason Armstrong, who are also joined by Dave Watson, Jeff Shell and Dana Strong, Brian and Mike will make formal remarks, while Dave, Jeff and Dana will also be available for Q&A. Let me now refer you to Slide 2, which contains our safe harbor disclaimer and remind you that this conference call may include forward-looking statements subject to certain risks and uncertainties. In addition, during this call, we will refer to certain non-GAAP financial measures. Please see our 8-K and trending schedules for the reconciliations of these non-GAAP financial measures to GAAP. Thanks, Marci, and good morning, everyone. I'm really proud of how our team executed throughout 2022. We achieved the highest levels of revenue, adjusted EBITDA and adjusted EPS in our company's history. And we returned a record $17.7 billion of capital to shareholders through both our recurring dividend, which we just increased for the 15th consecutive year and robust share repurchase activity. We did all this while accelerating investment in key growth initiatives, which are showing great progress, particularly our broadband network as we transition to 10G but also in Xfinity Mobile, Peacock and our theme parks. I attribute all this success to the incredible talent across our organization, who work collaboratively to ensure we are constantly evolving and innovating so that our customers have the absolute best experience with us at every point of interaction. What also sets us apart is our very strong balance sheet, which, when combined with the cost actions we have taken this past quarter, position us to perform well no matter what the macro environment might bring. I want to start with cable, where our financial performance both for the year and the fourth quarter confirm that we are striking the right balance between rate and volume in residential broadband, and we plan to continue to do so in 2023. At Xfinity Mobile and Comcast business remain strong growth drivers and we have successfully identified the appropriate mix between cutting costs to drive efficiencies and investing for our future. We have always maintained an intense focus on providing the absolute best products and experiences, which comes down to having the highest capacity, most reliable and most efficient broadband network. Our evolution to 10G and the unique way we are pursuing this through DOCSIS 4.0 is a huge benefit for our customers across the entire footprint that they will all have access to an entire ecosystem built around multi-gigabit symmetrical speeds, some as early as this year. It's also great for the company investors as our transition to a virtual software-based network infused with the marvelous AI capabilities will not only provide tangible benefits when it comes to operating and capital expenses, but it will enable us to innovate faster than ever before, solidifying our leadership position in broadband, which is extremely important given what is certain to be continued increases in demand for both speed and usage. In fact, we continue to see signs of this today. Our residential broadband-only customers are now consuming nearly 700 gigabytes of data every month, and customers on our Gigabit Plus products now comprise one-third of our broadband subscribers. In addition to creating more value from our current customer base and further penetrating the total homes and businesses that we pass today, another great opportunity is for us to extend our networks to homes and businesses in the U.S. that do not have the ability to receive our services. To that end, we increased our passings by 1.4% or $840,000 in 2022, and we expect to accelerate in 2023, where we are aiming to add around 1 million while still maintaining the same CapEx intensity level we achieved in 2022, reaching nearly 62.5 million by the end of the year. We are taking a disciplined approach, and we'll only pursue those areas that have a return profile similar to what we have been able to historically achieve. Wireless is playing an integral part of our overall strategy at cable, and it's an area where we continue to shine. This past quarter was another record in net line additions, bringing us to over 5 million total lines in just five years. Only 9% penetration of our current base of residential broadband customers, we have plenty of runway ahead, and we're just getting started in offering wireless to our commercial segment, which is another great example of how we are selling more products into our existing base of business customers. When you combine our broadband network, WiFi overlay and MVNO with Verizon, we are in the best position to win in convergence. We have a leg up on our competitors with a capital-light strategy that does not involve customer or network trade-offs. At NBCUniversal, we are seeing some great momentum in Peacock and parks. And across all of NBCUniversal, our intellectual property is really resonating. We had the number 2 studio in terms of worldwide box office in 2022, fueled by a strong slate, including Jurassic, Minions, Nope, Ticket to Paradise, Puss in Boots, Black Bone, Halloween, which have also had great carryover success to Peacock through our Pay-One window and select day and date releases. And our box office momentum continued into the first quarter with M3GAN, so all in all, a really strong film slate. Peacock ended the year with over 20 million paying subscribers, more than double where we started. And we added over 5 million paid subscribers in the fourth quarter alone. Our success was broad-based, fueled by some of the films I just mentioned but also sporting events like the World Cup, NFL, Premier League, several new originals and our exclusive next-day broadcast of NBC. Looking ahead, and based on our experience to date, we expect our subscriber cadence will follow our content launches, which will fall more in the second half of 23. And we continue to see positive trends in engagement, churn and ARPU. Mark Woodburry had a fabulous first year as our CEO of the Parks business, and we hit a number of new records this past quarter. It was the highest fourth quarter EBITDA for the entire segment, led by Orlando and Hollywood, and Japan had the best EBITDA performance since 2019. This was driven by attendance that for us surpassed pre pandemic levels at all three parks. While attendance at our Park in Beijing was significantly impacted by COVID in 2022, we are seeing some exciting demand to start the year. Given the excellent returns we have generated to-date, we continue to seek ways to expand our parks. I'm really excited about our two recently announced extensions. First universal park designed specifically for younger audiences near Dallas, and the first year around horror entertainment experience in Las Vegas. These are new innovative ways to utilize our substantial IP, including from DreamWorks and Illumination, while also extending our brand, both of which had helped fuel growth in all of our parks. Our linear video business, we are managing subscriber declines by taking a disciplined approach to our cost base. We are continuing to invest in our global technology platform, and you will see a number of announcements from us in the weeks and months ahead. For example, in 2023, we will launch one global user interface for Sky Glass, Xfinity, X1, Flex, XUMO, at our U.S. and International partners. Every entertainment customer around the world will get the same Emmy award winning voice controlled experience. This scale not only brings us operational efficiencies, but it also puts us in the enviable position when it comes to conversations with distributors, OEMs, programmers, app developers and talent. At Sky, we are managing through the macro economic challenges in Europe. While staying intensely focused on retention and continuing to provide our customers with the best entertainment and connectivity experiences. We're seeing some encouraging results. In the UK, Sky Glass had the top selling UHD TV model. Sky mobile is the fastest growing mobile provider, surpassing three million lines. And we are narrowing the gap between us and the current number one broadband provider with Sky Broadband, now sitting at over 6.5 million subscribers. Wrapping up, our consistently strong financial performance, healthy balance sheet, record high return of capital of shareholders underscore how the scale capabilities and talent across our company enable us to successfully execute our long term growth strategy. I'm convinced we are on the right path and that we have the right team to capture our many opportunities and overcome whatever challenges happen along the way. So before handing over the call, I want to congratulate Jason Armstrong, recently promoted to Chief Financial Officer, succeeding Mike Cavanagh. Could not be more confident and the leadership team's ability to continue to drive us forward and create more value for our shareholders. Thanks, Brian. And good morning, everyone. First, I'd like to just say that it's been a pleasure serving as CFO of Comcast for the last seven plus years. And I couldn't be prouder to have Jason be my successor. Knowing that with Jason, the financial leadership of our company is in proven and expert hands. Since Jason didn't take over as CFO until early in the new year, I will handle the CFO portion of this call and hand it over to Jason for the first quarter call in April. So now I'll begin on Slides four and five to discuss our consolidated 2022 financial results. Revenue increased just under 1% to $30.6 billion for the fourth quarter and 4.3% to $121.4 billion for the full year. Adjusted EBITDA decreased 4.9% to $8 billion for the fourth quarter, and increased 5% to $36.5 billion for the full year. The quarterly results include severance expenses booked in each of our businesses, totaling $638 million, which is $541 million higher than the prior year period. Including this increase, adjusted EBITDA increased 1.5% in the fourth quarter, and 6.6% for the full year. Adjusted EPS increased 6.5% to $0.82 of share for the fourth quarter and 13% to $3.64 for the full year. And we generated $1.3 billion of free cash flow for the fourth quarter and $12.6 billion for the full year, while absorbing increased investments in Peacock and theme parks, as well as higher working capital as content creation normalizes post COVID. Now let's turn to our business segment results starting with Cable Communications on Slide six. Cable revenue increased 1.4% to $16.6 billion, EBITDA increased 1.5% to $7.2 billion and cable EBITDA margins improved 10 basis points year-over-year to 43.5%. These results include $345 million of severance expense, which is $305 million higher compared to last year's fourth quarter, excluding severance cable EBITDA increased 5.8% and cable EBITDA margin improved by 190 basis points to a record high of 45.3%. These strong results also included the impact of Hurricane Ian in Southwest Florida, which resulted in the loss or severe damage to many homes we serve in this market. Excluding the hurricane impacts, we would have added approximately 4000 broadband customers versus the 26,000 loss we reported. And we estimate that we would have lost approximately 36,000 customer relationships versus the 71,000 we reported. Overall, our broadband customer results in the fourth quarter were fairly consistent with the prior two quarters, reflecting lower levels of new customer connections, offset by churn which remained well below 2019 levels. Now let's discuss cable financials in more detail. Cable revenue growth of 1.4% was driven by higher broadband wireless business services and advertising revenue, partially offset by lower video and voice revenue. Broadband revenue increased 5.4% driven by growth in ARPU and in our customer base when compared to last year. Broadband ARPU increased 3.8% year-over-year, when adjusting for some COVID related customer credits last year. This organic ARPU growth is similar to the growth we've generated over the last couple of quarters and is consistent with our strategy. We are focused on optimizing our customer relationships by consistently adding more capabilities, services and value, so as to provide the best broadband experience, which has and should continue to deliver broadband ARPU growth. The elements of growth this quarter include increased rate, attaching more customers to higher tiers, as well as other services. We expect ARPU growth will continue to be the primary driver of our residential broadband revenue growth in 2023. Wireless revenue increased 25%, mainly driven by service revenue, which was fueled by growth in customer lines. We added 1.3 million lines in 2022, including 365,000 lines in the fourth quarter, which is our highest number of net additions for any quarter on record. Business Services revenue increased 4.6%, which includes the results of Masergy in both this quarter and in the prior year period, as we lap the closing of this acquisition at the beginning of the quarter. Revenue growth was primarily driven by rate, including customers taking faster data speeds, higher attach rates of our advanced products, and rate increases on some of our services. Advertising revenue increased 9.1% driven by strong political revenue, partially offset by the absence of advertising revenue that is now part of XUMO, our joint venture with Charter. Adjusting for those items, cable advertising revenue decreased 1.6%, reflecting decline in our local core advertising business, partially offset by solid growth at our advanced advertising business. Video revenue declined 5.6% driven by year-over-year customer net losses, partially offset by ARPU growth of 5.8%, due to a residential rate increase we implemented at the beginning of 2022. And last, voice revenue declined 13% primarily reflecting year-over-year customer losses. Turning to expenses. Cable Communications fourth quarter expenses increased 1.4%, reflecting higher non-programming expenses, which included the $305 million in higher severance costs, partially offset by lower programming expenses. Programming expenses decreased 5.9%, reflecting the year-over-year decline in video customers partially offset by higher contractual rates. Non-programming expenses, which again include $305 million and higher severance costs, increased 5.6%. Excluding severance, these expenses were flat compared to last year, reflecting an increase in bad debt as we return to more normalized pre pandemic levels an increased technical and product support expenses driven by growth in our wireless business. These were offset by a decline in marketing and promotion and customer service expenses due to lower activity levels, efficiencies in running the business, and improvements we continue to make in our customer experience. Our focus on growing our high margin connectivity businesses, coupled with our focus on increasing operating efficiency and cost controls, drove strong EBITDA growth and margin expansion in 2022, excluding the higher severance expense, we grew full year EBITDA by 5.7% and increased EBITDA margins by 110 basis points to 44.8%. We believe that our disciplined approach to running the business, including the benefits from our cost reduction efforts this quarter, positioned us to drive higher profitability, and further expand margins, both in 2023 and thereafter. Now, let's turn to Slide seven for NBCUniversal. Starting with total NBCUniversal results, fourth quarter revenue increased 5.9% to $9.9 billion, and EBITDA decreased 36% to $817 million, including $182 million of severance expense in the quarter, excluding severance EBITDA decreased 22%. Media revenue increased 2.6% to $6 billion, mainly driven by Peacock, which nearly doubled its revenue to $660 million and Telemundos broadcast of the World Cup. Advertising revenue increased 4%, reflecting an incremental $263 million from the World Cup, as well as strong growth at Peacock and a healthy contribution of political advertising, partially offset by a decline in linear advertising. If we exclude the World Cup, advertising revenue declined 5.6% reflecting softening in the overall advertising market, distribution revenue increased 3.8% reflecting growth at Peacock driven by increases in paid subscribers, which more than doubled compared to last year, as well as higher contractual rates at our networks partially offset by linear subscriber declines. Media EBITDA was $132 million in the fourth quarter including a $978 million EBITDA loss at Peacock, reflecting the cost of new content, such as our exclusive next-day broadcast and Bravo content, our robust lineup of Pay-One titles, day and date releases like Halloween, NFL Premier League and the World Cup. Peacock's full year EBITDA loss of $2.5 billion was in line with the outlook we provided a year ago. And for 2023, we expect Peacock losses to be up modestly to around $3 billion. As we've said previously, we believe 2023 will be peak losses for Peacock and, from there, steadily improve. Excluding Peacock, Media EBITDA in the fourth quarter decreased 13%, reflecting the lower revenue and fairly flat expenses despite the higher costs associated with broadcasting the World Cup. Looking to the first quarter. While we remain focused on managing costs, we expect underlying Media EBITDA, excluding Peacock, to continue to be impacted by the top line pressures at our linear networks. Moving to Studios. Revenue increased 13% to $2.7 billion driven by growth in content licensing and theatrical revenue. Content licensing was up 16% driven by the benefit of our carryover titles and the acceleration in film windows as well as healthy growth in television licensing. Theatrical revenue increased 47% due to the success of recent releases, including Ticket to Paradise, Puss in Boots, Violent Night and Halloween Ends. EBITDA increased $109 million to $160 million for the quarter, reflecting the higher revenue partially offset by an increase in marketing and promotion expense, reflecting the size and timing of this quarter's theatrical slate as well as the corresponding higher programming and production costs. At Theme Parks, revenue increased 12% to $2.1 billion, while EBITDA increased 16% to $782 million, our highest level of EBITDA on record for our fourth quarter. These results were driven by growth at our parks in the U.S. and Japan partially offset by our park in Beijing, which was negatively impacted by COVID-related restrictions. At our U.S. parks, we continue to see strong demand with attendance and guest spending up year-over-year and with Orlando and Hollywood both delivering record high EBITDA for the fourth quarter. Universal Japan continued to rebound since capacity restrictions were lifted at the end of March and delivered strong year-over-year EBITDA growth in the quarter. Now let's turn to Slide 8 for Sky. Reported results were meaningfully impacted by currency translation due to the strengthening dollar, but I will speak to Sky's results on a constant currency basis. For the fourth quarter, Sky revenue was relatively consistent compared to last year at $4.4 billion. Direct-to-consumer revenue was also consistent compared to last year, reflecting growth in the U.K. driven by wireless and broadband revenue offset by declines in Germany and Italy. On a customer basis, we added 129,000 customer relationships in the quarter with positive additions across all three territories, the U.K., Italy and Germany. These net additions were driven by streaming, broadband and wireless customer additions and reflect our team's strong execution in a challenging macroeconomic environment across Europe. Rounding out the rest of Sky revenue, content revenue increased 6.5% driven by licensing our entertainment content, and advertising revenue decreased 9.6% primarily driven by lower revenue in the U.K., reflecting the timing of the World Cup and the macro environment. Turning to EBITDA. Sky's EBITDA decreased 15% to $340 million, including $89 million of severance expense, which is $53 million higher compared to last year's fourth quarter. Excluding severance, EBITDA declined 2% compared to last year, reflecting an increase in direct network costs driven by growth in our residential mobile and broadband businesses and higher other expenses, which were mostly offset by lower programming costs due to the timing of sports programming as four weeks of EPL games were paused during the fourth quarter to accommodate the World Cup. However, we will incur higher sports costs in the first half of 2023, reflecting the higher number of games as the season is extended and the remainder of the games which were paused are now played. Now I'll wrap up with free cash flow and capital allocation on Slide 9. As I mentioned previously, in 2022, we generated around $12.6 billion in free cash flow while absorbing increased investments in Peacock and Theme Parks as well as higher working capital as content creation normalizes post COVID. Full year consolidated total capital investment increased 14.2% or $1.7 billion to $13.8 billion due to increased spending at NBCUniversal and Cable partially offset by a decrease at Sky. At Cable, total capital spending increased 8.3% or $695 million with CapEx intensity coming in at 11.4% primarily driven by investments to further strengthen and extend our network. In 2023, we expect CapEx intensity to stay at around 11%, similar to 2022 levels as we aim to accelerate our homes passed growth to about 1 million and continue to transition our entire broadband network to DOCSIS 4.0 over the next few years. NBCUniversal total capital spending increased $1.4 billion driven by parks CapEx increasing $1.1 billion, of which Epic was around $800 million and reflects our continued investment in new attractions like Super Nintendo World at Hollywood and Donkey Kong at Japan. In 2023, we expect parks CapEx to increase by around $1.2 billion over last year as we continue to build Epic, which we plan to open in 2025 and begin work on our recently announced park extensions mentioned earlier. The required investment to develop these extensions is nowhere near the scale of Epic or Universal Beijing but rather enable us to leverage our already large market opportunity and can serve as a model that contributes to even higher growth at Theme Parks in the future. Working capital was $3 billion for the year, a $1.5 billion increase over last year's level, reflecting a post-COVID ramp of investment in content creation. Turning to capital allocation. We ended the year with net leverage at 2.4 times and returned a total of $17.7 billion to shareholders, including $4.7 billion in dividend payments and $13 billion in share repurchases. For 2023, we expect to continue to maintain leverage at around current levels, which I expect will support continued strong capital returns. As we announced this morning, we are raising the dividend by $0.08 a share to $1.16 per share, our 15th consecutive annual increase. This reflects our long-standing balanced capital allocation policy. We're committed to investing organically in the businesses while maintaining a strong balance sheet and also returning a very healthy amount of capital to shareholders. Thanks for joining us on the call this morning. I'll turn it back to Marci, who will lead the question-and-answer portion of the call. Good morning. And thank you. Brian and Mike as well giving your promotion to President, congratulations on that, by the way. And Jason, congratulations on the CFO role. Brian, Mike, since we're turning to a new calendar year, I wanted to ask for an updated vision for the company and how you see the company evolving over time. As part of that, investors are certainly interested how the company best addresses cable broadband competition and connectivity convergence and media streaming challenges and whether you see notable growth opportunities for the company that would shift allocation of capital as well. So how do you address the challenges and opportunities? And how has the company evolved over the next three to five years? Thanks. Thanks, Doug. It's Mike. So maybe I'll take a first crack, and then Brian can pile on if he likes. So vision in the next few years, it's -- I think how you think about that requires a little bit of a reflection of where we stand at the moment. So if I look at 2022 and you really reflect on what are truly excellent operating results. So kudos to the people running the businesses deep down into the organization to produce the kind of results we had, record revenues and record adjusted EBITDA. And that's fundamentally great management discipline, operating discipline, financial discipline in the day-to-day. When you zoom out a little bit, it puts us in a position where we are returning record capital in our industry at 2.4 times leverage, so it allows us the opportunity both of those things in good balance. To then go at your real question, which is what is our opportunity, what are our challenges and do we have the resources to go after them. And so I'd say there, you heard it in the call, but I'll recount them, we've got an excellent number of organic investments that are going after all the opportunities and challenges that we currently see. Obviously, as others emerge, we'll go after it the way we usually do. But those are you take the network and Dave can pile in. But we're on a path to 10G. So DOCSIS 4.0 is going to get us, as we've talked about, in a very capital-efficient way to a network that's going to have symmetrical upstream, downstream in a few short years. We're going to start rolling that out at the back end of this year. So I think our commitment is to have the best network out there and to put a tremendous amount of services surrounding that network, whether it be WiFi or Flex and the like, as you've heard us talk about before. You heard about the tech platform. Brian mentioned it. We're going to get to a single global tech platform, integrating all of the build of glass in the U.K., X1 here in the U.S., what we do in Peacock behind a single scaled global tech platform that we can use in many ways. You know about the XUMO partnership that we have with Charter, for example, to take that capability outside of our footprint. And then finally, on the Cable side, it's a wireless. Wireless, we've been at it for five years, have 5 million lines now. We put the investment in along the way, and we continue to do it, but it's a capital-light approach. And I think that totality is a great set of strategies for how we're going to drive growth in the cable business looking ahead. And so I'd say, expect us to continue to keep driving along those lines. On the Media side, we think Peacock is absolutely the right strategy for our company. And Jeff has repeatedly said, we're not going to place somebody else's hand. We have an excellent business in NBC and our cable networks. We spend quite a bit of money creating content and so migrating some of that content as eyeballs move to a more streaming universe. We like what we're doing. And we had a phenomenal year getting paid subs to 20 million paid subs from less than 10 a year ago. And we see this coming year as the peak year in investment there, but we'll keep on that plan. And then finally, I'll mention parks. Parks, we've got Nintendo opening in Hollywood in February. We're ramping the build of what's going to be a phenomenal theme park, Epic universe in Orlando, opening in 2025. And as I said earlier, we'll increase our spend this year in '24 to sort of peak levels there ahead of that opening. And then we're leveraging the great product that we have with some new ideas, some innovation around that with a kids-based theme park, smaller scale in Dallas and Hollywood Hard Nights in Las Vegas. So these are big investment agendas that go out all the issues that I think are out there across our different businesses. So I think we're well positioned to continue to drive primarily an organic investment agenda and drive growth across our businesses in the years ahead. Obviously, it's our job to consider inorganic things as they come up. But as I've said before, the bar is very high. It's our job to make sure that we are looking at organic opportunities and executing well against them, and I think we are. So Brian, you got anything to add? First of all, I could see why you're the right person for the job. That was a fantastic answer and covered a lot of the vision of the company. So I'm going to try not to be at all repetitive and maybe even zoom out further with the lens and say, what are -- just pick two themes of what you just talked about and say, think about the vision of the company, what are the two big trends. It's what's happening in broadband, both as a competitive reality, and I'm sure Dave will get into that with some of the questions; but in longer term, what's likely to happen to consumers' needs for usage -- what are we making our bets on in that vision question. And the other is the convergence to streaming and where are we in that journey. So if you think about the 10G initiative Mike talked about, it's really to widen our lead to clearly and demonstrably explain to consumers and give them a product and be able to brand it for resident consumers and businesses that we have something you want to have if you rely on a need and enjoy broadband and the investments we're making, the ubiquitous nature of it. And if you look at broadband usage, and we cited some stats in the prepared remarks, but if you just look at even Thursday night and the NFL being on Amazon, that creates a lot of broadband usage. And is there going to be more of that in the future or less of that in the future? And what percentage of America today consumes that way? And what will it look like 5, 10 years from now. And so we want to be a company that is uniquely positioned to capitalize on these macro changing trends. And the same goes in streaming. And Peacock -- with just my kudos to the team at the whole of NBCUniversal and Comcast and Sky working together have put us in double in one year to 20 million-plus paying customers in addition to what lies ahead. It's the best bargain. For $5 a month, you get everything from the World Cup to Sunday Night Football to incredible movies to incredible next-day NBC to all our cable content original content, and consumers are finding that. So I think our company, I echo what Mike said, I think we're extremely well positioned. And I we'll continue to grow organically and having the ability to keep the balance sheet strong and return capital to shareholders. And those finding that balance, we did it really well in 2022, and we hope to do it again. Good morning. Thank you. I want to ask Jeff about the NBC outlook, both sort of some of the key trends you're seeing in '23 but also longer term. I mean I think the business did over $8.5 billion of EBITDA back in 2019. I think $23 million will probably be down from 22 just given the Peacock losses and the pressure on the Media business. But can you just talk about your long-term opportunity at the NBCUniversal? Do you think you can climb back to those EBITDA levels over any sort of reasonable investment horizon? And what are you -- how are you feeling about sort of things like advertising and parks sitting here today given all the macro concerns? And then I just had one question for Mike on cash flow. You mentioned the $3 billion net working capital drag in '22. Any help on that for 2023, if you have any visibility there? Thank you, both. Ben, this is Jeff. I'll start and then hand it over to Mike. So we feel really good about NBC growth trajectory going forward. If you kind of break it down, our content businesses has had a great quarter and is doing -- have never been better than they are right now or movie studio. We're off to a great start this year. The slate going forward is really good. Our TV businesses, studios are great. So our content business is doing great, and that's a business that should grow over time. The parks business, Brian and Mike both talked about the parks business, it's never been better for us. We had a record year last year. Trajectory is going to slow a little bit in the U.S. just because we are doing so well. But we're seeing -- we found our footing in Japan in the fourth quarter. That's going to grow based on the Nintendo attraction there in Beijing, which really had kind of got to profitability in the third quarter suffered from COVID in the fourth quarter. First couple of weeks of this year, with the economy opening up there, is really doing well even with poor weather. So I think our parks business has a lot of growth ahead. And as Mike talked about and Brian talked about, we're investing in it. So those two businesses are great. The Media segment, as Brian just went through very well, we made a decision to invest in Peacock. It's very clear that we picked the right business model at this point, given where we are. And it's very clear that the content strength that I talked about, which has led to our linear networks being number one for decades, is paying off on Peacock. So what -- when we -- we were going to grow -- we've made that investment. We've been clear from the start that we're going to see a return on investment. I think we feel better on that now based on where we are. And we also made that investment to return the Media segment to growth over time, which we feel even more confident today than we did maybe a year or two ago, then that's going to happen. And the timing of that really is up to macro conditions, how -- when does the ad market recover, how -- what are linear declines going forward. And then, of course, we continue to cut costs in the linear segment to maintain our margins. So I'm pretty confident that we have a lot of growth ahead in NBCUniversal, particularly after the progress we've made this year and the Media segment, we wouldn't be investing in Peacock. We didn't think it was going to return the segment to growth over time. And then the -- on working capital, we said a year ago that it was going to be spiked to a higher than typical run rate level just on the back of the disruptions caused by COVID in getting content creation in the phase we're in up to normalized levels. So expect to just ease back off of the levels we saw in 2022. It's a hard number to predict, but I think we are past peak there. Thank you. And congratulations to both of you, Mike and Jason. The question I have is on margins. As I think about the Cable segment, I think most people at this point are aware of the puts and takes where growing broadband, it raises margins, losing video raises margins. As you think about wireless now sort of accounting for a larger and larger piece of the pie, how do those pieces fit together as sort of a longer-term outlook for margins? Is it possible for the growth rate of wireless at whatever margin it sort of contributes to keep margins growing in the cable business? Craig, Dave. So I think the good news is we have a great portfolio of opportunities and business lines. So as you said, we have real strength in broadband and not only just solid broadband relationships with the ability to drive revenue in a healthy way. So resi broadband, I believe, will continue to be accretive not just revenue but margin. And business services is a real long-term opportunity has been, will continue to be. So when you look at top line margin impact, including mobile, I think it's a good -- and video slowing down. On the top line, it contributes towards margin. The second thing clearly are the expenses. And just lower activity levels, our constant focus around the two big buckets of the transactional activity, the experience improvements that we have that really drive things like self-install and the apps that help people resolve issues independently. And then our focus around cost, just fixed cost, ongoing. And so that all those things, I think, shows that it's not a singular moment. This has been steady progress over a long period of time around margin. So I think we still have a good runway. Thank you. Going back to NBCU of kind of two topics on theme parks, you've got three park planned for the U.S. Can you talk about global plans? And as peak spend in '24, I think that's what Mike just said. And then on Peacock, it sounds like this year will be peak losses. When do you expect breakeven? And can you talk about long-term profit potential like what margins would you look for? And then finally, kind of all around, can you just talk about your appetite for acquisitions? Mike said organic and non-organic. I'm just wondering WWE is obviously for sale. There's IP. Is this the year we finally see some more media consolidation? Thank you. Did you hear my question? I thought it was me. Thank you. So I just wanted to go back to NBCU. You've got three parks planned for the U.S. I'm just wondering if you have any global plans. And it sounds like from what Mike said that peak spend will be in '24, I just wanted to clarify that. And on Peacock, it sounds like this year will be peak losses. Can you talk about like when you expect breakeven and what you think about the long-term profit potential or margins there? And then finally, Mike again said organic and inorganic growth. So I'm just wondering what your appetite is for acquisitions, whether it's something like WWE or IP. Like is this the year we finally see media consolidation? Thanks. Jeff again. Sorry about the delay here. So let me -- this is Jeff. So let me start with parks. So parks we are always looking to invest in our parks, given how well we've done. And during the pandemic, we took share. We've had pretty solid growth. And we -- it's a business that we want to deploy capital to, as Brian said, we're really excited about Epic. It's coming out of the ground. It looks great and our timing couldn't be better for that. But we always want to have things that we're investing in, both domestically and internationally. The concept that we're going to build in Dallas, which is a design for a younger audience, less investment, if it's successful, which we're pretty confident it will be, it's a concept that will work in a lot of places around the world that may not support a full-scale theme park like we have in Orlando or Beijing, but it could support something else. So that -- we're excited about that concept. And then the Halloween horror nights experience in Vegas, which I'm really excited about, could also be expanded to a number of different places around the world. So we're definitely having our eye towards places expanding internationally not just domestically with a number of markets kind of on the docket. And they won't all be places for a big giant primary theme park that we might look at different concepts for different markets. And as far as peak spending, I think Epic, I think we expect our peak spend probably to be this year, although '23 and '24 will be comparable as we ramp down at the beginning of '25 prior to opening. So that's the parks. Peacock, we are could not be more positive about our trajectory so far. We're right where we expected to be as far as investment, and we're well above where we expected to be as far as paid subs, which was going to pay off. We will hit our peak spend, as I think Mike or Brian said in the opening, this year and then improve steadily from there. And we wouldn't be making the investment if we do see the investment in Peacock alone delivering return over time. As I said, in my prior answer that I'm more confident now that we're going to get to that, and it's going to be a good return just on that investment alone and the overall Media segment. And based on how we're doing so far, I'm more and more confident that that we made the right choice of business model and that our investment is appropriate for that business. So I don't know, Mike, if you want to talk about acquisitions. Yes. Consolidation, and Jeff can pile in too, I mean, I think when it comes to media consolidation, we'll see what happens. But I think go back to the earlier discussion, we've got a robust set of plans to invest in our own businesses. So anything that we would look at when we saw our job to consider things, we have healthy discussions. And our bias has to be to be investing behind our businesses themselves, where we control, operate, know what we're doing, have momentum, no surprises. So like I said, the -- across any inorganic opportunity, we're going to put ourselves through the real discussion. Is it worth it relative to the choices we have to invest in our own business, like Jeff just described? And I would just add that we're always looking for bolt-on acquisitions that bolster our business. And I'll give two examples. We bought DreamWorks. We talked about that in the past, and it's been paying off steadily since our acquisition and just now, with Puss in Boots, which is a big hit at the box office really our entry back into the Shrek Universe, continues to make that acquisition look really favorable. And we've invested in our Blumhouse investment over time. We're a partner with Jason Blum, and we have a big hit, M3GAN, this month, which is coming out of that investment. So we're always looking at bolt-on acquisitions. Don't necessarily involve big industry consolidation questions. Yes, thanks for taking the question. So later last year, one of the points you had made was just sort of based on market conditions. It was unlikely that you were going to see your broadband subscriber base really change in size, so basically stayed pretty flat for at least some period of time, and we saw effectively that trend in your fourth quarter results. I was hoping you can give us an update. How would you frame market conditions right now? Are you seeing any tailwinds begin to emerge? And do you need a meaningful improvement in market conditions to get back to more sustainably positive broadband net adds? Or do you think some of the steps you've been taking position you to accomplish that at some point this year regardless of the backdrop? Thank you. Brett, Dave here. So let me start with kind of your first point on the overall environment and pointing towards our results in broadband. So starting with Q4, clearly, excluding the impact of the hurricane, we reported net adds, broadband net adds of 4,000. And this has been consistent, consistent the last couple of quarters, reflecting the continued impact of lower move activity, increased competition. But what's different has been the near record low churn. So this -- the current environment is similar. Macro -- the macro environment still reflects depressed move activity. Competition continues to be very strong, and we're seeing some normalization in non-pay activity and churn. So it remains a challenging environment to add subscribers right now. However, as our record high revenue, adjusted EBITDA and margins in 2022 show, we have a successful model. We're driving revenue, EBITDA and cash flow rather than just chasing units. And so you look at our ARPU growth, holding the line on the relationships, but our ARPU growth was 3.8% in terms of broadband. So we're protecting ARPU growth, constantly adding more value, investing in our network, all within the parameters that we've talked about. And so -- and it -- results within the mix of the base is showing. As Brian said, you know, the one-third of our customers, broadband customers that get our Gigabit Plus products. So this is only just 5% that number just three years ago. So you look at usage. You look at the entire long-term opportunity, I think as Brian said, whether it's a couple more sporting events that go towards streaming, it just points towards you need better broadband. So from our competitive situation that we see, as I said, it's going to continue, but I think we're going to focus on our great network, ubiquitous network. We're going to continue to invest in that. We will constantly segment the marketplace and address each competitor. And so I think it's a similar environment, but we're very focused on being in position to drive results. But yes, we're going to do both. We're going to balance rate and volume. Thanks, good morning. And congrats to Mike and Jason on your new roles. Just two topics, if I could. First, on the XUMO platform, if you can give us an update on how that's progressing and maybe some of the milestones to watch as you look out over the next one to two years. And then on the cost-cutting and efficiency actions that you took exiting 2022, how should we think about the annual cost savings opportunity? Thanks. Let me start -- Michael, this is Dave. I'll start with XUMO. It's really early. Excited about the opportunity. Early discussions are positive and just a variety of partners. So we're excited about the relationship with Charter. And so -- but it's really early at this point in terms of XUMO, but I expect more to come, and we'll keep you posted along the way. Mike? On the cost actions we took in the course of the year, it's really to get our businesses set up to drive the results we gave some commentary on the outlook. We don't give guidance, but I think consider it all factored into the outlooks that Jeff, Dave and I have given thus far on the call, which is, again, continued opportunity for expanding margins and growth in EBITDA in the cable business and everything Jeff just described on the Media side, including growth in parks, growth in studios and the net dynamics with linear versus Peacock in the Media side. Thanks, guys. Two follow-ups, if I can. Your tone around new footprint expansion and broadband efforts has -- there's no change. Does bead funding or state subsidies going forward, accelerate that further? Or do you think the $1 million annually is the right figure to think about going forward? For Jeff, any update on trends in advertising since your comments in early December? And then finally, I wonder if you guys can talk about the $500 million in severance this quarter. Is there more to come? And Mike, I heard you say that margins in Cable should continue higher. What impact do you expect on cost going forward? Thanks very much. Let me start, Phil, this is Dave, and talk about the footprint expansion expectations. So pretty steady progress. You look at '21, did $813,000; '22, last year did $840,000. So good progress and in line with our expectations. And we do expect to accelerate in '23. So there's an opportunity to do around 1 million passings. And so the opportunity clearly still within footprint and residential, also hyper builds we call the commercial growth. Those all still exist. We're excited about that. And that's the majority still of the footprint expansion. The newer ones will be the rural edge-outs that we've been talking about, and that will begin to pick up the pace. Having said that, we're excited about it. We're going to lean in. We think we're doing well early stage in terms of the grants and the wins around these communities. But we're going to take a very disciplined approach, and we're going to go after returns that are similar to historic levels as we do that. So -- and we're -- I think all of the -- whether it's the network upgrades, the footprint expansions, we're still right on target with what we said and going back to '21 and being around 11% Cable CapEx intensity. So very excited about both of those areas, how we upgrade, the elegant path to upgrade and the footprint expansion. Jeff? Thanks, Dave, and thanks, Phil. So on the ad market, I think in prior calls, the market -- the ad market steadily worsened over the course of last year. It kind of feels like it bottomed out around late November, early December. And really since then, it hasn't gotten worse and maybe even a little bit better. I describe it really as shallow. There's parts of the market that are actually doing really well, Pharma, entertainment. Travel is on fire. There's parts of the market that feels uncertain, tech, auto, financial services, all are weak. It feels like the weakness is due less to businesses not doing well and more to just macro uncertainty. I mean none of us really know where the economy is headed, and I think some advertisers in those segments are really holding back. And when they do advertise, they're coming in later than usual. So I think we have -- we're doing a little bit better than our peers for a couple of reasons. One is Peacock's growth is really helping to offset the linear weakness, which is fortuitous for us. And I think, secondly, we've made big investments in data and measurement, and we have the best team, and that's really helping. But I guess I would just summarize it by saying the ad market feels to me like it stabilized a bit. And we're assuming it's going to stay weak for the first half of this year and then recover. But who really knows based on the macro economy? And then, Phil, Mike. So just picking up on macro. I mean looking into 2023, as many businesses, just uncertainty about the environment, we took -- I'll tell you what we did on severance. We offered voluntary retirement across the company, something we do on a periodic basis, which has benefits, obviously, of giving more opportunities for younger talent anyway as well as some of the tactical situations we have in select businesses to just make sure we're as efficient as we can be heading into uncertain times. We've executed against all these things as we roll into 2023. So it's behind us. Great. Thank you. Maybe a couple of questions for Dave on wireless and on video. On wireless, you talked about the 9% penetration. I mean are you seeing the positive impact on the broadband base from selling wireless into that? And then do you expect to continue to lean in? I think you guys don't really look at that as a separate profit pool but just sort of supporting the broadband business. And is that unlikely to change? That's number one. You also -- Dave talked about selling into the business segments. Just anything, sort of any color on how you're doing that or what that opportunity is? And then lastly, on video losses, just they were little better than what we expected. Anything different there in terms of maybe selling of skinny bundles or how we should expect that to trend as we look into '23? Thanks. Sure, John. So when we look at wireless, we actually do, it's a nice growth opportunity in and of itself. But the core real opportunity is to surround broadband, both residentially and commercially, as you brought up. You look at the opportunity, the road map, and Mike said, we just crossed the 5 million lines. But the way we look at it, when you include business relationships, we had 34 million broadband relationships. And you look at the amount of lines that the other competitors do, the lines per relationship, we're talking about an opportunity that's around 80 million lines over the long run. So we had a strong quarter in mobile, really strong quarter. Good momentum. This has been building, will continue. So it's a good runway. We really like our position. We like the core service offerings approach, the capital-light approach, buy the gig unlimited, different tiers of unlimited and then really leveraging best-in-class WiFi. So the mobile game plan is really to support broadband. We do see continued positive results. When you package the broadband with mobile, there is a churn benefit to that. And so we'll continue to really -- that's our -- part of our core strategy is to do that. And leverage is a feisty competitive marketplace in wireless. For those that are offering different kinds of offers will be there with bring your own device as well. So we got a really good balance towards. And business services is just getting going in mobile. We're excited about that, and there -- it's early but good progress. In video, it's a combination just less attach rate on the front end. That is really one of the main drivers. But when you look at churn, churn is better, and it continues to improve on the video side. And when you look at the combination of video and broadband right now, that combination of full disconnect churn, it's down over 20% against the -- since the pre-pandemic 2019 level. So we segment the marketplace. Video is an important part of the portfolio. We'll continue to market it where it makes sense per segment. But overall, that's the story around video. That concludes the question-and-answer session and today's conference call. A replay of the call will be available starting at 11:30 a.m. Eastern Time today on Comcast Investor Relations website. Thank you for participating. You may all disconnect.
|
EarningCall_1195
|
Hello, and thank you for standing by, and welcome to the Comerica Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakersâ remarks, there will be a question-and-answer session. [Operator Instructions] Thanks, Greg. Good morning, and welcome to Comerica's fourth quarter 2022 earnings conference call. Participating on this call will be our President, Chairman, and CEO, Curt Farmer; Chief Financial Officer, Jim Herzog; Chief Credit Officer, Melinda Chausse; and Executive Director of our Commercial Bank, Peter Sefzik. During this presentation, we will be referring to slides, which will provide additional details. The presentation slides and our press release are available on the SEC's website, as well as in the Investor Relations section of our website, comerica.com. This conference call contains forward-looking statements. In that regard, you should be mindful of the risks and uncertainties that can cause actual results to vary materially from expectations. Forward-looking statements speak only as of the date of this presentation, and we undertake no obligation to update any forward-looking statements. Also this conference call will reference non-GAAP measures and in that regard I direct you to the reconciliation of these measures on our website coamerica.com. Please refer to the Safe Harbor Statement in today's earnings release on Slide 2, which is incorporated into this call, as well as our SEC filings for factors that can cause actual results to differ. Thank you, Kelly. Good morning, everyone and thank you for joining our call. In 2022, we generated another year of record earnings. And in many ways it has been an inflection point for our company. Colleagues return the office reinvigorated, ready to support our customers and reimaging the way we work, and we delivered results. Strong broad-based loan growth and [management of loan] [ph] and deposit pricing and rising rate environment drove revenue to an all-time high of 3.5 billion. Prudent expense discipline generated an efficiency ratio of 56% and earnings per share increased to $8.47. Our strategic investments and balance sheet management helped produce superior returns and position us to maintain a high level of performance. Our refreshed logo and core values reinforce our commitment to being a leading bank for business complemented by strong retail and wealth management solutions. Investments in more collaborative workspace, digital tools, enhanced products, and streamlined processes better enable our colleagues to put our customers first, and create a more elevated experience. Striving to be a force for good in our communities, we have achieved approximately 85% of our three-year goal to provide 5 billion in small business loans and deployed unique solutions such as our Comerica BusinessHQ, which provides collateral space in the southern sector of Dallas. Publishing our inaugural TCFD report was an important milestone in our corporate responsibility journey and highlights our long-term commitment to sustainable business. The report outlines our climate strategy, including supporting our customers, integrating climate issues into our business and reduction of our environmental footprint. As of year-end, green loans were 2.7 billion, a [60%] [ph] increase over 2021, assisted by our renewable energy business, which has already exceeded expectations with almost 350 million in loss. Our commitment to corporate responsibility was once again recognized as we were recruited for a fourth consecutive year in Newsweek's 2023 list of America's Most Responsible Companies and also included as one of the greatest workplaces for diversity. [Volunteerism] [ph] remains a priority and I'm incredibly proud of the over 66,000 hours, our colleagues committed to positively impacting their communities. Slide 4 provides further detail on our full-year results. Relative to 2021, average loans increased 1.4 billion or 3% over 50 billion. Putting aside PPP activity, loans were up 4 billion or 8% our highest organic growth rate in well over a decade with contributions from most businesses. Following growth of almost 13 billion in 2021, driven by Government stimulus, deposits decreased 2.2 billion in 2022, as customers utilize the excess cash and we executed strategic pricing actions. Revenue increased 19% driven by higher interest rates and strong loan growth. Non-interest expenses reflect strategic investments, higher compensation in conjunction with favorable performance, and modernization initiatives totaling 38 million. Credit metrics were excellent as driven by net charge-offs of only 3 basis points and profitable assets remained well below our historical norm. In summary, a strong performance with an ROE of 18.6% and an ROA of 1.32%. In the fourth quarter, we generated earnings of 350 million or $2.58 per share is outlined on Slide 5. Our financial results were excellent with all-time high revenues of over $1 billion, up 4% over the third quarter. Average loans grew almost 1.3 billion, which includes a 329 million decrease in mortgage banker where volume has been impacted by higher rates. Average deposits declined 2.6 billion. However, balance has stabilized at quarter-end and we began to see some positive trends. Credit quality was exceptional with net recoveries and our percentage of criticized loans remains well below our historical average. We built reserves in conjunction with growth and a slightly more negative economic outlook. Expenses reflected investments in our business and support our revenue generating activities. It was a record quarter and a record year. We are excited about the investments we are making and [I want to] [ph] support our colleagues and customers, but also to sustain our strong performance as we move forward. Thanks, Curt, and good morning, everyone. Turning to Slide 6, broad-based loan growth continued and exceeded expectations with average balances increasing $1.3 billion or 2.5%. Commitments, which can be a good indicator of future loan growth increased 5% with contributions from both businesses. Utilization remained stable at 45% and remained below historical averages as commitment growth outperformed the increase in borrowings. Loans in our commercial real estate business increased nearly $880 million as the pace of pay-offs slowed and we fund the construction projects already in the pipeline. Consistent with our selected strategy, nearly all the growth was in Class A multi-family or industrial projects built by large developers that we know well, providing significant equity contributions typically averaging between 35% and 40% of costs. Credit quality in this portfolio continues to be excellent. Criticized loans remain extremely low and we see no meaningful signs of negative migration. With our bankers that average 20 years of experience, a proven operational process, stringent underwriting, and consistent credit monitoring, we believe our approach results in a conservative portfolio appropriately positioned to navigate the current environment. National dealer services loans grew over $300 million as a result of new relationships and continued M&A activity by our customers. We continue to see a slow rebound in inventory levels and with consumer auto demand dampening and supply chain improving, the industry anticipates inventory levels to continue increasing throughout 2023. Corporate banking, wealth management, and entertainment also exited significantly to our strong loan growth. Elevated interest rates, lack of housing inventory, and normal seasonality, continued to pressure mortgage banker as average loans declined $329 million for the quarter. MBA forecast showed volumes remaining at depressed levels through the first quarter before potentially increasing. Loan yields increased 81 basis points to 5.45%, primarily reflecting the benefit from higher rates. On Slide 7, average deposits declined as customers continued to utilize funds in their business and seek higher yield. However, balances under the quarter better than we expected as we adjusted pricing in conjunction with aggressive Fed rate hikes. The strategy work as the period end interest bearing deposits increased to $31.5 billion. While we did see a modest uptick in non-interest bearing deposits spike in the year, we attributed largely to traditional seasonality with elevated business activities such as customers preparing to make tax payments and distributions in the first quarter. We continue to believe future FLMC monetary actions are key to the timing of deposit stabilization. Our overall mix remained favorable with 56% of average non-interest bearing deposits, largely in operational accounts reflecting our commercial orientation. Our liquidity position was strong with a loan to deposit ratio of 75% below our historical average. Beyond deposits, we have significant capacity to support loan growth, including repayments in our securities portfolio and efficient borrowing channels such for [over deposits] [ph] and federal home loan bank lines. Interest bearing deposit costs averaged 97 basis points and reflected the pricing actions taken in the fourth quarter. Our dynamic pricing strategy will continue to balance our funding needs with customers' objectives and the rate environment. Average balances in our securities portfolio on Slide 8 declined $1.4 billion, primarily reflecting the full quarter effect to the third quarter's mark-to-market adjustments. In addition, we are not reinvesting paydowns and are instead repurposing those funds for loan growth. Relatively stable long-term rates resulted in a positive mark-to-market adjustment of $73 million at period-end. Our total net unrealized pretax loss of $3.0 billion affects our book value, but not our regulatory capital ratios. While we maintain the portfolio as available for sale, mostly for reporting purposes, we typically hold these securities to maturity in which case the unrealized losses should not impact income. Despite a reduction in the overall portfolio size, securities income remained relatively stable due to higher yielding MBS purchases in the third quarter, replacing the pay down of lower yielding securities. Turning to Slide 9, net interest income increased $35 million to a record 742 million and the net interest margin increased 24 basis points. The benefit from higher rates lifted loan income $102 million and added 52 basis points to the margin. Loan growth added $19 million and 3 basis points. Other portfolio dynamics added $1 million or 1 basis point, and while the market remains competitive, we have successfully maintained our pricing discipline. As I mentioned, securities income was relatively stable. As far as deposits of the Fed, higher rates partly offset by lower balances added $5 million and 11 basis points to the margin. Adjustments to deposit pricing reduced income by $63 million, while lower balances added 1 basis point. Higher rates on our floating rate wholesale debt in addition to our August subordinated debt offering had a $29 million impact. Altogether, the rising rates provided a net benefit of [$53 million] [ph] to net interest income. Credit quality remained excellent as outlined on Slide 10 with $4 million of net recoveries, along with a reduction in our already low criticized and non-accrual loans. In fact, inflows to non-accrual loans were only $16 million, one of the lowest levels in recent history. Loan growth and the weakening economic forecast drove the provision expense up to $33 million and the allowance for credit losses increased modestly to 1.24%. With our consistent disciplined approach, as well as our relationship model and diverse customer base, we believe we are well-positioned to manage to a recessionary environment. Non-interest income on Slide 11 was robust at $278 million and was impacted by volatility in the rate environment and equity markets. Deferred comp, which is offset in expenses, increased $9 million, generating a $6 million return for the quarter. Higher rates earned on funds associated with settling our internal derivative portfolio drove risk management income up $8 million. The quarterly [variance] [ph] in the Visa Class B total return swap along with the increase in car and brokerage all contributed positively to the quarter. As expected, customer derivative volumes slowed from recent strong activity and there was a $1 million favorable CBA adjustment, which is a $4 million reduction from the third quarter. Deposit service charges reflected positive momentum in treasury management, but they were more than offset by higher earnings credit and lower fees associated with deposit balances. Fiduciary income was negatively impacted by fees related to equity returns and BOLI had a seasonal decline of $2 million. Despite this quarter's fluctuations, we have a solid core product set delivering a strong level of non-capital consuming fee income with promising growth potential. Turning to expenses on Slide 12. We made significant progress towards our modernization objectives consolidating banking centers, enhancing corporate facilities, and achieving an important milestone and migrating our technology. In all, we incurred $18 million in expenses for the quarter, which is below the estimate we previously provided due to better than expected severance and asset write-downs. Excluding modernization and deferred compensation, which is fully offset, non-interest expenses increased $19 million. In support of our growth initiatives, we successfully attracted talent and continue to invest in products, further elevating our customer experience. Increases in T&E, legal and marketing were correlated with the strong business activity in the fourth quarter and driving future revenue with initiatives such as retail reimagined. Foundational investments in our infrastructure enhanced controls and compliance in this evolving landscape, as well as making us more nimble with regards to technology development. We have some inflationary pressures, including salaries for new staff and recent merit increases and saw seasonal increases in occupancy, marketing, and other related expenses. Overall, we successfully balanced investments and other pressures with accelerated revenue growth, resulting in a solid efficiency ratio of 53%. Slide 13 provides details on capital management. With record earnings, our strong capital generation outpaced capital needed for loan growth, increasing our CET1 ratio to an estimated 10.02%. As always, our priorities to use our capital to support our customers and drive growth, while providing an attractive return to our shareholders. We closely monitor loan growth, profitability, and credit trends as we balance maintaining our CET1 target of approximately 10% with our dividend and share repurchase strategy. Our common equity increased 2% benefiting from strong profitability and the impact from OCI losses was minor. Excluding the AOCI losses, our common equity per share increased over 3%. Also note that our tangible common equity ratio was 4.89%. However, excluding AOCI, it increased to 9.30%. Our outlook for 2023 is on Slide 14 and assumes no significant change in economic environment. We expect loan momentum to continue and produce another year of strong growth across all of our business lines, resulting in average loans increasing 7% to 8%. The pace of growth should be relatively consistent at 1% to 2% each quarter. We expect average deposits to decline 7% to 8% as customers continue deploying operational deposits or seek higher yielding options. We anticipate a seasonal decline in the first quarter followed by a partial rebound and then stabilization as we move through the year. Comparing fourth quarter [or] [ph] year-over-year, deposits are projected to be down only 1% to 2%. As previously mentioned, we continue to believe the timing and scale of deposit activity will be influenced by our [indiscernible] monetary policy and economic activity. With this uncertainty, forecasting deposit levels is very challenging. As we look at mix, we project an interest-bearing growth driven by strategic pricing actions. By year-end, we expect to be closer to our historical 50/50 deposit mix still very favorable. As far as pricing, we expect the first quarter to reflect the full quarter impact from rate actions we took in the fourth quarter. And after that, [indiscernible] should be more modest as we continue to focus on customer relationships, competitive dynamics, and our funding needs. We project strong net interest income, up 17% to 20% over our record 2022 level, which reflects the full-year benefit from higher rates, and we are assuming rates follow the 12/30 forward curve. First quarter will be impacted by two fewer days seasonal deposit outflows and continued deposit pricing actions. We expect net interest income to increase through the year as we continue to benefit from rising rates and loan growth in conjunction with expanding relationships and acquiring new customers. Credit quality has been excellent and we expect it to remain strong. Therefore, we forecast net charge-offs at the lower-end of our normal range 20 basis points to 40 basis points. Assuming the economy performs in-line with our expectations, we expect a gradual normalization in credit metrics and our reserve level. We expect non-interest income to grow 5%. Customer related income is projected to increase particularly in card due to our payment strategy and fiduciary income, which benefits from investments in our wealth management platform. Also, we forecast an increase in risk management income related to our internal hedging position. Note, this income will vary over time as rates move. Deferred comp was an $18 million drag in 2022, which we assume will not repeat. On the other hand, elevated volumes of customer derivatives that we saw in 2022 are not expected to continue. However, we believe they have stabilized at a strong level and are poised to grow over time. A reduction in our deposit service charges is expected due to an increase in commercial account ECA rates and adjustments to our retail NSF fees. We also assume [Boeing] [ph] returns to a historical run rate of approximately $9 million to $10 million a quarter and the $7 million CBA benefit does not repeat. First quarter is expected to be impacted by seasonality and syndication fees and we assume deferred comp of $6 million in the fourth quarter will not repeat. The second half of the year is expected to be stronger than the first as loan syndication activity, hard fees, derivatives, and other products trend up. Our 2023 expenses are expected to grow 7% or 4% on an adjusted basis, excluding the $64 million increase in pension, a $19 million reduction in modernization charges and assuming the $18 million in deferred comp benefit does not repeat. Drivers of the 4% include the annual merit increase and other inflationary pressures, as well as additional growth in cost tied to revenue generating activity such as higher staff levels and outside processing related to card. Further, we estimate a $15 million increase in FDIC expenses and higher software costs. We expect these headwinds to be partly offset by resetting performance comp to normal levels. First quarter expenses are expected to be lower with the decline in performance comp, seasonal declines in advertising and staff insurance, as well as other items that are expected to decline from an elevated fourth quarter level such as modernization expenses, deferred comp, and legal costs. Annual stock compensation is expected to partly offset these reductions. Remaining modernization expenses are expected to be weighted more towards the second half of 2023. We remain committed to prudent expense management, including investments we are making to increase revenue and enhance efficiency, evidenced by the efficiency ratio forecasted below 55% for 2023. In summary, we drove robust loan growth and fee generation in 2022. In addition, we benefited from higher rates while executing our hedging strategy and managed deposits, credit, and expenses. We generated record revenue and EPS, reduced our efficiency ratio, and delivered strong returns. Our fourth quarter has positioned us well for a strong 2023. Thank you, Jim. By leveraging our more predictable earnings stream, we are better able to strategically invest in our business and Slide 15 illustrates our roadmap. Along with our long-term strategies, these initiatives enhanced our ability to continue to exceed our customers' expectations. Modernizing our operations and further securing our foundation creates a stable, but agile platform enabling us to better address evolving needs. Enhancing our capabilities based on the voice of our customers allows us to invest efficiently driving fee income, retention, and new acquisition. Selectively exporting our business model to high growth markets capitalizing on our expertise and relationships to broaden our reach as we strive to grow at a faster pace in the economy. The calibration of our products, markets, and delivery is critical to sustaining our legacy while achieving our vision for the future. Slide 16 highlights our compelling story. Our business demonstrated ability to deliver broad based revenue growth and our pipeline, commitments, and product innovation creates growth momentum. As a leading bank for business, complemented by strong retail wealth management capabilities, we've got our five business mix and market strategy to create a unique relationship banking model. Tenure of our colleagues and customer relationship is evident in the success of that strategy. Credit expertise allows us to not only minimize risk, but also serve as a customer acquisition tool demonstrating our understanding of the business and needs. Looking into 2023, we expect another year of exceptional results. While we continue to make critical investments, which project positive operating leverage, maintaining strong profitability metrics, we've got our unique position in growth markets with a proven reputation for credit, expense, and interest rate management combined to create a powerful investment thesis for our shareholders. Hi, good morning. Thanks for taking my questions. I was just wondering for 2023, can you help us with how you expect your funding mix to evolve through the year? And as you mentioned, I mean itâs difficult to forecast deposit growth given the Fed actions in the overall environment. So, if you can help us with any updated thoughts on where you might be okay with your loan-to-deposit ratio going and how much flexibility you have there? Thanks. Good morning, Manan. It's Jim. I'll answer that question. Starting with the funding mix, it's really important to us to stay diversified, so we're using a variety of efficient funding mechanisms while keeping some dry powder for future loan growth. And so, when we look at what we plan to do in 2023, first and foremost, we are funding much of the loan growth and to the extent we have deposit run-off, we're funding that with securities that we are allowing to mature. That includes both MBS securities that mature at a somewhat predictable rate, as well as some lumpy treasury maturities that we have. Beyond that, we are getting a little bit more competitive with our deposit pricing, both in terms of retaining deposits and attracting deposits that might not be currently on our balance sheet. And then beyond that, we do have efficient lines of the FHLB, which we plan on using to some extent. We do plan on adding some broker deposits, not a lot, but we will add a modest amount likely at some point during the year. And so, we will use a variety of sources. We will keep a lot of dry powder on the sidelines to make sure that we can fund ourselves very efficiently going forward. In terms of loan-to-deposit ratio, it is currently well below historical levels at 75%. We expect it to continue to be below historical levels as we look out in the future, certainly for 2023. So, no concerns from that standpoint. And we feel really solid in terms of our ability to fund this loan growth and fund any deposits that might run-off. That's really helpful. So, for the securities paydowns, I know you mentioned it's about a billion â a little bit over a billion for next quarter, can you help us with how that evolves through the year? Are there any other [bond maturities] [ph] coming through in the second half? Yes, we would expect the MBS securities to continue to mature at a rate of about $450 million a quarter. We do have $700 million of treasuries that mature in the first quarter. And then we have another $300 million in the second quarter of this year. And then we have a very small tranche, I believe, in December, that won't be a big factor for 2023, but we should get somewhat of a boost from those maturing securities as they occur through the year. Good morning. I want to start, so the guidance applies NIM expansion on [indiscernible] again for the first quarter, and we know it's a very fluid situation, but from a big picture view, as we sit here today, how do you guys see the NIM trending beyond the first quarter? Good morning, Steve, it's Jim. As you know, we typically don't like to focus on NIM just because of our business model, and it does tend to be a little bit more lumpy than other banks. We like to focus on net interest income. But to answer your question, we do expect NIM to be relatively stable in the range that it was in the fourth quarter. It may tick up by a few bps as we see securities run-off with those lower-yielding securities, but I think where we're at right now in the fourth quarter is, kind of the area that we will likely hover in. Yes, deposit beta is moving, as well as, of course, the overall rate environment. We were about a 26% beta in the fourth quarter. Rates did continue to move through the fourth quarter. So, I would say, we were approaching 30% beta by the time you got to the month of December. We do think in the first quarter, we will start moving and eventually reach about a 35% beta. And for the full quarter average in the first quarter, I do think it will be in that low to mid-30s, pushing up to 35%. And then as we move through the second quarter, I do have us moving into the upper 30s, that does include going after some higher-price deposits to make sure that we can fund our loan growth in an efficient way. And then once we get through the second quarter, as we hover in that upper 30s, if we had some broker deposits, it could push towards about 40, I would then expect it to, kind of hold there, and that's about the time that rates peak also. So, that's kind of the trajectory we're assuming and that I see for deposit betas. Okay. That's very helpful. And then maybe for my final question. Just diving a bit deeper into the decline in non-interest bearing, you guys are citing customers investing in their business, but I'm curious how much is your customers chasing higher rate alternatives? And along those lines, up until this quarter, what we had heard from many of the regional banks was that treasuries were the key competitor, but what's coming up this quarter is that the regional banks themselves are really stepping up competition for deposits. So, how much are your customers chasing and can you talk about the competitive environment right now, particularly from peer regionals? Thanks. Yes. I mean â if I understood the question, you're dipping a little bit out in terms of volume there, but our customers, when they do look at the higher-yielding options, they are looking at off-balance sheet money market funds. And we are increasingly becoming competitive to make sure we can compete from that standpoint. And we think that's an efficient way to go. It's certainly better than wholesale borrowings for us. In terms of where the leakage is occurring, we do some surge deposits still in the DDA. And as we talk to customers and look at what's happening in the flows, it does seem like probably 40% of them â to the extent, 40% of the deposits that have gotten off the balance sheet are due to rate and then the remainder is, kind of due to funding CapEx, operations, and maybe a variety of other things. So, certainly a mixture. We do think, to the extent customers are using deposits to fund their operations. We view that as a very positive sign. It is consistent with the loan story. When you look at the strong loan growth that we've seen and we forecasted, but we are increasingly becoming competitive with money market funds where we feel we need to. Good morning, everyone. Just kind of a follow-up there, Jim. Are you seeing any cresting in deposit pricing pressures? Is it decelerating at all? I wouldn't say it's decelerating. I wouldn't say it's accelerating either. It kind of feels like it hit a certain pace in November-December, and the more price-sensitive customers have already asked to be repriced. So, from that standpoint, you could see the pressure start to step back a little bit. And some of these things â some of these are discussions that go on for several weeks. So, it's really hard to pinpoint exactly when it's [cresting] [ph], but it's certainly not accelerating, but I do see that momentum continuing probably through the first quarter in terms of exception pricing. In terms of what we need to do with standard pricing, it does feel like that maybe is abating a little bit, but there are always those exception customers that are out there, and I don't expect those to take a big step back over the next quarter. And we'll likely get more competitive intentionally so in terms of just going after customers that perhaps have moved their balances off balance sheet over the course of the last nine months. Okay. I know you just said you don't like to talk about the NIM, but I'll ask you about it in anyway. You're up 170 basis points year-over-year, and you're talking about stability, what kind of threats do you see to that NIM level? I know you've done a lot of hedging, but do you feel like that's a sustainable NIM level in, kind of varying up and down rate environments? I think the key to that is going to be DDA. That is really the wildcard, and it really has the ability to move net interest income a lot. You think about just $1 billion of DDA movement could create a $55 million drag in this forward curve environment. So, that is going to be the wildcard. So, we think we can hover kind of in the upper 3s, call it the low to upper 3s â or I'm sorry, mid to upper 3s, but more weighted towards the upper 3s, but I do think that DDA is going to be the key to that assumption and that outcome. Okay. Good. And then just one quick one to Melinda. Expected reserve build, how would you like us to think about that? It seems like credit is very clean. And obviously, you're talking about the lower-end of charge-offs. So, how do you want us to think about the reserve build? Yes, Jon, good morning. I would say that consistent with what we said last time, that if the economic forecast stays relatively stable, you're going to see continued loan â or reserve build that's really consistent with our loan growth. So, the reserve right now, we feel is conservatively positioned. We feel really good about it, and assuming no material deterioration in the economic forecast, I think that reserve build will approximate what we have going on from a balance sheet growth perspective. And the current assumptions on the reserve build is for â our baseline is a mild recession. So, I think we've adequately factored in what this current economic forecast looks like. And at this time, there are no further questions. I would now like to turn the conference back to Curtis Farmer, President, Chairman, and Chief Executive Officer. Well, we again say that I'm very, very proud of our record quarter. Thank you to all my colleagues for all they do every day. They take care of our customers and help our company grow. And thank you always for your interest in Comerica. I hope you have a good day. Thank you.
|
EarningCall_1196
|
Ladies and gentlemen, thank you for standing by. Welcome to the SEI Fourth Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded. Welcome, everyone. Thank you for joining us on today's fourth quarter 2022 earnings call. Joining me on today's call are Ryan Hicke, SEI's Chief Executive Officer; Dennis McGonigle, Chief Financial Officer; and the leaders of our business segments, Paul Klauder, Phil McCabe, Sanjay Sharma and Wayne Withrow. Kathy Heilig, SEI's Controller is also with us. Before we begin, I'd like to point out that our earnings press release can be found under the Investor Relations section of our website at seic.com. This call is being webcast live and a replay will be available on the Events and Webcast page of our website. We would like to remind you that during today's presentation and in our responses to your questions, we have and will make certain forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to our notices regarding forward-looking statements that appear in today's earnings press release and in our filings with the Securities and Exchange Commission. We do not undertake to update any of our forward-looking statements. Thanks, Lindsey. Good afternoon, everyone. I hope you all enjoyed the holidays and are off to a great start in 2023. Before the holiday season, we had the pleasure of hosting many of you in Oaks for our investor conference in November. I really hope everyone enjoyed that experience. Personally I was engaged and energized by the entire engagement of the investment community. I was really excited to share our vision and strategic focus for the future. We're going to continue to apply our proven business model by turning challenges into opportunities, helping clients and prospects more effectively deploy their capital for growth and leveraging our financial strength. During the quarter, markets continue to feel the impact of economic factors, including inflationary pressures, geopolitical tensions, fiscal policy and more. Fourth quarter revenues declined 9% from a year ago. Our fourth quarter earnings were down 23% from a year ago. Fourth quarter EPS of $0.83 decreased 19% from the $1.03 reported in the fourth quarter 2021. In the quarter, we repurchased 1.3 million shares of SEI stock at an average price of $59.36 per share. That translates into $79.6 million of stock purchases. We also declared an annual dividend of $0.43 per share. We continued to build off the third quarter's positive sales momentum, but we're still absorbing some losses that offset our wins. I feel very confident that we are turning the tide in a positive direction here, and we've spent a lot of time at key prospects and clients this year already. Net sales events totaled approximately $20.8 million, $10.9 million of which were net recurrent. During the quarter, we also had a successful execution of a recontracting strategy, resulting in more than $108 million of annual recurring revenue extended across our processing businesses. We expect to also remain surgical and vigilant in our expense management. I'm sure you all saw that one of the major themes coming out of [taboos] as companies say they are giving priority to profitability and efficiency amid concerns about macroeconomic conditions, whether that's to reach their strategic goals, slim down their workforces or streamline operations. The market, especially the tech and financial services industries are clearly making adjustments to spending and we are going to manage SEI well through this time, but lean into those investments where we have high conviction as to our ability to drive growth. We also see this time of catalysts and opportunities for SEI to more actively partner with existing and new clients to help them become more successful. Dennis will go into further details later on our financial results. Turning to our lines of business. In the Investment Managers segment, our alternative business continues to see our largest clients opportunistically launching new products. One of our large multi-strategy clients expanded in the private credit business, and a flagship investor platform client at a private equity business as well. In the traditional business, we continue to add new business in all product lines with both new and existing clients. In particular, our CIT business continues to thrive and expand. At a global level, we continue to grow our ETF, private equity and private debt business, primarily through cross sales with existing clients and successful new client wins. Turning to our Investment Advisors business. We began immediately leveraging the synergies between our U.S. asset -- of U.S. advisory business and our asset management distribution businesses globally. We are only a few months into this effort, but we are starting to make progress. We've integrated these business segments to better leverage competencies, aligning our talent and go-to-market strategies across segments. Although it is early in the organizational alignment, when we look at the market landscape from institutional clients to BD affiliated advisers to the growth of pure RIAs, we are excited about the future here and feel strong about our positioning. A key component of our strategy is the continued unbundling of our investment options paired with the conviction and oversight of our investment management unit, providing clients both flexibility and choice. Our ETF product line, the SEI systematic core strategies, strategic partnerships with Capital Group and Dimensional were not only top net cash flow contributors, but they're increasingly resonating with existing and new advisers and solving their client needs. Across this suite of solutions, we saw over $400 million in net cash flow for the quarter. The Institutional Investors segment experienced new client wins, which included SEI Novus. Revenue and profit during the quarter were directly impacted by capital markets and client losses. Capital market activity was related to a decline in equities, long-duration fixed income balances and alternative investments. But despite the volatile marketplace last year, OCIO sales in 2022 produced strong results. Asset values will be a headwind as we move into 2023, but we will remain focused on where we believe there are growth opportunities including selling and installing OCIO new business in growth markets, retaining current OCIO clients, further integrating SEI Novus and advancing the ECIO platform, integrating and leveraging SEI Private Wealth Management in our institutional business. In the Private Banks business, we had a very active quarter. We recontracted eight clients, including three in the U.S., four clients in the U.K. and one TRUST 3000 clients. Four of these eight clients were in competitive situations. Our contracts with Wells Fargo was resized as previously announced and our relationship has been extended until December of 2028. We signed three new names in the quarter, including Hilltop Bank and First Financial in the U.S. and we also implemented two clients that were in our backlog. We will continue to rightsize expenses in this segment and look to accelerate sales activity, including cross-sell opportunities across our markets. I'm acutely aware of the attention that has been paid to this segment in the past. The leadership changes we made last year, the aggressive increase in client engagement and expense management combined with a renewed focus on sales and what we believe are attractive segments for SEI make me optimistic that we have solidified the foundation for this business now for future growth. Highlighting some more positive traction in growth areas in our investments in new business segment, SEI Sphere continues to be a focus area with an aggressive growth plan for 2023. This includes increasing the size of the sales force, investments and marketing, accelerated activity with existing SEI clients and new prospects and increased traction in the cyber and cloud services offering. During the quarter, we also began building a corporate development team. They will be focused on the development and execution of our strategic transactions plan to drive growth. Finally, our partnership with LSV remains very strong. Dennis will report on their financial results for the quarter. As I've mentioned in these calls, we're also focused on initiatives and programs that support the development of our talent and enrich our culture particularly in diversity, equity and inclusion. We continue to invest in these areas as competitive advantages for SEI in the future. To echo my comments at the investor conference in November, SEI is going on offense in 2023. We'll focus on seizing opportunities that we believe will meaningfully drive growth and we'll continue to make the changes necessary to keep us on the path that we've laid out. 2022 was a year of organizational transition for SEI coinciding with the volatile market environment. We remain steadfast in our belief that we are well-positioned to not only help our client succeed, but continued driving our own success in the year ahead and beyond. This concludes my prepared remarks. I'll cover information related to the quarter for the company and units. As Ryan mentioned, EPS for the quarter was $0.83. This compares to a $1.03 during fourth quarter of 2021 and $0.45 for the third quarter of 2022. Revenue for the quarter was $457 million compared to $502 million in 2021 and $471 million in the third quarter. Total expenses for the quarter were $363 million, which compares to $358 million last year and $420 million in the third quarter. Excluding items related to the voluntary separation program and other severance, expenses for the third quarter were approximately $358 million. Expenses in the fourth quarter included $2.7 million of severance and $3.5 million in incentive compensation true-ups for the year. Revenues from asset management and administration were impacted by lower average assets during the quarter due to how we entered the quarter, capital market performance during the quarter and cash flows. Processing revenues were impacted by a one-time $6 million reduction in revenue, related to Wells Fargo, which was discussed on last quarter's call. On the sales front in our processing businesses of private banking and IMS net sales events totaled $25 million and are expected to generate $15.1 million in recurring revenue. In our asset management-related businesses, net sales were approximately a negative $4.7 million. Private banking processing sales were $10.2 million, of which $3.3 million is recurring. This reflects three new SWP sales, two in the U.S. and one in the U.K. We re-contracted eight clients during the quarter, representing $53 million in annual recurring revenue and an average extension of four-plus years. One of these re-contracts was Wells Fargo resulting in the recorded revenue reduction. One other re-contract was with a large U.K. client that extended our relationship for five plus years, while successful in retaining this client it will result in a current reduction and run rate revenue of approximately $7 million in 2023. We view this as an investment in the key relationships in the U.K., due to their long-term growth prospects and opportunities for us to grow this relationship overtime. This re-contracting item is separate from and not included in our sales results. At year end, we successfully installed two clients on SWP. The current backlog of sold, but expected to be installed revenue in the next 18 months is $40.1 million. Asset management revenues and private banking were up slightly during the quarter as a result of positive flows of approximately $500 million. Expenses in the quarter were down from the third quarter of 2022. This reflects our focus on expense management as Sanjay and his team reset the business for growth. On the IMS front, net sales for the quarter were $14.8 million, $11.7 million is recurring. The quarter sales activity remains active, reinforcing our belief that the trend of outsourcing is continuing to grow. During the quarter, we re-contracted 15 clients totaling $55.2 million in annual recurring revenue, with an average length of over three plus years. Revenue for the quarter was flat to third quarter, reflecting the impact of capital markets offset by client installs. We continue to see growth within many of our top clients. Expenses were up slightly from the third quarter, reflecting continued inflation pressures, growth in our talent and a true-up on incentive compensation for 2022. Our backlog of sold, but expected to install in the next 18 months recurring revenue is $32.9 million. For Investment Advisors, net cash flow was approximately negative $675 million. This number reflects increased momentum in strategic initiatives, we have launched over the past two years. Offset by negative flows in mutual fund products. Activity included custody assets on the platform increased $473 million. Our dedicated RIA team produced $66 million in net positive cash flow and cash flows in the portfolio is built on our ETF strategies and our dimensional offering was approximately $350 million. Our newer offerings are helping us move the business forward and to offset the negative flows we see out of mutual funds. Revenues for the quarter were down from third quarter as a result of asset levels entering the quarter, capital market performance during the quarter and net flow activity. Expenses were up slightly due to inflation and year-end activity. We recruited 34 new advisors during the quarter, 15 of which were in the newer RIA channel and reengaged 13 existing advisory firms. Advisor activity remains strong, but we continue to see a slowdown in market activity on the part of both advisors and their clients. In the Institutional Investors segment, OCIO net sales events for the fourth quarter were essentially flat. The unfunded client backlog of gross sales at quarter end was $2.5 billion. Revenues for the quarter were down from third quarter due to capital market activity, offset partially by net positive client fundings. We continue to see pricing pressure across all institutional markets and continued headwinds in the corporate PB segment globally. Expenses were also down reflecting reduced direct costs as well as general expense management. In the Investments in New Business segment, revenues and expenses were flat to third quarter. We had net recurring sales of $500,000 in the quarter. We expect expenses in this segment while shifting to and supporting new initiatives to remain in this range. LSV produced $31.7 million of profit during the quarter. This compares to $26.7 million during the third quarter. Revenues for LSV were $107 million compared to $91.6 million in the third quarter. LSV recorded performance fees of $13.4 million during the quarter, reflecting strong positive relative performance. The growth in revenues is a result of investment performance and capital growth in assets offset by net negative client flows. Net sales were down slightly, while net flows from existing clients due to de-risking and reallocation were negative $2.3 billion. Market appreciation was approximately $12.8 billion. LSV continues to have active sales activity and continued positive performance will help that. Our tax rate for the quarter was 18.1%. That concludes my remarks. As a reminder, all of our unit heads are on the call. Just a couple of efficiency-related questions, so first on the quarter, it looked like it came in a little bit lighter than usual on margins. So just wondering if you could give us some color on how we should interpret the trajectory for pretax margin? And if there's not a rebound in markets this year, are there any expense items that you could flex lower? Sure, I mean margins given the nature of our - the predominant nature of our revenue streams being asset-based, when we have these down markets, and we're - most of our revenues are average asset base. So the market might be up kind of point-to-point. But in between, there's a lot of activity, which results in kind of lower average assets. That's revenue that really comes right off the bottom line. So margin compression is somewhat a function of that. I'd say in the quarter, though yes, we did have good expense management overall and did that in the context of maintaining the investments and the things we know are important and feel really and critical to our future growth prospects. If we have downward pressure, continued downward pressure on markets, we do have some variable costs that we'll adjust based on assets that's, kind of the first expense item on our P&L. Beyond that, a big chunk of our compensation is variable. So we certainly have the ability we felt necessary to adjust that based on company - overall company financial performance as the year goes on, we've done that say, under other periods under extreme market pressure we've made those adjustments. We do have some variable spending, if you will on things that we could hold off on if we chose to. I'd say that our general rule of thumb, though is difficult markets - do end. And when we come out of them, we want to be in this position of strength to take advantage of markets reopening and clients and prospects moving back to making business decisions on our side. So we wouldn't give up - certainly would never give up the future and the opportunities the future presents in tougher market cycles. Well, not as so we've been through it before and everybody around this table has been through it before. So we'll work - our way through it. Thanks that's clear. And then just one follow-up, the press release called out greater investments in compliance infrastructure. Can you just help us understand what that is? And is that a one-time build or is that a multiyear build that would be helpful? Thanks. I'd say it's really just a continuation of what businesses like ours have been facing over the past say five, 10 years, but certainly accelerated over the past five years. And that's really our ability to meet the compliance requirements of the regulatory frameworks within which we have to operate in all the jurisdictions we have to operate and also making sure that our knowledge of those compliance requirements makes their way into the products and services we are delivering to clients because they are also dealing with those same regulatory compliance pressure. So it's almost - first we have to digest the meal and then we can share the meal with the clients after we digest it. And if you look around the globe, whether it's the U.K., Ireland, Europe, the U.S., Canada, the regulatory pressure every client just continue to build. So that's really what that referencing. And also, I'd say that there's been continued shift of in many jurisdictions where they want the regulatory work to be local, locally done rather than centralized outside of their domain. So that's adding a little bit to the - or has added over time, a little bit of the cost pressure. Thank you for taking my question. Ryan, during the Investor Day, you have identified some area for growth such as outsourcing and partnership opportunities, cybersecurity and RIA. Could you please talk about if there's any particular growth area that you would focus on in 2023? Thank you. Sure Owen. Good to hear from you Happy New Year. I kind of take those in stages. So if you look at our focus on - I'll come back to the outsourcing one in a second. You looking at something like cyber, that's the SEI Sphere business that I mentioned in the call. We've actually increased our sales force there, added a little bit more in terms of our capabilities in the cyber and cloud offering and actually really started to get more aggressive taking that service out to existing clients. In the RIA space, Dennis talked about in Wayne on the call, yes we have a dedicated team there we put in place last year. We're really starting to see some positive traction and momentum in flows from that segment. When you look at the total addressable market and the size and breadth of that segment, it is definitely an area where we really feel that we compete well that our value proposition aligns and that we actually are a little differentiated. Because of our ability to kind of unbundle the technology, the administration and the manufacturing with our open source solutions and our own manufactured solutions. We feel very good there. And it's interesting on your kind of outsourcing point in the first box from November, I was thinking about this the other day that right in the outset from April through, I'd say, July, without seeing a lot of our clients, and I would call that a little bit more of a listening tour. Now we're on kind of round two of those. Bill and I were just on the road last week and it's a little bit more of a growth tour. And that - those conversations with two of our larger clients last week are more about how can we be doing more together with them? Where could SEI add value? Where do they want to deploy their capital? And those conversations, I think, are actually starting to happen in a more widespread way across all SEI client bases. So that's something that I get excited about because our engagement with our top clients has been really strong. We have a lot of clients coming on campus in the next 30 to 60 days. But I think that transition is, key there. And then the fourth area, Owen, that we talked about in November was alternatives, and we will continue to lean in that space, not just through bills, business and IMS. But in terms of how SEI creates more opportunity from a manufacturing perspective around alternatives and where we believe we can facilitate more capabilities with our position with technology between the manufacturing space and the distribution space, especially in the U.S. So long-winded answer to your simple question, we are really focused in those four areas to varying degrees of traction, but it feels good. The client engagement is very high right now. Got it, that's super helpful. And then maybe - Dennis just a housekeeping question about the interest and dividend income, I saw there was a $6.6 million interest and dividend income. How should we think about this line item going forward? Thank you. Well, it's really - I mean, Owen I mean it's pretty simple the interest rates go up. We're earning more on our cash. Now we're not - certainly don't view interest income is how we're going to drive growth. But as long as if interest rates stay where they are or continue to creep up and our balance sheet kind of stays under its current construct and interest income will improve. So... I'm sorry. The interest income we earn on our balance sheet is really comes from the cash we have on deposit were invested in money market funds or other cash instruments. That's where -- that's all that is. Hi, good afternoon. I guess, first, I wanted to just follow up on the margin question. How are you guys thinking about the longer-term operating margin for the business? And then maybe more near term for 2023. I guess came in closer to 20% this quarter, but it was closer to high 20s, more so historically. Is that where it should trend back to eventually? Mike, I'll answer first and then Ryan will tell me whether I got this right or not. My expectation is the margins will trend more to where they have been historically. We have different businesses operating. We certainly have an expectation that the private banking margins will improve over time. That's really what Sanjay has been working and his team are working on kind of resetting the business, bedding down the kind of revenue picture on the client side and making some progress on the spending side. So there's certainly expectations for us that, that business will -- has been reset in the late stages of being reset. And as we grow it, we'll capture more margin. The IMS business, I think you'll see everybody is on the call, they can comment as well after I'm done. That business is kind of a mid-30s, 34% to 36% margin business. Typically, when it's creeped up to the high 30s, that's more of an anomaly than kind of how we see the business operating. And we expect the margins to kind of be in that 34%, 35% range over time. And these are all market neutral comments. So Investment Advisors, I think, is one area where we're going to be consolidating the AMD, the asset manager distribution components of revenue and profits with the adviser channel, that will have a dampening effect on the margins just because of margins in the asset management distribution business and the types of clients we serve there in the global nature and how we report revenue and expense in that business because the sub-adviser cost for the non-U.S. assets are an expense item on the P&L. That runs at a lower margin business than adviser business has run historically. So that will have a little bit of a dampening impact just on the math corporate margins, it should have an impact. But there, given the mix of business over time, as Wayne talk about some new types of products and capabilities of strategic asset offer versus mutual funds as a straight-up product, the margins on those products, as well as selling custody-only assets onto the platform with a lower price point. We always expected the margins in that business to contract slightly, but with an expectation that it will be a much bigger business. So kind of higher dollar profit, slightly lower margins. And then couple that with the institutional business, which has always been a high-margin business. But with the compression of revenue, and as I mentioned and Paul has mentioned many times, the pricing competitiveness in the market, while that's been kind of a 50%, high 40s percent margin business, their margins will probably track a little bit over time, but with market success, again, dollar profits should improve. So overall margins, I would expect them to be kind of in historical ranges, but for different reasons than maybe they have been in the past. Mike, I don't have anything to add to that. I think Dennis captured it all. And I think kind of echoing an earlier point, we have a good understanding and a good track record of how to operate the business in kind of difficult times. We're going to continue to operate with courage and conviction in the areas that we believe we want to invest for the future. But I also think, as Dennis mentioned, with Sanjay and the team have done the last nine months to really stabilize private banking, and we can grow off that point will also help to offset some of the areas where we might see some compression. But that compression will be driven by growth of new solutions, which would be a good thing. Okay. Thank you, Dennis and thank you, Ryan. To switch gears to the recontracting actions. I'm good to hear that you've been able to extend those relationships and thanks for quantifying some of the impacts there. How do you -- how should we think about what's the opportunity with some of those specific clients to cross-sell and will deepen the relationship there? Is there opportunities to mitigate some of those recontracted headwinds here give some specific examples that would be helpful. Thank you. Sure. Okay. Thank you. What I would say on a recontract side is actually we did really well. It was 15 different clients. It was about $55 million in revenue, for the most part, a little bit more than three years on average and fees stayed pretty much the same. In some cases, we sold some new products and services. So for us, it was really good. I think if you look at IMS for the quarter, our sales were about $14.8 million, and that was pretty much 50-50 between cross-sell and new business. So the pipeline is strong. The clients are doing really well. I mean I think we're in a really good place right now. Sanjay? Yes. Thank you, Phil. I would echo Phil on the similar lines. When I took over private banking responsibility back in kind of Q2 of last year or so, one of the key up was to retain clients, engage our clients and grow with the client's growth. So based on that, we came with the startup of how we ensure that we fix the leaky bucket but because we've seen that happening in the earlier phases. So we came with the strategy, engaging with the clients and that was the result of those initiatives that in the fourth quarter, we could recontract eight clients. And if I quantify those recontracts except one client, we are pretty much neutral. So except one client where we made -- again, it was a part of our strategy that how we can grow with that client that specific client was looking at consolidating their vendor partner footprint and looking at the growth opportunities. And I'm very pleased to say that, yes, we were selected as one of the strategic partner there. And now we are working actively with that client to come with a road map in terms of how we can grow together. So as I would bring it back that the recontracting is a part of our growth strategy, so that we can cross-sell and port banking especially in that segment, it can open up the rest of SEI capabilities as well. And Mike, the other thing I would add to what Sanjay and Phil said is that this is kind of more of our -- there aren't kind of change internally is as I mentioned earlier, we have three or four organizations coming in the last week in February alone with their executive team for an Oaks visit. They're going to be meeting with a lot of people around this table as opposed to just the unit head, who has the client relationship. So I think that whole posture and positioning has changed for us so that when clients are on site or we're out seeing clients, there's a little bit of a broader representation of SEI leadership and engagement there so that we're positioning the company and not just a unit. And I could tell you, I mean, activity doesn't necessarily always equate to results, but we have the right activities right now, and we're getting the right level of engagement. I think the clients have actually been super receptive a broader conversation around the capabilities that SEI can bring to bear to help them succeed. Thank you. Appreciate your participation on the call today. I'm personally energized by the opportunities that lie ahead for SEI. We will continue to focus on leveraging our reach, driving sales and profit growth, capitalizing on market trends but also helping clients maximize their opportunity right now and delivering what the market values. I appreciate everyone attending our call today. Thanks. That does conclude our conference for today. Thank you for your participation and for using AT&T conferencing service. You may now disconnect.
|
EarningCall_1197
|
Welcome to this Ãrsted Q4 2022 Earnings Call. [Operator Instructions] Today's speakers are Group President and CEO, Mads Nipper; and CFO, Daniel Lerup. Speakers, please begin. Thank you very much, and welcome to this call. As you may have seen from our pre-released earnings two weeks ago, we achieved a record-high operating profit in 2022 despite the unusual and very volatile market conditions. Our financial performance is supported by a fleet of assets, continuously operating at excellent availability rates and contributing to the security of energy supply across all markets in which we operate. This shows the benefit of our strong operational portfolio and the diversification of our asset base. Based on the financial results, the Board of Directors will recommend to the Annual General Meeting that a dividend of DKK 13.5 per share is paid for 2022. This equates to an 8% increase in line with our dividend policy. On that note, let me dive into the strategic progress we achieved during 2022, starting with our offshore business. In August, we commissioned the world's largest offshore wind farm, the 1.3 gigawatt Hornsea 2 project in the U.K. This is a very significant milestone, and I'm very proud of the entire team who are under very challenging conditions with COVID-19 delivered this project. Furthermore, we progressed the construction of the Greater Changhua 1 &2a project, which is our first large-scale offshore wind farm in the Asia Pacific region. We achieved first power in the first quarter of 2022 and expect to fully commission the project in the second half of 2023. In the U.S., we took final investment decision on our South Fork project, and we are well on track to meet commissioning in 2023. In addition to progressing with our construction portfolio, we made significant progress within our development and opportunity pipeline. We were awarded a contract for difference for the 2.9 gigawatt Hornsea 3 in the U.K., which will be the world's single largest offshore wind project. In addition, we formed a partnership with Copenhagen Infrastructure Partners to develop up to 5.2 gigawatts of offshore wind in Denmark across fur open door projects, and we applied for permits to build four additional large-scale offshore wind farms in Sweden, bringing our Swedish portfolio to a potential total capacity of 18 gigawatts. We also took tangible steps into floating offshore wind with our 100-megawatt floating project, Salamander in Scotland and our partnership with Repsol to explore the joint development of floating offshore in Iberia. Additionally, we are part of the joint venture behind the Scottish Stroma, which in 2022 was awarded a site for approximately 1 gigawatt of floating offshore wind on the Northeast Coast of Scotland. As a testament to the value of our current project portfolio, our farm-down strategy once again proved its attractiveness with the completion of the farm-down of Hornsea 2 and Borkum Riffgrund 3. On top of our firm pipeline which is defined as our installed decided and awarded capacity comes a number of pipeline opportunities within bottom fixed and floating offshore wind as well as Power-to-X. In our onshore business, we continued our strong growth trajectory as we commission 0.8 gigawatts and advanced seven projects with a combined capacity of 1.4 gigawatts to final investment decision, including the 600 megawatt solar and storage project Eleven Mile and the 471 megawatt solar project Mockingbird, both in the U.S. In addition, we expanded our growth platform in Europe with the acquisition of the French German developer Ostwind and four partnerships in Spain to pursue early-stage solar PV and onshore wind projects, which gives us a strong presence across key renewable growth markets in Europe. In combination, these efforts increased our firm capacity of an onshore with more than 30% during the year. Furthermore, we closed our first ever onshore farm-down by agreeing to divest 50% of our portfolio of four onshore projects in the U.S. Similar to our strong farm-down track record in offshore, the transaction secured an attractive net present value retention and provided proceeds which we can reinvest into value-creating growth. Within our Power-to-X business, we achieved several key milestones throughout the past year. We acquired the remaining 55% of the FlagshipONE project and took the final investment decision. The facility will have an electrolyser capacity of 70 megawatts and will be the largest e-methanol facility in Europe. Furthermore, we signed a landmark Green Fuels agreement with A.P. Moller Maersk to partner for a project, delivering 300,000 tonnes of e-methanol per year in the U.S. It is also worth highlighting that our - both our Green Fuels for Denmark project and our Haddock Project in the Netherlands received PCEI funding in 2022. PCEI is standing for International Project of Common European Interest. The strategic progress meant that our firm capacity increased with 4.5 gigawatts during 2022 to 30.7 gigawatts. In addition, our substantiated pipeline across offshore and onshore projects and opportunity pipeline in offshore increased with more than 25% to roughly 85 gigawatts. There is no doubt that green energy is the most - impactful solution we have for fighting global warming, and we need to speed up the build-out of renewable energy. But it is also becoming evident that took succeed with the green transformation, we must create positive impact on nature and people to ensure we solve key environmental and societal challenges and maintain public support for the green build-out. Ãrsted has set industry-leading sustainability commitments and as part of reaching our science-based target of having net-zero emissions in Scope 1 through 3, we became a founding member of First Movers Coalitions near zero concrete commitment and entered into a partnership with Worldwide Life Foundation to improve ocean biodiversity. The world is facing a climate crisis, and it is indisputable that a transition to a sustainable energy system is needed. We continue to be part of this much needed renewable energy build-out and with a significant strategic results across our business, we remain confident in our long-term financial targets and growth ambitions. Let's turn to Slide 4. Throughout 2022, the renewables industry has been challenged by continued supply chain bottlenecks, cost inflation and slow permitting of new projects. Despite all these challenges, renewable energy continues to be significantly cheaper than any fossil fuel alternative even with challenged supply chains, and it is further more likely to be the best possible insurance policy to avoid future energy price increases like those seen last year. Therefore, action must be taken to increase the pace of the necessary investments in renewable energy, and we need to push regulatory and political barriers to focus on fast and streamlined permitting processes which today continue to represent a major bottleneck within our industry. In light of this challenging backdrop, we are pleased to see that the political attention and support towards the renewable build-out has been significantly positive development during the past year. In Europe, we have seen different political initiatives such as the adoption of several Fit-for-55s, the repower EU, the SPI declaration and the Marine Board Declaration, And more recently, the European Commission announced the planning of a Green Deal industrial plant, which will be aligned with the 2050 climate targets and provide significant opportunities for the renewable energy sector. Included in the Green Deal Industrial Plan is the Net Zero Industry Act, which is focusing on regulation to scale development of green energy, supply chains and raw materials. Additionally, the plan is focusing on changes to state aid rules to counter relocation of industries and investments, in skills and workers and last - year, international trade with focus on protection against China. Such initiatives would be incremental, positive for the renewable industry within Europe, which would benefit from the increased EU support and - as well as easier access to national funding made available through relaxation of EU State aid rules, which should, of course, be done in a way that preserves fair competition. In the U.S., an important step has been initiated by passing the U.S. Inflation Reduction Act providing US$385 billion in funding for renewable energy generation, green hydrogen production and climate risks over the next10 years. The Inflation Reduction Act is one of the most important climate initiatives since - they compares agreement and will make a tremendous difference for the green transition in the U.S. with historic investments into clean energy especially in light of the current environment where offshore projects are challenged. In Asia Pacific, we also see good progress with firm offshore wind capacity built out targets in Taiwan and green new deal in Japan. Australia has announced regulatory changes to progress offshore wind power with political momentum for renewable energy solutions. We fully recognize Australia's strong offshore wind potential and backed by supportive policies and momentum for green energy, Australia has all the ingredients for a thriving offshore wind market. Looking across our portfolio, we are well positioned to tap into the political support due to our significant presence within onshore, offshore wind, solar PV hydrogen and storage. Through our 30-plus years in the industry, we have established a strong global presence with trustworthy stakeholder relations across the supply chain, local communities, unions, governments and policymakers. We have strong competence within development, construction, operations and maintenance and I have more than 8,000 dedicated colleagues who go to work every day to bring us one step closer to a world advance entirely on green energy. Moving to Slide 5 and the outlook for offshore wind auctions in 2023. Throughout 2023, we expect to see numerous auctions and tenders across all three regions where we are present. More than 25 gigawatts is set to be auctioned during 2023, which underlines a strong growth outlook for offshore wind. On top of this build-out, we continue to see a significant increase of open door opportunities across European countries, which greatly increases the addressable market for the build-out of offshore wind. We expect to see continued growth in the long term with an expected global offshore wind build-out of more than 20 gigawatts yearly towards 2030 and more than 30 gigawatts yearly between 2030 and 2035. With an annual growth rate in installed capacity of 20% over the next ,decade we see ample opportunities to fulfill our ambition of adding around 3 gigawatts of offshore capacity to our portfolio yearly, exactly like we did in 2021 with additional 4.5 gigawatt capacity and 2.9 gigawatts in 2022. However, I will reiterate a word of caution being that in light of the supply chain bottlenecks, cost inflation and increasing cost of capital, it is essential that we see the contracted prices in auctions and tenders reflect the realities of the current inflationary environment. Otherwise, the necessary investments in renewable energy are at risk of slowing down and caused a devastating loss of momentum for the green transformation. On that note, we are encouraged to see that Massachusetts removed its price cap and that improved framework conditions for the ORIX [ph] have been launched in New York, Rhode Island and New Jersey as inflation index mechanisms are being implemented to counter some of the adverse impacts from the unprecedented increase in interest rates and cost inflation. In a response to New York State's third round of offshore wind solicitations, we have submitted a proposal which include multiple bids with different configurations. We applaud the high number of auctions and tenders both near term and long term. As a direct consequence of the unprecedented cost inflation and rapidly increasing interest rates that the industry faced in 2022, we had to incur an impairment of our U.S. development project, Sunrise Wind. As the project is the last project in our execution pipeline towards 2025, the project faced specific challenges compared to the rest of the portfolio and the project experienced acute cost increases, specifically driven by the prices for installation business and the associated services. On a portfolio level, we have locked in around 90% of the cost of the projects towards 2025. Moreover, all pre 2025 COD projects have a positive forward looking net present value on an individual basis, and we currently assess that this portfolio has positive life cycle net present value, assuming 40% ITC. As we have previously noted, we continue to explore all options to improve the business cases including ways to have more robust top lines. Notwithstanding the Sunrise Wind impairment, I want to emphasize our continued commitment to Sunrise Wind and the rest of our U.S. offshore wind portfolio. We are developing the largest portfolio of U.S. - of projects offshore in the U.S. with seabed leases secured many years ago at very low costs, which we will leverage for future offshore wind solicitations in the U.S. like the very recent New York 3 auction. With our unique global presence, we will assess the opportunities across technologies in existing and new markets to make sure we efficiently prioritize our capital allocation, and we will continue our strong focus on value creation and financial discipline when bidding into auctions and tenders. Thank you, Mads, and good afternoon, everyone. Let me start with Slide 6 and an overview of our full year EBITDA for 2022. As we did release our operating earnings two weeks ago and today confirm these numbers, I will not go into many details on the EBITDA. For the group, we realized a total EBITDA of DKK 32.1 billion including new partnerships. This is a record high EBITDA and the achievement should be considered in light of macroeconomic headwinds, high volatility within the energy markets, as well as adverse impacts from our hedging program. Excluding new partnerships, our EBITDA amounted to DKK 21.1 billion, which exceeds our initial expectations for the year. In fact, this number includes a negative effect of DKK 1.3 billion from IFRS-9-related ineffective hedges, which will improve EBITDA in future periods. When excluding these temporary IFRS-9 adjustment, we achieved a group EBITDA, excluding new partnerships, of DKK 22.4 billion, which is an increase of more than 40% compared to last year. As highlighted during the conference call a few weeks ago, our earnings composition for 2022 was considerably different from our initial expectations. This was primarily driven by the high volatility and increase in power prices as well as adverse hedging impacts. However, the developments within 2022 have demonstrated the earnings robustness of our diversified asset portfolio. The financial outperformance of initial expectations is driven by a strong performance within onshore as well as our Bioenergy and Other segment. Our Onshore division have operated at high availability rates throughout the year, increased generation capacity and managed to secure favorable prices during the ramp-up phase of assets under construction in the U.S., as well as benefiting from upside sharing mechanism within some of our PPAs. Within our Bioenergy and Other segment, we have secured attractive earnings within - sorry, we have secured attractive earnings within our gas activities and benefited from the higher power price levels. Finally, we remain confident in our long-term EBITDA growth towards 2027, where the combination of our operating assets and projects to be installed will secure a high degree of earnings visibility. Let's continue to Slide 7. For Q4 2022, net profit totaled a negative DKK 0.3 billion. Contrary to Q4 2021, we did not complete any farm-downs. And in addition to this, the impairment related to Sunrise Wind reduced the net profit for the quarter. Adjusting for these effects, net profit for the period was significantly higher than last year, driven by a higher EBITDA. Our return on capital employed came in at 16.8%, which was an increase of 2 percentage points compared to last year, driven by a higher EBIT over the 12-month period and significantly ahead of our long-term target. Throughout the fourth quarter of 2022, we saw a significant increase in our equity, which ended the year at DKK 95.5 billion. The increase is driven by hedges going into delivery and the lower power prices. With this, the hedge reserve decreased with more than 50% during the quarter. The remaining negative hedge reserve will be matched by higher future revenue from the underlying assets when the contracts fall into delivery. Around 30% of this hedge reserve will materialize before end of 2023 and thereby gradually increase our equity. Let's turn to Slide 8. At the end of 2022, our net debt amounted to DKK 30.6 billion, a decrease of DKK 15.1 billion since end of the third quarter. Our cash flow from operating activities was significantly impacted by net cash inflow from collateral postings amounting to DKK 17.4 billion, which is driven by the reduction in forward power prices. By the end of December, we had posted a total of DKK 14 billion in collateral payments, where the majority will unwind over the next 2 to 3 years. During the quarter, our gross investments totaled DKK 9.8 billion, primarily driven by our investments into construction of offshore and onshore projects. We received a payment from a partner related to project development and lastly, saw a positive effect from issuance of hybrid capital and an exchange rate adjustment due to decreased pound, sterling. Our key credit metric FFO to adjusted net debt stood at 43% for the full year of 2022. The level was above last year, primarily driven by higher EBITDA. Let's turn to the next slide. For the full year 2022, our taxonomy aligned and eligible share of revenue was 73%, our share of OpEx was 80% and EBITDA was 85%, and the share of gross investments was 99%. The non-eligible part of our revenue primarily relates to our long-term gas legacy activities and non-eligible power sales. Green share of energy came in at 91% compared to 90% last year. The development was primarily due to more wind and solar farms in operation as well as higher wind speeds. As we've been ordered by the Danish authorities to prolong the operation of the SBI Power Station beyond Q1 2023 and resume operation of the coal-fuelled unit Studstrup [ph] and the oil-fuelled Kyndby Peak Load Plant. This will expectedly have a negative impact on our green share of energy and our taxonomy aligned KPIs in '23 and '24. The order requires that we operate the units until June 2024, and we, therefore, maintain our commitment to become carbon neutral by 2025. Turning to safety. We regrettably do not see a performance which is up to our expected standards. As our total recordable injury rate is at 3.1 for 2022. We have seen more recordable injuries with our contractors, partly offset by a minor reduction in recordable injuries for our own employees. We continuously work to improve and promote a safety culture and especially in light of the latest trend, we've implemented several initiatives such as increased leadership enrollment, safety stand-downs and targeted safety campaigns on specific issues. Let's turn to Slide 10. Throughout 2022, we've seen material unintended and adverse impacts to our financials due to our previous hedging framework. These impacts have related to over hedging, temporary IFRS-9 adjustments, as well as inflation indexed power purchase agreements. We have learned the hard way that our previous risk management framework was designed for very different market conditions and had ended up being too complex. Our updated hedging framework will significantly reduce the risk of adverse hedging impacts in the volatile market conditions we are seeing and instead support the high predictability of earnings that our portfolio of renewable energy assets is capable of delivering. Historically, our hedging framework has served us well, as it has provided us stability and visibility of earnings. However, it was designed for risk management and earnings optimization under fundamentally different market conditions than what have prevailed recently, illustrated by the extreme increase and volatility of power prices over the past few years. To adapt to the unprecedented market conditions with high volatility and significant increase in power prices, while also better reflecting our current business composition, we decided to seize all new hedging activities end of 2021 and conducted an extensive revision of our hedging framework. The design criteria were based on some of the key learnings that we have made over the past year. First, it has been crucial to reduce our hedge level so we significantly reduced the risk of having to buy back hedged volumes. Second, we have seen a significant increase in the amount of the collateral that we have had to post related to our hedge portfolio. We have experienced a significant drag on our liquidity. And throughout the year, we took several proactive steps to ensure a sufficient level of liquidity to meet the collateral requirements while also supporting our ongoing build-out and operations. It has been a key condition for our new framework that we significantly reduced the risk of having to post collateral to a similar extent in the future. Finally, our previous framework was highly systematic and methodical in the sense that we would strictly follow our hedging stair case by meeting fixed hedge levels at given time horizons. However, we've come to learn that we must introduce more flexibility into the framework such that we can maximize value and support commercial initiatives, for instance, by locking in power prices above the levels that are assumed in the business case. If we turn to the next slide, where I will cover the updated framework based on these design criteria. Even with the significantly increasing power prices, we continue to have a very high share of EBITDA coming from long-term regulated and contracted activities. Going forward, we will hedge no more than 70% of the remaining limited merchant exposure from our offshore and onshore assets within the current and the following calendar year. With this approach, we will significantly reduce the risk of unintended adverse hedging impacts in the future, including lower risk of over hedging, lower collateral postings, as well as a reduced impact from temporary IFRS-9 effects. Based on historical wind and production data, we can conclude that our former very high hedge requirements resulted in overheads volumes in 1 of 3 months, while a hedge level at 70% would lead to over-hedged volumes in 1 out of 20 months. This is a much more comfortable probability especially given current market volatility, elevated power prices and increased renewable penetration. Our renewable portfolio contains a natural risk-reducing mechanism, given the negative relation between production and price. In a high wind scenario, the merchant price will be relatively lower, yet this will be offset by higher generation from the subsidized assets. On the contrary, in a low wind scenario, the merchant prices will be relatively higher and the high price level on the merchant generation will counterbalance the lower generation from the subsidized assets. This provides a natural offsetting portfolio effect from our renewable assets. The negative relationship between production and price is expected to grow even stronger in the future as renewables will make up an increasingly larger share of the energy supply. In designing our new framework, we have considered this offsetting effect between power generation and price volatility. As such, the extent to which we will hedge our merchant generation depends on the portfolio composition of subsidized a merchant exposure, as well as the prevailing market prices. The graph on the right-hand side illustrates two portfolio compositions, which hold different shares of merchant exposure. The portfolio with a 100% share of merchant exposure indicates that increasing the hedge level for the portfolio will increase the revenue uncertainty due to removal of the natural portfolio effects as well as increasing the risk of over hedging. On the contrary, for a portfolio that holds a merchant exposure share of around 40%, increasing the hedge level will reduce the revenue uncertainty but only to a certain extent. Hedging the merchant generation at a too high level will remove the natural portfolio effects and introduce risk of over hedging. This implies that for a portfolio with a low share of merchant exposure, holding a high hedge level increases the risk of over hedging, which is the adverse impact that we have seen in our portfolio over the past years. The decision to lower the hedge level and duration will result in a lower risk within our portfolio going forward as a combination of high share [ph] of regulated and contracted earnings and the portfolio effect I just described will support revenue certainty going forward. With our new framework, we will decide on our year-to-year hedge level based on the overall portfolio composition and thereby avoid situations where hedging is risk increasing rather than risk reducing. We are moving away from our systematic and methodical hedge approach to a more flexible and dynamic framework that provides the needed flexibility to ensure we strike an optimal balance between regulated and merchant earnings. It's important to highlight that we are still implementing this framework as our previous hedging framework have locked in a relatively high hedge level within offshore for 2023 as well. However, we have taken proactive steps in reducing the extent to which we may be negatively impacted by our hedge level. As an example, we have opportunistically bought back forward sold volumes at favorable prices to reduce the risk of over hedging. And as a result of this, we are heading into 2023 with an offshore hedge level of around 85%, which is meaningfully lower compared to the close to fully hedge level in 2022. On a group level, we hold a hedge level of around 70% for 2023. Finally, let's turn to Slide 12 and our outlook for 2023. As highlighted during our conference call a few weeks ago, we guide our full year 2023 EBITDA in the range of DKK 20 billion to DKK 23 billion. I will not go through the underlying assumptions behind our guidance now as we covered it back then. However, I will note that the financial outlook for '23 showcases a significant earnings improvement from our operating renewable energy assets, particularly within the offshore business. As per our guidance for '23, we are expecting to see earnings increase of more than 80% for our generating offshore assets, which is a key growth and value-creating part of our business. For our gross investments, we expect to be in the range of DKK 50 billion to DKK 54 billion. This is driven by timing effects of investments that have been postponed from '22 into '23, as well as an overall increase in the investment level given the billed out of our pipeline within offshore and onshore. At our latest Capital Markets Day, we presented four key financial estimates that supports our growth plan of approximately 50 gigawatt installed renewable capacity by 2030. As a consequence of the supply chain disruptions in the weight of the COVID-19 pandemic, cost inflation, and the prolonged permitting processes, especially in the U.S., our gross investments from 2022 â sorry, from 2020 to 2027 will enable our 50 gigawatts build out, are currently trending higher than the approximately DKK 350 million we had planned for. However, if the inflation and energy price levels remain at elevated levels, these factors will positively impact our EBITDA CAGR and ROCE over the period and lead to an increase in the relative share of EBITDA that is merchant. Notwithstanding the higher trend in CapEx, we remain committed to our current CMD plan. And on that note, I'm also really excited to announce that we will host our Capital Markets Day on June 8, where we will present a progress update on our long-term strategy. So please save that date. Thank you. [Operator Instructions]. The first question will be from the line of Kristian Johansen from SEB. Please go ahead. Your line now will be unmuted. Yes. Thank you. So my question is regarding your 50-gigawatt target. So looking at these pipeline [ph] figures you gave combining your firm capacity and substantiated pipeline it's now at 59 [ph] gigawatts going back to your CMD in 2021 it was 48. So obviously, as you also illustrate, this number is going up fairly significantly. So to me, it sort of signals that the probability that you can beat your 50 gigawatt target is also going up. So can you just share some thoughts on how likely that will be? And then also what will it take for you to actually go out and change this target? Yes. Thank you very much, Kristian. I will be happy to comment on that. You're right, that substantially pipeline of firm capacity has gone up substantially, which we're really happy. That you cannot take a sort of as an automatic indication that this will of course go up, but because it right now due to the industry conditions we are describing, it's very important for us to ensure that we focus on the most value-creating investment opportunities, which is why it's a great privilege to have a quite wide substantiated pipeline to pick from. And bear in mind that as we progress our work, the opportunity pipeline will continue to feed down into the substantial pipeline as well. So I would say, absolutely, yes, this makes it even more likely to get to the approximately 50 gigawatts that we have set, but also that it is also necessary to have a wide pipeline of substantiate projects or traffic [ph] opportunities that make value creation even more likely. The next question will be from the line of Deepa Venkateswaran from Bernstein. Please go ahead. Your line now will be unmated. Thank you. That's Deepa Venkateswaran from Bernstein. So my question is on the U.S. impairment. I think a lot of the investors are struggling to handicap maybe further downside or how much further issues that might be. So I was wondering if you can give some disclosures even if it's at the total project level for all your near-term U.S. projects, what's the total CapEx? And how much have you spent and what percentage inflation there has been. So we can also do the math on what might be the risk should there be further inflation? Thank you. Yes. Thank you, Deepa. We won't be going out with an updated number on our full U.S. portfolio. I think the headline numbers you have are the DKK 350 million for our build-out towards 2027, but maybe a little bit more clarity on what we have spent so far in the U.S. I can give. So we say that roughly a spend of roughly DKK 13 billion, mainly on the near-term development pipeline being the NEP [ph] project and Ocean Wind 1. And it corresponds to roughly a low double-digit percentage of the totality of the near-term development pipeline in the U.S. Thank you, Deepa. The next question will be from the line of Alberto Gandolfi from Goldman Sachs. Please go ahead. Your line now will be unmated. Yeah, good afternoon. Thank you for taking my question. I wanted to ask about debt leverage and a little bit more. If we look at Bloomberg consensus for 2023, debt expectations are DKK 66 billion and you have just reported 30. So if you look at some operating cash flow, if we look at your gross CapEx and your typical approach of rotating assets, I know you normally don't provide any guidance, but can you help us understand this figure? I mean, are we grossly overestimating net debt for 2023, how much of the DKK 11 billion working capital inflow in Q4 is going to reverse? And if consensus is incorrect, I mean, isn't the FFO to net debt much better than we were thinking because of the margin calls, the absorption, this working capital inflow, so how much of that reverses, again, to be seen, But does it also mean we're a little bit too worried about the timing of an equity rate, You kept saying the equity raise would be potentially for funding a deal. Or perhaps if you keep - if your win rate is much better you know, if your substantiated pipeline gets converted faster. So should we think it in those terms you know, based on the current plan and what you have won so far, you don't really need equity. And so if you can comment on this relationship debt equity will be fantastic. Thank you so much. Yes, I'll try to do that, Alberto. And when we look at our capital structure projections both our internal numbers and also for the rating agencies, we, of course, believe that we will be able to live up to the thresholds that are set out in those capital structure metrics. And that is basically what we have solved for in order to deliver on the roughly 50 gigawatt in 2030. So that's our starting point. And you will, of course, see that there is fluctuations in net debt and the FFO to net debt year-over-year. But we, of course, believe that we can live up to those thresholds. When it comes to collateral, we have DKK 14 billion tied up roughly right now in collateral. And [Technical Difficulty] a fair share of that will be coming back in 2023. So I don't know whether that can kind of close some of the gap. I'm not completely into the details of the average Bloomberg number, but that could potentially explain some of it. When it comes to the ABB, as we've said before, it is not our plan to use it to close a gap in our capital structure, it's our financial flexibility we have that we will use in a situation where we see that the combined probability of all of the options that we have to grow above 50 gigawatt becomes large enough for us to say, okay, now it makes sense to issue more equity in order to fund further growth beyond the 50 gigawatt. Thank you, Alberto. The next question will be from the line of Rob Pulleyn from Morgan Stanley. Please go ahead. Your line now will be unmated. Hi. Good afternoon. Thank you very much for taking my question. There is only one and hopefully, you can share some color. So there's been a lot of discussion around these U.S. projects, which I think we should all remember, was signed by the previous management team. And I was wondering whether you'd be willing to share your thoughts on what the key lessons learned over the last two years were and how that experience may shape the future and are shall we say, risking value creation and the outlook for Ãrsted? Thank you very much. Yes. I'll be happy. Thank you very much, Rob. I'll be happy to give that a shot and Daniel to supplement as well. Is that - no doubt, one of the key learnings is that that is being - we are happy to see that being also apparently implemented across several states is that inflation indexing on the revenue line is something that's really important. We have worked quite intensely with the regulators to ensure that that is something that happens because in a situation where the cost of capital and also the CapEx inflation is going up, then having this fixed revenue line with a fixed annual escalator is just obviously challenging. So working with the regulators to ensure that we derisk that from a developer point of view, and therefore, that the risk sits with those who can best handle it rather than forcing developers to build in risk premium is one key learning. The other key learning is, of course, and that is not too different from our long-term strategy, is to ensure that the more CapEx certainty we can get soon, the better because the - I mean, the variability we have seen also in Scopes that were previously sort of not that unpredictable is something we have learned can change as the bottlenecks in the industry change. So having the foresight and also structural and systematic foresight into where are the most likely bottlenecks, where can they happen and ensure that we tie up really both the capacity, but also having the fixed price agreements as we are doing as we speak. So we are not just sitting on those learnings. We are implementing them by ensuring that we do frame agreements that are not just capacity, ensuring but also some that are locking in significant parts of that volatility that we otherwise face. Those are two examples of learnings that we are both taking and are already in the midst of implementing. Thank you, Rob. The next question will be from the line of Casper Blom from Danske Bank. Please go ahead. Your line will now be unmated. Thank you very much. A question relating to the U.S. projects also, Mads, you mentioned that one of the cost items where you had seen a lot of inflation were within vessels to do the installation, especially within the Sunrise Wind projects. I assume that it's not a market with hundreds of vessels and that relatively few vessels could quickly change things. And what are you seeing sort of here in terms of the pipeline on vessels going forward? And do you see any upside from potentially other projects being delayed, postponed, maybe not even built that, that could actually make things easier, even sort of in the near term for you? Thank you. Yes. Thank you very much, Casper. We have very little doubt that there will be a structural, overall positive capacity expansion because in a tight market, obviously, the vessel owners are seeing significant opportunities. And that is not just in the U.S. that is globally. And we are seeing FIDs on heavy lift vessels that are happening as we speak. And that's a good thing, and that is something that will clearly add to the capacity. We continue to push that because as you can see from one of the slides we showed today, the capacity expansion of what needs to be built out, we need to ensure that we also encourage both in the market predictions, but also in the commitments we give that we can secure more - even more capacity. So since it takes time to build these - the honest answer is, Casper, that the nearest term projects. So for example, the portfolio of U.S. projects we have towards 2025, those are unlikely to be impacted positively or negatively for that matter of any capacity expenses that are happening. But on the sort of towards 2030, there's no doubt that we are seeing this as an area that we are hoping and believing could be debottlenecked. Thank you, Casper. The next question will be from the line of Harry Wyburd from Exane. Please go ahead. Your line now will be unmated. Hi, everyone. Thank you very much for taking my questions. I'm really sorry to labor the point on the write-downs. But can I ask a slightly technical question. If we think about projects for the COD [ph] being after Sunrise, I guess I don't have very big book value right now. So what's the risk that as you progress through time and spend money on them that you â you know, you then have to get to a point where they do have book value and then you have to look at whether you need to write them down. In other words, what's the risk that the CapEx you spend over the next couple of years, CapEx and DevEx sort of value disruptive. And then we get to 2 years' time, you've got to write that down, but you don't have to do it right now because [Technical Difficulty] basically zero on those projects. And maybe if I could sneak in the vessel cost. Obviously, you've seen much higher vessel costs on Sunrise. Did you make the same assumptions for the other projects as well? Are you sort of implicitly assuming the vessel costs come down, like you said, to 2030? Thank you. I can take the last first and then hand over the first question to Daniel, Harry. I think as we also wrote in our text around the impairment of Sunrise Wind, the reason why that is the project we impair whereas the others have a comfortable headroom under the current assumptions is that we had locked in more of those Scopes, including the vessels. So therefore, it's not because we have done something terribly wrong or have any sort of significant outstandings on the remaining projects, it's just because Sunrise was the last to log in, in a market where prices on rates were going up significantly. That explains that. So we are - we do have, as we mentioned, sort of 90% CapEx price lock in for those 2023 to 2025 COD projects, which gives us a very high degree of certainty where Sunrise was the last one, and that was hit specifically by those steep increases. Yes. And on your first question on the later dated development portfolio in the U.S., it is a fairly insignificant amount that we have booked on those projects. So I don't see a big impairment risk on those projects. It's more back-end dated spend. It's projects where we have some more flexibility because they are to be delivered later in the decade. And we will, of course, make sure that when we take FID on those projects and also spend more on them that we do it with the consideration to make sure that we have a meaningful value creation on those projects. When I listen to your presentation, I hear the following key points. Much more capital needs to be attracted to the sector. Much more government support is expected around the world. There is perhaps more risk in some projects than previously recognized as highlighted by the end of last year, higher bids are needed from developers. Taking these together, is it fair to think that in the coming years, returns in the sector have actually got up quite a bit. But in terms of the headline IR you can achieve and also the spread above WACC, which that reflects? Thank you. Yes, it is definitely our expectation that the absolute returns will have to go up as we see more inflation, higher cost, higher interest rates. When it comes to the spread we want to get out of winning a project, it will, of course, be very project-specific, depending on timing, whether there's inflation indexation and whether we can log in cost certainty at point of bid. So there's, of course, a lot of things playing into that. But we are, of course, taking into consideration the increased uncertainty that we are seeing and that should come through either higher spread to WACC, but it could also come through a higher contingency if we are in doubt whether we will be able to deliver on the CapEx that we are assuming in a bit case. Okay. The next question will be from the line of Mark Freshney from Credit Suisse. Please go ahead. Your line now will be unmated. Hi. Thank you for taking my question. So on vessels, as I understand it, there's a bit of a chicken and egg scenario, some of the builders [ph] or asset owners don't want to build these vessels until they've got firm commitments, you don't want to give them until you've got firm clarity as to when you need the vessels. In the past cycle, I mean you yourselves were a joint vessel owner with Siemens. And I'm just wondering why - and so RWE and partially Centrica were. So I'm just wondering why you haven't - given the clarity you have in your business plan, why you're not going ahead and building your own vessel because you know you need it. And if I may be cheeky and ask a one liner in addition. Can I ask what the WACC you're using for the impairment testing of the North American projects is? Thank you. Yes, I can answer. Thanks a lot. I can answer the first question. We - you're right, we did go in as vessel owners. Fundamentally, we would much rather spend our capital on building out renewable energy. And we think there are ways in which we can actually pass on, like you say, we have a much greater pipeline and therefore, build out certainty than any other in this business, which means that we are in a unique position to actually be able to make those commitments. And that is why we are - we'd much rather go into a dialogue with those who have operating vessels as their main business, give them the commitments and the firm outlook that would mean that they can make safer investment decisions, rather than off spending our capital on being vessel owners. So we are absolutely leveraging the strength of our predictability of portfolio, but again, we prefer not to make to be owners of vessels. Yes. And on the WACC point, I can't give you a specific number, but we are using a fairly market conform way of applying WACCs in our impairments. It's the same WACC we use for our investment decisions. It's with up-to-date current rates. It's based on a classical cabin approach with leverage assumption and betas for the market. So I would say it's a fairly standard approach and it is, of course, also being increased by the high interest rate environment that we are seeing right now. And Mark, if I can just add sort of maybe a second half to your first question about vessels. I think not relating to whether we only do not, but one of the key considerations for vessel owners, whoever they are, is of course, how future-proof is my investment. And given the ever-increasing size of turbines and the foundations, of course, this is one of the things that everybody is trying to predict how big does my vessel need to be. And therefore, if it grows, if the equipment grows too big, will there be a risk that my vessel will be outdated in two few years compared to my depreciation period. And that is also one of the reasons or one of the things we can contribute with as a customer is that we can actually - we can decide what turbine and foundation size we want to use and therefore, also give that greater certainty if we want to go into those dialogues. Thank you, Mark. The next question will be from the line of Dan Togo from Carnegie. Please go ahead. Your line now will be unmated. Yes, hello. And thank you. Just a question here to understand the flexibility in your CapEx and financial planning here. You have this 50 gigawatt target and 30 gigawatts for offshore and you expect to expand by these 3 gigawatt per annum gain around that area per annum. You're a bit ahead now, I understand. But what is the flexibility, let's say, you hear in '23 and maybe even in '24 - 5 gigawatt in the auctions and tenders. Will that necessarily then trigger that you need to make a capital raise? Just to understand what are the sort of say, the step stones here? And what is the flexibility in your financial planning currently? Thanks. I can kick it off, Dan. Thank you. If we have a year or two where we would gain sort of a firm capacity of 2 times 5 gigawatts, that would be that would highly likely be something that would trigger absolutely [ph] because that would be an acceleration of that. And essentially, that would mean that we'll be close to the full 2030 opportunity and therefore be a strong indication that, that growth beyond the 30 gigawatts offshore is possible. I would though caution to say that, that is probably not the most likely scenario. And we really want to, as we've said many times, we are not so hungry on the gigawatts that we won't have a special eye to ensure that we really go for the most value-creating opportunities. That is really important also with what we have seen is that we work on the project opportunities, whether they are centralized tenders or open door where we feel most comfortable with the value creation potential. And we'd rather go a little low to ensure that we are on the safe side on value creation than go really high just because the opportunities are there. So that's a balance, we, of course, need to strike, but we would likely raise capital in that scenario, but having 2 times 4 or 5 in the coming 2 years, I think, is less likely to happen. Thank you, Dan. The next question will be from the line of Jenny Ping from Citi. Please go ahead. Your line will now be unmated. Morning. Hi, thank you. Mads, Just following up on something you said earlier in terms of the projects in the U.S. as a portfolio shows a positive NPV, assuming a 40% ITC. Can you just actually tell us which one of your U.S. projects has the customer rebate clause in them, included as part of the agreement that was originally signed? Thank you. Yes, we can. That is - if I understand your question correctly, that is our Ocean Wind project. So that's New Jersey. And also for the later projects is New Jersey and Maryland that have these passback clauses, whereas Northeast programs, so both Southwark Revolution and Sunrise are all without a passback clause. Well, that is for - I mean, on the original case, there was an ITC of 12%. And so it would be beyond that, right? Dan, I'm looking at you. So there's a passback mechanism above the 18% that was in there when we made the first bid in New Jersey. Therefore to Jenny, to state the obvious, then obviously, for Ocean Wind 1, where the assumptions for ITC were lower than obviously the potential upside for - to get the full 40% is very significant and higher than for Ocean Wind 2. Thank you, Jenny. The next question will be from the line of Ahmed Farman from Jefferies. Please go ahead. Your line now will be unmated. Yes, hi. Thank you for taking my question. I think in your comments, you mentioned that the current CapEx trend is above what you viewed in the business plan when you guided to the DKK 350 billion. I was just wondering if you could give us some more specific color on that? How significant is - are you seeing the current trend above the business plan assumptions. And then if you can maybe provide some granularity on how CapEx trends in the U.S. compared with some of your key European markets? Thank you. Yeah. So its correct, that we are expecting that the average [indiscernible] the 2027 numbers we gave at CMD on the CapEx side will be going off due to the cost inflations and bottlenecks that we are seeing. But we also expect that EBITDA and ROCE will go up to basically compensate for that. We won't be updating all of these numbers now. We can just say that we see it trending higher. But of course, at a CMD later this year, I think that's, of course, some of the key metrics that we will be giving you some more details on. And on the differences in â on the cost development across the regions, I think its fair to say that in the U.S. being a more immature market we are seeing cost trending up a bit faster than what we are seeing in Europe and you also have the constrains of â for example the Jones Act where it becomes a little bit more difficult to get the full suite of vessels for your construction projects. And so higher increases in the more immature markets. Thank you. Can I just clarify a follow up just on the ROCE point. Does it just compensate it or is that some positive optionality here on the negotiate. I say that because you are obviously reporting above 16% this year and your target is you know, 11% to 12% over the period? Yeah. You could argue that ROCE wouldn't go up if it didn't compensate for the higher CapEx. So our precision [ph] is that ROCE will be trending higher as CapEx and EBITDA is also trending higher. Thank you, Ahmed. The next question will be from the line of Steve Forexan [ph] from ABG. Please go ahead. Your line now will be unmated. Thank you very much for taking my question. Just that â a bit more technical question to your decommissioning provisions, they are going up by more than DKK 5 billion or nearly 60%. And of course, you have grown your portfolio and so but you also talking about change through the methodology in Scope and how you do a decommissioning in provision. And so if you could elaborate a bit on what to expect and what's behind that [indiscernible]? Thank you. Yeah. So its of course, an area where we have gained some more knowledge and have also been leaning a bit up against some older assumptions and we also see the vessel market becoming more expensive. So there is partly an impact from higher vessel rates and we due to and making sure that we don't tissue [ph] up the habitats of the offshore Wind Farms. We will probably - this is going to be very far out. The cutting the monopoles instead of exploring them which was one of the previous assumptions and then we've also found that that would lead to do the decommissioning in two trains instead of just one. So there is a number of reasons for this as we've done a very big deep dive on making sure that that the assumptions we use also make sense for future works so to say. Thank you, Steve. The next question will be from the line of Peter Bisztyga from Bank of America. Please go ahead. Your line now will be unmated. Yeah. Hi, thanks for taking my question. So if you could step out key milestone needs to be passed to actually make FID and actually start construction on your U.S. projects because February 2023 now more slightly operates â in 2025, so it strikes me, you know, [indiscernible] contributing EBITDA at some point in the next couple of year. And Mads can you just clarify something broadly [ph] you said you expect to be overall MPV [ph] positive assuming 40% ITC. So just following up on Jenny's question, and is that statement only proving if you are able to renegotiate the customer rebates in New Jersey and Maryland? Thank you. Yes. I can certainly address those. Thanks a lot, Peter. So on the milestones, it is essentially getting the ore scopes ready and having sufficient locked in debt we are very close to, but also to ensure that we have a sufficiently strong value creations that we feel it is financially right and proven to take those FID. So it is a combination of â let me put it also in a wake way, [ph] stakeholder dialogues concluding in a satisfactory way to ensure that our EPC and especially our contracts, but also our EPC plan is mature, those will essentially be the two things that are needed. And you're absolutely right, at hopefully near term FIDs probably won't rush them until we are â we have that full construction plan ready and until we have a satisfactory conclusion on getting the topline that we need for the projects. And specifically on the prospect, I'll say that the â we can't comment on the specific dialogues and unfortunately there we continue to be boring with that. But we are â we do see a pathway to getting that portfolio, so 2023 to 2025 we do firmly believe that that is one where we can get the life cycle MPV also to be positive and not just a forward looking. That is as close as I can get it. Its relying on the assumption that the â the 40% ITC will be possible to get on these projects. And that is of course our expectation. Thank you, Peter. The next question will be from the line of Lars Heindorff from Nordea. Please go ahead. Your line now will be unmated. Thank you. A question regarding the vessels - installation vessels. I don't know if you could give a status on what goes on in Taiwan at the moment. You're still waiting for a new installation vessels. And to what extent that will have an impact or any material impact on your CapEx assumption compared to what they originally were when you reinitiated the project? Thanks. Yes, certainly, we can comment on that. We are very far in having contracted vessels for our upcoming Taiwanese project. So that is not an outstanding concern. It's a short answer, Lars. Thank you, Lars. The next question will be from the line of Alex Wheeler from RBC. Please go ahead. Your line now will be unmated. Hi. Thanks for the presentation and taking my question. You spoke about the large amount of capacity to be auctioned in 2023 and that it's essential to see the contract prices reflecting the current environment. With this in mind, are there specific geographies which you currently see is more attractive as you look to auctions in 2023 based on the current visibility and prospective auction structure? Thanks. Yes. Thank you very much, Alex. The simple answer to that is obviously what is already in the public domain, namely that the New York 3, where we have chosen to bid in. It is actually not right now possible to stay firmly where are those most attractive opportunities. Because, for example, Japan, which was very challenging in the first round, as I think every industry of servers knows. We are still working on sort of the - on clarifying whether that the revised upcoming auction framework is something that makes us believe that, that could be attractive, which we believe it can. So that would be an example. And then also, we are working heavily on getting under the skin of the recently announced German auction framework to evaluate whether we believe that, that framework will give opportunities for the strongest value creation. Obviously, we are not a big fan of auction frameworks where negative bidding becomes an option, which it seems it does. But on the other hand, the ample capacity means that there could still be opportunities within that. So we are - I would say that we are closely following everything. But - and what we know for a fact is that even though we unfortunately did not come out successful, then that the upcoming Dutch Ijmuiden 4 gigawatt auction is one that is very likely to also be attractive for us. But otherwise, we are following all markets and do not rule out anything on this slide, except Ireland, where we don't have the seabed available. Thank you, Alex. The next question will be from the line of Vincent Ayral from JPMorgan. Please go ahead. Your line now will be unmated. Yes. Thank you for taking the question. I'd like to come back on the hedging. You made a few slide on that. Clearly, you've been hit by all the hedging in 2022. You were talking about hedging levels about 95%. And its turned like 10 days ago, on the pre-release, we heard about 9%. Today, you talked about 85% as a final number there for the hedging level are not for wind in 2023. So you probably bought back some volumes. And the question I would have here is probably cost money. Is it locked into the 2022 numbers? Yes or no? The second thing is you talk on the same thing, your new strategy on the hedging to reduce down the hedging and not go above 70% at a group level, which is fine. But you also talked about IFRS-9, but IFRS-9 is a non-cash issue. It's a matter of presentation. You have been presenting on a non-adjusted basis. Why don't you move to an adjusted basis? And if you don't, basically, how much do you expect to unwind exactly in 2023 if the power prices were to stay where they are because of not doing anything with the current commodity prices with a lower IFRS-9 impact in ââ22 - quite clearly. Thank you for answering these questions. So when we had our conference call two weeks ago, I said around 90%. And the more precise number is the 85%. But the call was not about that hedge percentage. So it was more of a rough number. And we have been buying back hedges both in late 2022. So there's a little bit of cost in there, and also some here in the beginning of 2023, and that's, of course, also reflected in the guidance that we've given. On the IFRS-9 point, you are right. But we want to make sure that we follow the IFRS-9 way of reporting our numbers. So that is what we are doing in our annual report, but we've also given you the supplementary information so that you know how big the drag has been on our numbers. And in 2022, it was the DKK 1.3 billion. As it is a timing effect and we expect it to be coming back, we have factored in a profile that matches the underlying hedges. And out of those 1.3, you have a couple of DKK 100 million coming back in '23, which is also included in our guidance. Thank you, Vincent. The next question will be from the line of Louis Boujard from ODDO. Please go ahead. Your line now will be unmated. Yes, good afternoon. Thank you very much. Maybe one question regarding your flexibility in your pipeline. On the 11.2 gigawatt of awarded and contracted renewables [ph] capacity, which has not yet been FID on the offshore wind project. Do you have eventually some room if the discussion and if the negotiation does not come to an end in some of them to take the decision not to go ahead and not to take the FID and eventually to withdraw them. And if yes, what could be the financial consequence for one or two of these projects if that to happen? Yes. Thank you very much. I would say that it is our clear ambition to make all of these projects a reality. And you say that the - in principle, we - I mean, there's always a way out. But of course, that needs to be factored in. What are the costs of that, both in terms of the commitments that we might have incurred and so on. So in general, it is a much more likely scenario not likely, but more likely than walking away from the projects and we say we might buy ourselves time to work with our partners to make those projects better because there can be some flexibility in the timing of it. And that is what - that is much more where we are looking at. Where does that timing flexibility, which we have in some of the projects, clearly, where does that actually play into being able to maybe hit a period of time where there are less bottlenecks, where there's less strain on commodity costs and so on and where it fits better into our construction train of different projects. So we do have flexibility, and it is not impossible to walk away from anything, but we do remain committed and are working. First, within the existing time lines, but if absolutely needed, also with a possible extension to make the projects investable. Okay. If I may, just as a follow-up, shall I understand that it is possible eventually to have CapEx, which would be extended on a longer time frame then? Yes. And there's other opportunities, of course, come in. So - so I would say that we are looking at, as we talked about before to a previous question, that there are very significant opportunities, including both onshore, offshore centralized auctions but also open door. And some of those can also come relatively near term. We actually - we said that, for example, in the up to 5.2 gigawatt Danish open door opportunities, those are some that could actually COD as early as potentially 2027. And so if we go ahead and potentially extend to make the projects better from the already awarded list, there could be options not saying that, that would happen, but there could be options to spend that CapEx on other projects. But please don't hear us saying that we are currently planning to extend or that we are planning to walk away, but also say that if that happens, it won't automatically mean a total of extension of the CapEx spend, we would likely pursue other value-creating opportunities if they are there. Thank you, Lou. The next question will be from the line of Tancrede Fulop from Morningstar. Please go ahead. Your line now will be unmated. Hello and thank you for taking my question. I have two of them. The first one is on CapEx and your guidance for gross investment for 2023 of DKK 50 billion [ph] DKK 54 billion [ph] It is quite above the expectations of around DKK 32 million. So if you would have helped us to understand the sources of your upside how much is due to phasing, maybe the delay in Greater Changhua and how much is related to inflation? This will be my first question. And the second question for the U.S. project. You said that most of them will be NPV positive if they are eligible to an ITC of 40%. So shall we understand that okay, NPV positive, but the spread IIR-to-WACC will be below your target funds of 150, 300 basis points, meaning that you will proceed with projects if your return result? Thank you. Yes. I can give perspectives on that. So the main boxes of the - for the CapEx spend in 2023, which is the DKK 50 billion to DKK 54 billion, there's an approximate DKK 5 billion that would be a spillover from 2022 into 2023. And on top of that, we are looking, as we talked about to a previous question, we are looking at hopefully and expectedly a fairly sort of high number of FIDs being taken, which would obviously accelerate our CapEx spend. But also bear in mind that with the total CapEx that we announced at the last Capital Markets Day, if you divide that by the number of years, the average would be sort of approximately DKK 44 billion to DKK 45 billion. So over the last 3 years, it would actually be around that level. So it's not an abnormally high level. But due to the phasing between the 2 years and also, hopefully, an accelerated CapEx spend on projects FID, we don't - we see this clearly within our plan. And on the U.S. projects, the direct answer to your question is, yes, in light of the new realities with the cost of capital and also the CapEx inflation these projects will not be within our guided range of 150 to 300. We clearly - obviously, when we bid in, they were well within that range at the time. But due to those circumstances, now they're not. But the portfolio of the 23 to 25 is under the assumptions we discussed before, they are - at the portfolio level, they are NPV-positive, but not within the range. Thank you, Tancrede. The next question will be from the line of Dominic Nash from Barclays. Please go ahead. Your line now will be unmated.\ Yes. Good afternoon, everyone. Just one question from me is regarding your partner â or your partners, I should say, in Eversource and PSEG. Could you give us an update on what's going on with the Eversource positions to? Are they still looking to sell? And what sort of time frame are you looking for to get news flow on that? And will you be looking at potentially buying back or getting the 50% Eversource sale and buying back to materials of PSEG? Thank you. Yes. I can comment on it, but it won't be a very specific answer. But yes, the process is ongoing with Eversource in the sales process and - and we are highly unlikely to acquire the remaining 50% stake despite us doing that at cost in Ocean Wind 1 with the 25%, which was due to, as we also explained in the previous call, not because Eversource is running away, but due to the fact that now it's ITC rather than PTC and Eversource - sorry, PSEG had difficulties monetizing that. So that was the reason for that. And then with Eversource, that is progressing. I don't think we're in a position to give a time line on that. That needs to be Eversource, who gives an answer to that. But - and as previously commented, we are - if anything, it would be a dialogue that between us and Eversource about potentially acquiring the seabed, but not the 50% stake on the Northeast program. Thank you, Dominic. As we are running out of time, I will now hand it back to Mads for any closing remarks. Yes. And I would simply like to thank you very much for joining, and appreciate all the great questions, as always. And should you have more questions, you know that our IR team are more than happy to answer them. So thank you very much. Stay safe, and have a great day.
|
EarningCall_1198
|
Welcome to the Texas Instruments' Fourth Quarter 2022 Earnings Release Conference Call. I'm Dave Pahl, Head of Investor Relations, and I'm joined by our Chief Financial Officer, Rafael Lizardi. For any of you who missed the release, you can find it on our website at ti.com/ir. This call is being broadcast live over the web and can be accessed through our website. In addition, today's call is being recorded and will be available via replay on our website. This call will include forward-looking statements that involve risks and uncertainties that could cause TI's results to differ materially from management's current expectations. We encourage you to review the "Notice regarding forward-looking statements" contained in the earnings release published today, as well as TI's most recent SEC filings, for a more complete description. First, you likely saw last week we announced that Haviv Ilan will become President and CEO on April 1st and that Rich Templeton will continue as our Chairman. I'm sure you'll want to join me in congratulating both of them. Secondly, let me provide some information that's important to your calendars. Next week on Thursday, February 2nd, at 10:00 a.m. Central time, we will have our capital management call. Similar to what we've done in the past, Rafael and I will summarize our progress and provide some insights into our business and our approach to capital allocation. This will include an update of our 300 millimeter capacity expansion plans to support the increasing confidence that we have in our long-term growth. Moving on, today, we'll provide the following updates. First, I'll start with a quick overview of the quarter. Next, I'll provide insight into fourth quarter revenue results, with some details of what we are seeing with respect to our customers and markets. I will then provide an annual summary of our revenue breakout by end market. And lastly, Rafael will cover the financial results and our guidance for first quarter of 2023. Starting with a quick overview. Revenue was $4.7 billion, a decrease of 11% sequentially and 3% from the same quarter a year ago. As expected, our results reflect weaker demand in all end markets with the exception of automotive. A component of the weaker demand was customers working to reduce their inventories. In first quarter, we expect a weaker than seasonal decline, with the exception of automotive, as we believe customers will continue to reduce inventory levels. Turning to our segments, fourth quarter Analog revenue declined 5% year-over-year and Embedded Processing grew 10%. Our Other segment declined 11% from the year-ago quarter. Now, I'll provide some insight into our fourth quarter revenue by end market. I'll focus on sequential performance again this quarter, as it is more informative at this time. First, the industrial market was down about 10%. The automotive market was up mid-single digits with strength in most sectors. Personal electronics was down mid-teens with broad-based weakness. Next, communications equipment was down about 20%, and finally, enterprise systems was also down about 20%. Lastly, as we do at the end of each calendar year, I'll describe our revenue by end market for 2022. We break our end markets into six categories that are grouped by their life cycles and market characteristics. The six end markets are industrial; automotive; personal electronics, which includes products such as mobile phones, PCs, tablets and TVs; communications equipment; enterprise systems; and other, which is primarily calculators. As a percentage of revenue for 2022, industrial was 40%, automotive about 25%, personal electronics 20%, communications equipment 7%, enterprise systems 6%, and other was 2%. In 2022, industrial and automotive combined made up 65% of TI's revenue, up about three percentage points from 2021 and up from 42% in 2013. We see good opportunities in all of our markets, but we place additional strategic emphasis on industrial and automotive. Our industrial and automotive customers are increasingly turning to analog and embedded technologies to make their end products smarter, safer, more connected and more efficient. These trends have resulted and will continue to result in growing chip content per application, which will drive faster growth compared to our other markets. Gross profit in the quarter was $3.1 billion, or 66% of revenue. From a year ago, gross profit decreased primarily due to lower revenue, increased capital expenditures and the transition of LFAB-related charges to cost of revenue. Gross profit margin decreased 320 basis points. Operating expenses in the quarter were $863 million, up 9% from a year ago and about as expected. On a trailing 12-month basis, operating expenses were $3.4 billion, or 17% of revenue. Restructuring charges were $48 million in the fourth quarter and were associated with the LFAB factory preproduction costs. As production started at the beginning of December, these costs then transitioned to cost of revenue, where they will be reflected moving forward. In addition, depreciation has begun on these assets. Operating profit was $2.2 billion in the quarter, or 47% of revenue. Operating profit was down 13% from the year-ago quarter. Net income in the fourth quarter was $2.0 billion, or $2.13 per share. Earnings per share included a $0.11 benefit for items that were not in our original guidance. Let me now comment on our capital management results, starting with our cash generation. Cash flow from operations was $2.0 billion in the quarter. Capital expenditures were $1.0 billion in the quarter. Free cash flow on a trailing 12-month basis was $5.9 billion, down 6% from a year ago. In the quarter, we paid $1.1 billion in dividends and repurchased $848 million of our stock. In total, we have returned $7.9 billion in the past 12 months to owners. We also increased our dividend per share by 8% in the fourth quarter, marking our 19th year of dividend increases. Our balance sheet remains strong with $9.1 billion of cash and short-term investments at the end of the fourth quarter. In the quarter we issued $800 million in debt. Total debt outstanding was $8.8 billion with a weighted average coupon of 2.93%. Next, to summarize the benefits of the CHIPS Act, we accrued about $350 million on our balance sheet under long-term assets in fourth quarter, in addition to the $50 million accrued in the third quarter. These accruals are due to the 25% investment tax credit for investments in our U.S. factories. This will eventually flow through our income statement as lower depreciation, and we will receive the associated cash benefit in the future. Now let's look at some of these results for the year. In 2022, cash flow from operations was $8.7 billion. Capital expenditures were $2.8 billion, or 14% of revenue. Free cash flow for 2022 was $5.9 billion, or 30% of revenue. Our cash flow reflects the strength of our business model. As we have said, we believe that growth of free cash flow per share is the primary driver of long-term value. Turning to our outlook for the first quarter, we expect TI revenue in the range of $4.17 billion to $4.53 billion and earnings per share to be in the range of $1.64 to $1.90. We now expect our 2023 annual effective tax rate to be about 13% to 14%. In closing, we will stay focused in the areas that add value in the long-term. We continue to invest in our competitive advantages, which are manufacturing and technology, a broad product portfolio, reach of our channels, and diverse and long-lived positions. We will continue to strengthen these advantages through disciplined capital allocation and by focusing on the best opportunities, which we believe will enable us to continue to deliver free cash flow per share growth over the long-term. Thanks, Rafael. Operator, you can now open the lines for questions. In order to provide as many of you as possible an opportunity to ask your questions, please limit yourself to a single question. After our response, we will provide you an opportunity for an additional follow-up. Operator? Yes, thank you. Good evening. I guess, the first question is, if you could just maybe characterize what you're seeing going to Q1, you're talking about that being worse than seasonal. Is that also broadly based in terms of the decline as you've seen in Q4? And I know you don't guide by segment, but any kind of color you could provide by segment as to what you're seeing and the extent to which customers are burning inventory as you know into the first quarter? Yes, Chris, thanks for that question. I'd say that the trends that we saw in the fourth quarter will continue into first, meaning that we expect our end markets to decline with the exception of automotive. So automotive is continuing to be resilient. And we do believe, as you just said, that the customers are continuing to work to get their inventories lower. So you have a follow-on? I do. Thank you. I wonder if you could speak about the pace of depreciation expenses as you go through next year. You spoke about RFAB and I know it started production and it's hitting depreciation now. Is there additional incremental depreciation coming from RFAB as you go through the year. What happens to LFAB as you, I guess, maybe the timing of that when that starts production and start hitting depreciation? And then how should we think about some of the benefits that come from CHIPS Act that tend to decrease depreciation over time. I'm sure you're going to speak about that on the Capital Day coming up as well. Yes. Let me take that, and we're going to go through all of that, both the CapEx, depreciation and ITC and the CHIPS Act in great detail next week. For now, what I would tell you is, as you said, RFAB2 is in production, Lehi is in production. So both of those are running that cost now is in cost of revenue, and theyâre both depreciating and that that is a function of the â when the equipment is placed in service, it starts depreciating, right? So as both of those ramps, the equipment goes in service starts depreciating. But big picture, what we told you last year on depreciation was that it would ramp roughly linearly to about $2.5 billion in 2025. And again, weâll give you an update on that next week, but I do want to say just as I said 90 days ago, that since we talked about this last year, our confidence surrounding our long-term growth prospects have only grown. And if you alluded to, weâve had the CHIPS Act also since last year that, that legislation pass in August. So weâll â next week, weâll give you the â all the puts and takes between those trends and weâll paint a clearer picture at that point. And maybe just add a small piece that linear ramp will go from about $1 billion a depreciation that we had this year at about $0.5 billion a year till we get to $2.5 billion, so just kind of doing the math for you. So thanks, Chris, and weâll go to the next caller, please. All right. Itâs the Chris Brothers. Hey guys, so Dave, I believe you said that your confidence in the long-term growth rate has only increased. Maybe just share with us what youâve seen in the last three months to six months thatâs giving you that confidence. Do you expect the, I guess non-auto markets to bounce back this year? And conversely, would you expect auto to cool off or to remain strong all year? Yes. I â and I â again, thatâs â thanks for the question, Chris. It â the longer-term growth rates are really weâre speaking to how things are going to grow over the next three and five and 10 years. And that higher confidence comes from the higher semiconductor content growth that weâre seeing particularly in industrial and automotive. And the fact that that those two markets now make up two-thirds of our revenue. So just as that structurally grows faster than the rest of the market, weâre convinced more than ever that that will continue to drive our top line and also the products that we have inside of those markets. And Iâd say also the strong customer response weâre getting to our geopolitically dependable capacity. So since weâve shared publicly our plans last February in capital management call, I just say that, that the response has been very, very strong. So those are really the three things that are adding to our confidence. You have a follow-up? Yes. One on inventory. So itâs bouncing up towards your long-term target. Can you talk about when you would start to ease back utilization rates to maintain that inventory? And then maybe spend a little bit of time on the mix. I know thereâs still shortages out there. How do you think â how long do you think itâll take to, I guess, balance out your inventory this year to achieve some sort of ideal mix? Yes. So let me take that. And first, big picture let me point you to our scorecard. The one that we used for capital management when we talked about the objectives in â when it comes to inventory is to maintain high levels of customer service, keeping stable lead times while minimizing inventory obsolescence, our strategy and our portfolios such that itâs long-lived a very diverse, our customer base. So the risk of obsolescence is very low. So thatâs a part of the equation. And the other part is the upside that we get by having that inventory both short-term and long-term to support customers. So thatâs why weâre comfortable holding higher levels of inventory. Iâve been talking about from current levels we could add a $1 billion to $2 billion of additional inventory. And the timing, that all depends on revenue trends. So if theyâre higher, then itâll take longer. If those serving trends are a little weaker, then itâll be a little faster to get there. On the mix is a number of angles on that, chip stock versus finished goods, we have a mix of both of those. In some cases, it makes sense to have more of one than the other, but theyâre both very low risk. So thatâs how we think about it. Hey, howâs it going? Thank you so much for taking the question. Dave, hoping you guys could talk a little bit about trends in China, what you saw in Q4, if there was any choppiness toward the end of the quarter, and more importantly, how youâre thinking about Q1 and beyond. I guess, thereâs hope out there that China as an economy bounces back in 2023. Are you guys seeing any early signs of a recovery in terms of end consumption of your products? Yes, Iâd say, some of the disruptions that we saw earlier in the year, we didnât see any of that here in the fourth quarter. And so nothing exceptional to report with China as a region versus the other regions. And we long held the practice that we call it out if thereâs something going on. So really nothing exceptional. And certainly, as that economy comes back and consumption increases in China, obviously helping the world GDP, but that would obviously help us as well. It was what we would expect. So you have a follow-on? Yes, I do. Your analog business in the quarter was down 5% year-to-year and obviously you guys are the first to report. So itâs hard for us to compare and contrast. How you guys did relative to your competition or your peer group. But it feels like you may have underperformed in the quarter, and I realize itâs only one quarter. Whatâs the competitive landscape like today? What kind of pricing trends are you seeing as demand patterns start to soften? Thank you. Yes. Iâll take that question and Rafael, if you want like to add. But I think certainly looking at any particular quarters weâve talked about before that our performance is just best measured over time. And I think that thatâs the way the markets behave and even looking at one year or even longer, youâve got to look at three and five and 10 years of performance especially when you go through choppy times like weâve been through in the last 18 months or so. And so pricing just to comment on that, Iâd say that thereâs nothing unusual going on with pricing. As you know, pricing doesnât move quickly in our markets, our practices and pricing though I know that theyâve changed with many of our peers, our practices have not changed. We just continue to price aggressively in the marketplace, but pricing isnât the reason why customers choose our product. Thereâs usually not the top few reasons why they choose our product. So really no changes on that front. So thank you for those questions, and weâll go to the next caller. Hello, good afternoon. Thanks for taking my question. In the last earnings call, the team talked about seeing increasing cancellations. Did cancellations continue to increase through Q4? Did they level off? And then we are consignment-based business, what are the aggregate trends that you are seeing within your customers six to nine months, sort of rolling forecast? Yes. Harlan, so the first question is, in a weakening environment, not too surprising. The cancellations were up in the quarter. So we did see an increase there. And from a consignment versus classic backlog, customers really not much difference there. Their visibility â even though weâll get visibility out six months, their visibility to their demand can change, as we know very rapidly within the 90 days or certainly even within 30 days as those windows move a long time. So I would say that thereâs not much changed in that. And oftentimes if customers arenât canceling orders, what theyâre doing is rescheduling them back out in time. So certainly seeing that happen as well. Do you have a follow on? Yeah. So embedded drove 10% year-over-year growth in the second half of last year, it also drove slight sequential growth in the fourth quarter. So the business is holding up relatively well versus analog. And I know that the team seems to have moved past some of the headwinds in this segment as youâve sort of focused investments on selective markets and opportunities, right? Is that refocusing, like helping the near-term trends in embedded? And with all of the restructuring, how do you think about the forward opportunities and growth outlook for embedded over the next few years? Yes, yes. Thanks. Great, great question. Thank you for it. Yes, first I would just say that our efforts having impact, they are. And I would just say that weâre pleased with the progress that weâre making there with embedded. And we believe that progress in those results just need to be measured again over time. So, we continue to work on that business and weâll continue to do that. When we think about the market opportunity for embedded and analog, we think that both of those markets have about the same growth opportunities. So in time the growth rates will converge, though they could be â you could see differences in any given quarter. But longer term, we believe that they can grow at the same rates. So thank you. And Harlan will go to the next caller, please. Thanks a lot. Dave, I had a question about just the analog business generally, both with respect to share and margins. The margins are quite a bit lower than in early 2021 on quite a bit more revenue. I guess, is that all just still supply chain related costs? And do we get that back at some point? And then on share, just in that same point, the share, we donât know what the â all of the calendar fourth quarter looks like, but itâs pretty clear that the share is going to be down about 150 basis points this year, and youâre kind of back to 2012 levels. So I just wonder kind of whatâs going on there? Is there some pricing issue that might explain why that share would be down so much? Thanks, Dave. And then I have a follow up. Let me go ahead and start. Yes, let me address first on your margin question. Analog is a huge portion of the company. So anything youâre seeing in analog is what youâre seeing at the company level. And when it comes to gross profit, weâre very pleased with the results you came in about as expected. And decreases, as we said in the prepared remarks, it decreased primarily due to lower revenue, the transition of LFAB-related cost to a cost of revenue, as well as the cost related to increased investments over the last several quarters that are now flowing through the P&L. And those are long-term investments that are going to position us very well for top-line growth for many, many years to come. And on this, the second part of the question, I think Dave already answered, you go to look at this over a long time, not any one quarter and particularly during choppy times. So, stay tuned on that. Yes, and Iâll just add that I think our approach to building closer relationships with customers has served us well. As you know, weâve moved and taken more of our revenue direct as well as providing services through ti.com. So itâs provided a lot of advantages including, as being better able to see and respond to changes in demand. And you know as customers are reducing their inventories now, we havenât employed any long-term sales agreements or non-cancelable, non-reschedulable contracts, really just focused on customers, and trying to meet their needs and service them well for the long-term. I think all those things has us in a position where we do believe that weâre able to grow the top-line faster over the next few years. And as we talked about, weâll give you some insight into that next week, and how thatâs going to change some of our plan. So was that Timâs follow up, or, you have a follow up, Tim? I do Dave. I do Dave, thanks. So just a comment that autos grow in Q1. Is that a year-over-year comment? Or you expect autos to be up on a Q-on-Q basis, also in Q1? Thanks. Yes. So year-on-year, automotive was up about 30%. And just put that in context from fourth quarter 2019. I just picked that because itâs pre-pandemic levels are â revenues in auto are up in the mid-70%s [ph]. So we continue to see strong growth there. So thatâs the year-on-year. The comment that we made before that it was up mid single-digits it was the sequential comment, Tim. Hi, thank you very much, Dave. Iâll just stay with autos. So itâs interesting data point versus the pre-pandemic. But Iâm just looking at the auto business and the rest of the business everything is decelerating as you would expect, and auto seems to be, if not accelerating, kind of in that high-20%s, 30% range. I just wanted your perspective on, whatâs your sense? Usually all these things are pretty interconnected and maybe itâs a quarter or two quarters before everything going to follows the same cadence. So, weâd just love to get some perspective from you guys on the disparity between autos and the rest of the broader businesses. Yes. Ambrish, thanks. Iâd say that as we â you almost have to go back to the beginning of the pandemic and how revenues behaved as we went through first quarter and into second and third. And if you remember, as the pandemic spread in third quarter, we saw wide and very deep cancellations across all of the markets including automotive. But as we all went home to set up our home offices, we either bought a new monitor or a printer or PC. So very quickly our personal electronics customers came back and came back very strong if you remember. The other markets began to follow, but automotive was the last to respond. And people early in the pandemic werenât shopping for cars, they werenât going out of the house. So they had that issue. And as manufacturers tried to reopen, they had more issues with COVID protocols and working to bring their plans back online. So itâs not too surprising that there as an asynchronously came out. Itâs asynchronously going down. So â but all these markets we believe over the long term will behave the same. And at some point we believe that we will see a correction in automotive. It may not, but we donât â we just donât know. And weâll continue to ship product to customer demand. Itâs obviously very strong. Thereâs lots of reasons why besides us gaining share, thereâs more content, thereâs mix and other factors inside of that. But clearly thereâs inventory built across all markets. Itâs inclusive of automotive. So do you have a follow-up? I did. Just a quick one on the cash grant side of the CHIPS Act. And whatever I have read, it may be incorrect. But my recollection is that in Q1, Q2 timeframe, the government will delineate kind of the guidelines and whatâs your expectation of when that cash starts to come in? Yes. So the CHIPS Act has both an ITC, investment tax credit and grants. So youâre asking about the grants. Weâre still working through those details. We do not have an update to share right now though the applications open in February. So we are actively â weâre going to actively seek funding on those in whatever â for whatever we could qualify. So weâre going to submit our application in February. But right now, we donât have any information to share on that. The â all the accruals that we have taken so far, the 400 million that we have taken are all for the ITC, for the investment tax credit, 25% investment credit for U.S.-based manufacturing. And the timing on that, Rafael, you will let us know about when that flows through the cash flow later on, right? Yes. In fact, let me take a second and kind of walk through how it flows through the financial. So you can actually look at our balance sheet on the Page 4 of our release. The other long-term assets that is up to 1.1 billion. You can see the increase year-on-year, thatâs the 400 â thatâs what a 400 million receivable is for that ITC. If we had not taken the ITC, that $400 million would have gone to property, plant and equipment. So you can see property, plant and equipment $6.9 billion that would have been $7.3 billion. So instead on a long-term asset, a receivable therefore it's not going to depreciate that $400 million doesn't appreciate because it's not part of PP&E, and eventually, we'll get the cash. Now to your question right now, based on our interpretation of the law, we're not going to get that cash until late 2024. And then every year, it will be like one-year in areas, right? You get a kind of one-year late, but that could change. Clearly, that's something that companies are advocating forward to get that cash early. But right now, we're not planning to get that until 2024. So again, that's how you see it on the balance sheet, lower PP&E. You see a receivable instead. Then because of lower PP&E, you have lower depreciation over the life of the asset [ph] and then the receivable because the receivable venture, you get the cash, so it goes from a receivable to the cash line, right? And then eventually, we return it to the owners of the company or use it for other â for the corporate core business. Yes. So yes, so not to add more confusion, but we get the cash through filing the taxes. However, this will not affect the tax rate because the accounting will put that, as I just described, through lower PP&E and you actually see the cash in the cash flow statement in the investing section. But the actual receiving of the cash happens at tax filing time in October or so of September of every year, and we just paid less taxes to that. But again, not to confuse you, the tax rate will not change. Hey guys. Thanks for squeezing me in. You mentioned customers getting inventory lower in the quarter. You're more direct than many of your peers that you have a better, I guess, view into end demand theoretically. And so â can you help us understand are we close to bottoming? Do you think we're getting to healthy levels? And were there particular end markets that saw more acute inventory correction in the short-term? Thank you. Yes. Joshua, maybe just quickly, obviously, when customers begin reducing inventory, its number one quarter phenomenon. It usually takes several quarters for that to happen. We won't have a sight and it obviously will also depend on what happens to their end demand, which we can't predict. And â but yes, we do believe that we get better visibility because we do have more direct relationships with customers overall, so you have a follow on? Yes. Thank you. You know, a lot of attention gets paid to your CapEx for obvious reasons, but R&D grew I think 7% or 8% in 2022 after being flat for a few years. And I think you guys fair or unfair get dinged for under-investing on the R&D lines. So I was wondering could you walk through some of your priorities for that spending and how should we think about R&D into 2023? Recognize it might be a question for next week. Thank you. Sure. No, Iâm happy to address that. So first, these are long-term investments in nature. The R&D, clearly thatâs where we get the, continue to build on the broad portfolio. Thatâs where we have process technology and that we get results over many, many years into the future. And weâre going to protect those investments. But itâs not just R&D, even in SG&A we have areas that are tied to capabilities. TI.com is the best example. Thatâs another place where weâre investing, and thatâs tied to a long-term top line growth of the company to be strengthening the reach of channels advantage, you could add CapEx to that picture. Thatâs also obviously a long-term investment to strengthen our manufacturing and technology advantage. If you look at the, over the last four or five years, our OpEx, so R&D and SG&A, theyâve been at a very steady $3.2 billion for like four or five years. This year for the first time, we picked that up to $3.4 billion. So we went up a little bit as we increased investments. And actually that was an impact on due to inflation, which weâre not immune to that, you can expect that to continue increasing a little bit over the, in 2023 and over the next several years as we continue to increase investments. Thereâs also the inflation component and but big picture, those are great long-term investments that will feel the growth for the company over the next 10 to 15 years. Okay. Thank you, Joshua. And thank you all for joining us. Again, we look forward to sharing with you our capital management update next Thursday, February 2nd, at 10:00 AM Central Time. And a replay of this call will be available shortly on our website. Good evening.
|
EarningCall_1199
|
Good morning, and welcome to the Perseus Mining Investor Webinar and Conference Call. All attendees are in a listen-only mode. [Operator Instructions] Thanks very much, Nathan, and welcome to Perseus Mining's webinar to discuss our December 2022 quarterly report. As in the past, I'm joined on this call by our CFO, Lee-Anne de Bruin, who will be available to answer specific questions as needed later in the call. Now both Lee-Anne and I are joining you this evening from our Yaoure Gold Mine in Cote dâIvoire, where we are currently engaged in our quarterly program of reviewing the operations. Now the Internet and the power supply usually very reliable and sound, but if we go missing partway through the webinar, it will be because of telecommunications problems. And so I'll apologize in advance, but let's hope that that apology is not necessary. And what I plan to do today is, firstly, to provide an overview of what Perseus has achieved operationally during the period ending 31 December 2022, and then follow that up with a Q&A session. I'll keep my presentation as brief as possible with all the details that you need to understand what Perseus has achieved this quarter are fully documented in the market release that was published earlier this morning. But let me highlight a few key points and then we'll discuss the detail if you wish. I'd like to start saying by -- started off by saying how really pleased I am that I'm able to report that in line with the trend that Perseus has gone out for some time now, we've delivered yet another strong gold production and cost performance this quarter, which resulted in the south performing both in our market guidance for gold production and costs in both the December 2022 half year and the full 2022 calendar year. Now for the half year, we produced 268,371 ounces at an all0in site cost of $9.30 per ounce. And in the full calendar year, we produced 521,220 ounces at an all-in site cost of $9:41 per ounce. Now both of these results outstripped out production and cost guidance, as I said. In other words, they were above the top end of the guided production range and below the bottom end of the guided cost range in each case. Now in this regard, I also note that both the Edikan and the Sissingue mines outperformed their guidance ranges, as well, while Yaoure finished the year in the upper half of its guidance range. So a great result, will run. Now as importantly, we continue to deliver on our promises and that's a core value of our company as you well know. Now in the December quarter itself, we produced 130,911 ounces of gold, which is slightly less than our quarterly production record set last quarter, but still a very solid result. Now weighted average all-in site costs for the quarter at $9.83 per ounce was less than the commonly used benchmark of about $1,000 an ounce and being based on a weighted average production cost of $8.81 per ounce, this is a very solid result given the challenges that exist with cost inflation as well as logistics and procurement in the world at the moment. This all-in site cost prices for Perseus towards the bottom end of the global cost curve, a position to which we have not always been able to lay claim. Now like everyone else in the mining industry, Perseus is set to battle hard against the global trend of rising cost. We are managing to keep our costs reasonably in check, but this certainly doesn't happen without effort. And full credit must go to our site teams who are certainly proactively looking for opportunities to reduce costs. The strong performance by Perseus over the last few years continues to demonstrate quite clearly, I think, that the benefit of our corporate strategy of transforming into a multi-mine, multi-jurisdiction company. This approach has enabled us to not only materially increase our production and cash flow, but also reduce volatility through [investors] (ph) by spreading our risk over three operations in two different countries. Our very strong and reliable operating performance is also transformed our business financially in the 2022 calendar year, helped by a strong gold price, which averaged about $1,714 per ounce over the year. Our operating performance generated notional cash flow from operations of $402 million. And after repaying debt, our funding inorganic growth, paying overheads and declaring not only a dividend, but a bonus dividend as well. We ended the year with $405 million or almost AUD600 million of cash and bullion on the balance sheet. Now this represents an increase of about $76 million net cash relative to the end of last quarter, which translates into an increase of about $242 million or AUD324 million year-on-year, and that's about 149% increase. This result clearly set the company up for a very promise -- has clearly set us up for a very promising future. But before discussing that, let's talk in more detail about the immediate past as reported in the quarterly. Now for the past few quarters, our Yaoure mine has been the standout performer. And this quarter, once again, it contributed nearly 50% of our gold production, producing 65,352 ounces of gold at an-all in site cost of $7.98 per ounce, which of itself places Yaoure well down the list in terms of the global cost curve. This amount of gold production was very much in line with our expectations. And while it is less than the previous quarter, the result reflects an expected change in the mining location in the CMA pit to a slightly lower grade mineralized zone. Now all other KPIs at Yaoure were at or above targets, including grade reconciliation where the contained ounces of gold in the ore feed to the mill equaled almost exactly the contained ounces as per the block model. So notwithstanding a slight pullback in production, Yaoure is going extremely well. The Edikan mine, which had a trouble start to 2022, has continued to show the benefits of the turnaround first reported in the September quarter. In the December quarter, Edikan produced 53,850 ounces, about 3% more than the last quarter, and that represented about 40% of our quarterly production. And that took place at an all-in site cost of $1,058 an ounce. So a vast improvement on the cost reported earlier this year and a performance that meant that on a half yearly basis gold production was above market guidance for the mine and all-in site costs were below the guidance range as I said earlier on. The half year, on half year increase in production of 58% was quite pronounced. And I'm very pleased to say that so far this quarter, we're getting similarly strong results at Edikan. So it certainly seems to be getting its straps very well. Now last but not least has been our Sissingue mine. Now we -- where we had another strong performance relative to plan, this quarter. In the December quarter, Sissingue produced 11,709 ounces of gold at an all-in site cost of $16.72 per ounce. Now both of these metrics were slightly better than our expectations at this stage of the mine life, and in fact resulted in Sissingue outperforming the half year market guidance as well. Now in part, this performance, the improved performance is a result of the positive 6% reconciliation in ounces contained in the mill feed relative to our block model, but most other metrics were also very strong relative to the internal targets. Now I should point out that during the September quarter at Sissingue, we processed low grade material from small pits around the main Sissingue pit [indiscernible] being in something of a holding pattern until all in the Fimbiasso east and west pits could be accessed. Now I'm very happy to say that we're now mining higher grade ore from Fimbiasso ease, and this will be -- will we be starting to haul this back to the mill towards into the current quarter. So a step up in the contribution from Sissingue is not very far away. So all in all, it's been another very good quarter for Perseus in terms of gold production and costs on all three sides, as I said. And looking to the future, we expect that this level of performance will continue. So, our market guidance for production and costs for the next half year is 230,000 ounces to 260,000 ounces at an all-in site cost of $1,000 to $1,200 an ounce, which on a full year financial basis translates to something like 498,000 ounces to 528,000 ounces of gold at an all-in site cost of $1,000 to $1,100 per ounce. Now I should also note that in conducting our mining and exploration activities across the company, we have sought to do this in a manner that is in line with the globally recognized sustainability standards that was set out in our fiscal 2022 sustainability report. Now the exact metrics of our ESG performance this quarter are documented fairly clearly in the quarterly report, but I will highlight just a couple of these achievements. In terms of safety, our lost time injury frequency rate across the group reduced from 0.26 to 0.25. The sites combined achieved a safety milestone celebrating something like 1.6 million hours without an LTI for Edikan, 17.2 million hours without an LTI for Sissingue, and more than 2.4 million hours without an LTI for Yaoure. So that was a fairly decent kind of a safety performance. On the social front, Perseusâs significant economic contribution to our host countries of Ghana, Cote d'Ivoire and now Sudan continued and for this quarter it came to about roughly $116 million or about 33% of revenue. Now this included about $99 million paid to local suppliers, representing 80% of our procurement on a purchase order value basis, $9 million paid in salaries and wages to local employees, $7 million in payments to governments, taxes and royalties and other payments and about $1.4 million in social investment. These sums are very important to our host countries, some of which are struggling financially at the moment and we're very proud to be able to continue to contribute in this way. Local and national employment has been maintained at above the 95% -- 90%, 95% of our total workforce. Our agenda balance across the group slightly altered this quarter with female employees reducing from 13% to 12% and consequently male employees increasing from 87% to 88% male. Given the industry in which we operate, but more particularly the cultural orientation of our host countries, these ratios are quite reasonable. To illustrate the point I noted in our corporate office in Australia, the female to male ratio of employees is about 31 to 69. So -- and the senior management team, 40% female, 60% male. So that reflects the cultural orientation of Australia as much as anything as opposed to our African host countries, which have a different approach. We had no environmental incidents of any type during the quarter and in absolute terms our total Scope 1 and Scope 2 greenhouse gas emissions has increased marginally from 0.47 to 0.5, which is not anything to be too concerned about. So on an ESG front, we're performing reasonably well and we remain quite committed to continuing to incrementally improve our ESG performance relative to the internally adopted standards, which, as I said earlier, aligned with internationally accepted standards in the vast majority of cases. Now turning to financial matters. During the quarter, notional cash flow generated was $101 million, which as mentioned earlier meant that for the full year, a total of $402 million of notional cash was generated from the operations. And as I said, after deducting exploration, development costs, corporate overheads, et cetera, with gross cash and bullion on hand at the end of the period was $405 million, that was made up of $361 million of cash U.S. and 24,431 ounces a bullion that was valued at spot at about $44 million. Now as I said, 149% more than at the same time last year. So that represents very, very strong growth in this area. Now during the quarter, we did repay the outstanding balance on a corporate debt facility, so that has left the debt balance at zero. Now you may recall also at the end of the last quarter, at the end of September, we were carrying 93,634 ounces of bullion on hand as a result of some timing issues that we were dealing with. But as has promised [indiscernible] price was fixed at the time of reporting was delivered into forward sales contracts this quarter, reducing gold inventory, but more importantly, boosting our cash balance just as we said it would. Now speaking of gold price hedging, Perseus currently has a mix of designated forward sales contracts and spot deferred contracts covering about 345,000 ounces of gold at a weighted average sale price of $1,906 an ounce. Now this represents about 23% of our production on a three year rolling basis and is important to us as even if the gold price weakens we laid current levels as a result of strong USD or some other fact that Perseusâs projected cash flows are to a large extent underwritten. Now right now, Perseus is generating a lot of cash and its balance sheet is very strong. Pricing is in a position to fund all of our activities, including exploration and the development of new projects such as the Meyas Sand Gold Project in Sudan and the continuation of our dividend policy from existing cash balances that will add any future cash balances. A very nice position to be in. Now speaking of business growth activities, this is another area which we've been very busy and pleasingly productive this quarter. Turning firstly to our latest acquisition, the Meyas Sand Gold Project, which was formally referred to as Block 14 in Sudan. Now as reported last quarter, we had awarded a 100,000 meter drilling program to Capital Drilling, a very highly regarded international drilling company. And during the December quarter, they mobilized site and have started drilling at the site of the Meyas Sand project. Their designated task is to firstly perform infill drilling on the main deposit at Meyas Sand to convert inferred mineral resources into measured and/or indicated mineral resources that we can incorporate into a ore reserve estimate and the mine plan. In addition, they had another local drilling company tasked with performing sterilization drilling to ensure that proposed sites for plant waste dumps and turning stamps are not in [indiscernible] located on top of valuable mineral deposits. During the quarter, we also continued to work closely with Lycopodium, our engineering contract -- contracted to advance the front end engineering and design study. [indiscernible], of course, prepared the definitive feasibility study for the previous owner of the property. So they're very familiar with the project. And of course, having worked with our construction team before on a couple of occasions. They're also very familiar with the exacting standards that Perseus will require when the project is to be built. Now at this stage, it's a case of checking assumptions and incorporating the extensive lessons we have learned from the development and the operation of both the Sissingue in the Yaoure plants, both of which were built by Lycopodium on our behalf. And both of which are running very, very well, I might add. And very importantly, the other task that needs to be done is to confirm the capital budget. Now as part of the FEED study, we've also completed confirmatory pressure testing of the water aquifer in Area 5 that will ultimately supply water for the Meyas Sand operation when it's up and running. Once again, the contract is used for this exercise, AGE Hydrology have a lot of experience in Sudan. And based on the results we've seen to date, we expect that it will be confirmed that the aquifer has more than enough capacity to satisfy all of our water requirements for the entire life of the Meyas Sand gold mine, as well as to satisfy a number of community projects that we're currently considering. Aside from the above, there is a lot of work happening on the ground in Sudan in preparation for an influx of a large number of workers to the Meyas Sand site once construction starts. Things are tracking very well in this regard at the moment and we are grateful for the terrific support of our project that we're receiving from key ministers and the departments within the Sudanese government. Now given the above, we're currently targeting taking a financial investment -- a final investment decision on the development of the Meyas Sand project in the second half of this year, most likely early in the third quarter. Now in terms of funding the development project, we expect to be able to fund the entire capital cost of development from existing cash balances available at the end of the current quarter. So this assumes that our earlier cost estimate of something in the order of $45 million to develop the mine is confirmed by our current FEED study. Notwithstanding a strong cash balance, we are investigating several debt financing options. And if we proceed with one of them, we'll be able to not only fully fund the development of the Meyas Sand Gold Project, but we'll also have significant capacity to pursue other growth opportunity should they come along. I have to say that, ownership of the Meyas Sand Gold Project gives Perseus a distinct first mover advantage in to them, a country endowed with enormous mineral wealth and one that is keen to welcome foreign investment. And I'm pleased to say that several other exploration, pre development opportunities are starting to emerge as a result of our presence on the ground. Itâs much too early to be talking about any project beyond Meyas Sand Gold Project at this stage, given that rich mineral [indiscernible] it's not difficult to envisage that Perseus is operating footprint in today and could expand the fullness of time. And we're very well positioned to make that happen. Now, while on the subject, [indiscernible], I should say that Perseus does not take sides in political debates in our host countries, but we are greatly encouraged by recent moves in Sudan to bring together all sides of politics to reach a court and a mechanism for guiding the country forward in a peaceful and stable manner. Now whether this results in the civilian led government and peaceful democratic elections within a couple of years will be evident very shortly. In fact, I was reading today that I think that might be the case in early February. But from all the appearances, the goal certainly appears to be within reach, which is good for all stakeholders, including the citizens of Sudan and of course Perseus. Now moving on to other organic growth initiatives. As announced recently, we have through exploration success close to our existing infrastructure made pleasing progress towards being able to sustain our targeted production of 500,000 ounces plus of gold per year towards the end of the decade without taking into account any M&A or greenfield development activities that might come our way. Following the end of the quarter, we issued a market release detailing the results of ongoing exploration during the quarter to date at Yaoure gold mine where drilling has returned high grade gold results from the CMA Northwest and CMA North targets down dip from the recently announced underground ore reserves. And what this does? It demonstrates that there is really significant potential for further underground resources growth, which will lay to the development of an underground mine here at Yaoure. Now in Ghana, following the release last quarter of an indicated mineral resources in Kasoa, as well as completion of a feasibility study on the project resulting in a probable ore reserve of about -- containing about 332 ounces of gold. We've recently applied to the Ghanaian Minerals Commission to the land covered by Agyakusu exploration license that hosts the Agyakusu deposit to be incorporated into our mining lease. Now last week Ghana had very encouraging discussions with the authorities that should result in that expanded mining license being issued fairly shortly, which will allow us to upgrade our life of mine plan to include an operation involving trucking ore from Agyakusu to the Edikan plant for processing. During the quarter, we also exercised options to buy the Agyakusu DML and Domenase exploration licenses. The transfer of these licenses into Perseus' name has received ministerial approval and the transfer process should be completed within days if it hasn't already happened actually. This will enable us to start drilling three more exploration targets that have been identified on our land package near Edikan. And if they live up to the potential shown or even one or two of them, this could provide further extensions of the life of Edikan operation. Now having recently invested time and money in turning the Edikan operation around, being able to extend the Edikan mine life has a lot of merit in terms of upgrading the quality of our asset portfolio. So in conclusion, as I said at the start of the call, each of the December 2022 quarter, half year and full calendar year has been outstanding for Perseus in all fronts, including gold production, all-in site costs, cash flow generation and business development. And pleasingly, the switch being conducted in a safe and sustainable manner in line with our targeted standards. We have delivered gold production and all-in site cost thatâs comfortably beaten their half year and full year market guidance. And in doing so, we've outperformed a lot of our peer growth. Our all-in site costs are currently very competitive in terms of our global peers and we are managing our business successfully in a tough economic environment with excellent growth potential in front of us in the form of the Meyas Sand Gold Project and from the exploration successes that we're cropping up adjacent to existing infrastructure at our mines. We're traveling pretty well. But I guess as importantly in this respect, we've got the human capacity and its existing financial means to successfully execute and unlock the value as we've demonstrated several times in the past. In an equity market since our share price is holding up well and we're performing recently strongly relative to our market peers. In fact, I think that in terms of market cap, we're now Australia's fourth largest listed gold producer and we present a very viable alternative to investors seeking to invest in high quality gold stocks. Before concluding, I do want to acknowledge the contribution made to the success of Perseus over the last 12 months by all of the men and women in four countries that make up the Perseus team. They've done an outstanding job, and I'm very fortunate that I'm my current round of side business, as I said, the start of the Cote dâIvoire currently on-site at Yaoure. I've had the opportunity to thank them all personally for their great efforts in delivering on our promises. Okay. Thank you very much for your attention today. This brings my presentation to a close, and now we're available, Lee-Anne and I are available to take any questions that you might have. Thank you, Jeff. [Operator Instructions] Your first question comes from Reg Spencer at Canaccord. Go ahead, Reg. You're on mute Reg. That's much better. Thanks, Nathan. Good morning, Jeff and Lee-Anne. Just a couple of questions from me. FID from Meyas Sand or Block 14, as it was formerly known. When might we expect some updated metrics, be that CapEx or OpEx for that project? Will that be ahead of FID, noting that there still does appear to be some relatively strong inflation or industry inflation around at the moment? And then as part of that question, how acute might those pressures be in Africa versus somewhere like Australia do you think? Well, let me say this. Look, that's the estimate that I've mentioned of the $450 million, it is $130 million more than the capital cost estimated by the previous owners. So in coming up with that estimate, we've already factored in quite significant cost inflation on the basis of shipping costs and logistic costs, in particular steel costs that we were seeing about six months ago, now some of those cost pressures have actually abated. So we're very confident that that number will come in around that level, it's not below. So we'll have to wait and see. But as to the timing of the release of that information, Reg, I can't say to you today precisely where it will be. But it will be when we're comfortable with those numbers and we're confident that we know exactly where we're tracking. Great. Thanks, Jeff. And just over at [Fimbi] (ph), I hope you have finally some programs into Bagoe. Can you just remind me of what the rough grade profile might look like at Fimbiasso until you get into Bagoe? Is there any change from the previous life of mine plan or should we just stick to what was in there previously? Yes. No, it's no changes to the grades that we reported in the past. I mean, I think the average over the next couple of years of gold production [indiscernible] I think it's 72,000 ounces a year on average. One of those years is quite a bit better than that and one of it's a little bit lower. But I think that what we've given the market today is what we're expecting to see. Okay. Well, thanks very much. I have played the lack of questions means that we've answered all of your thoughts. It has been a good quarter. As I said, we are very pleased with the way things are tracking and certainly this quarter is delivering more of the same. So we are in a fairly healthy place right now and we're certainly looking forward to bringing further updates during the course of the quarter to you as news comes to hand. But anyway, we are in a very strong position and we want to thank our shareholders very much for the support that they've given us over a long period of time. It is certainly starting to pay off. Anyway, thank you very much. We'll talk again in a few months' time.
|
Subsets and Splits
No community queries yet
The top public SQL queries from the community will appear here once available.